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BYD's Plunge Equals Compelling Opportunity

June 07, 2012 | About:
Whenever Warren Buffett is bullish on something, we should take keen notice. Especially if it's reinforced by confidence from Charlie Munger, who only considers buying great business. At the peak of the financial crisis, Berkshire Hathaway (BRK.A)(BRK.B) poured more than $200 million into Chinese battery and automobiles manufacturer, BYD (BYDDF.HK), via its controlled subsidiary, MidAmerican Energy. This purchase was said to be influenced by Charlie Munger, introduced by a Chinese-origin fund manager who manages Munger's money, Li Lu. Charlie Munger once stated that his family holds a “little more” than half of the fund with the BYD investment.

In the first quarterly report of 2012, BYD has reported large decline in its profit comparing to the same quarter last year. Diluted earnings per share decreased nearly 92% of the previous quarter diluted EPS. Thus, the share price lost more than 42%, from $3.32 per share in the beginning of February 2012 to $1.9 now.

Correspondingly, in the Hong Kong Stock Exchange, BYD dropped from HK$26 to HK$15. The current price of HK$15 is only around 17% of its top price of HK$85.5 in October 2010.

Despite the severe fall in its profit, BYD posted the comparable revenue and operating cash flow along with its previous period. But the company experienced higher business tax and surcharge, financial expenses and impairments losses of assets. Several notable changes for those three items are disclosed in this quarterly reports:

  • Business tax and additional expenses during the reporting period increased 93.35% as compared with the corresponding period last year mainly due to the increase in the provision for the sales tax

  • Finance expenses during the reporting period increased 54.37% as compared with the corresponding period last year mainly due to increase in the financial interest during the reporting period

  • Impairment loss of the assets during the reporting period increased 1302.49% as compared with the corresponding period last year mainly due to the increase in allowance provided for drop in inventory price


So subjectively, I think the fall in its profit of this quarter is very temporary. And it's the market factor which makes the company increase allowance for the drop in its inventory price.

Over the long run, Berkshire Hathaway's investment can be considered a bet mainly on its lieutenant, Wang ChuanFu. Munger has commented that Wang ChuanFu is “a combination of Thomas Edison and Jack Welch — something like Edison in solving technical problems, and something like Welch in getting done what he needs to do.”

Li Lu has mentioned about Wang ChuanFu in his 2010 lecture in Columbia University: “He got into battery manufacturing in that particular way because he really had no other option. He had no money, he only had $300,000 in venture capital funding before IPO and that was it. He raised money in an IPO and Buffett gave him $200M, now they have 160,000 employees. $6-7B in revenues, $500M in net profit. It is amazing. So he has this ability to adapt in a competitive environment. He has demonstrated that ability again and again. The way he does automation is far cheaper than anyone else and more reliable. He continues to surprise me with his ingenuity, to figure out ways to do something better than everyone else. What he is currently doing is very different than what everyone else has done. At the end of the day, you might look at what he has done.”

With the current drop in its current market price, investors might consider this to be the opportunity to accumulate the shares, even with the current challenges and critics that the company is facing right now. Last but not least, investors might be better off buying Charlie Munger's view: “My experience with great companies that have a little glitch is they come out stronger. “

Disclosure: Long BYD

About the author:

Anh Hoang
Money manager into global equities, especially with US and Vietnam markets. CFA level 3 candidate. Lecturer for Stalla - CFA course in Vietnam

Visit Anh Hoang's Website


Rating: 3.0/5 (14 votes)

Comments

LwC
LwC - 2 years ago
IMO this looks like speculation on price action, not "intelligent investment."

The author provides no real clarity about the company's financials and makes no mention of the problems that BYD has with their battery technology. Also, a NYT article about BYD a few days ago pointed out that BYD unit sales in China are down something like 40%, and that interviews with Chinese auto consumers reveal that many consider BYD product to be of inferior quality and therefore they prefer to buy other manufacturers' vehicles. The death of several riders from a fire in a BYD electric taxi involved in an accident a couple of weeks ago received wide attention in the Chinese press and did nothing to enhance the desirability of the BYD vehicle.

The NYT article also pointed out that BYD has apparently decided to abandoned it's all-electric car strategy for a hybrid technology that is still being developed (or stolen; oh, I mean reverse engineered). They will have to compete with the likes of Toyota Prius in the Chinese market. Good luck with that.

It appears that the only reason the author gives for recommending the BYD shares is that Munger and Buffett fell for the hype, and since the shares have traded down it must therefore be a good investment. Part of the hype at the time of the BRK investment was that BYD would market an electric vehicle in the US in about two years, and of course we all know that it didn't happen. My guess is that the prospect of that happening any time soon is probably about nil.

Good luck.

ken_hoang
Ken_hoang - 2 years ago
Hi,

I would be very interested to see the NYT times stating the recent 40% in sales in China? It must be recently right? Pls provide me with the link so that I can read it further.

Munger has invested with BYD since it hasn't got car manufacturing business, only lithium batteries. If Berkshire invested and looking for the expansion into the US market within two years, then the time horizon of our two legendary investors were very very short.

LwC
LwC - 2 years ago
Sorry that I can't help you with a link to the NYT article since I read the newsprint version. Yes it was just a few days ago.
mr19667
Mr19667 premium member - 2 years ago


Hi Anh Hoang

One thing that was not mentioned in your article is confirmation, backed up by a source, of the cost of BRK's investment in BYD. Do you know at what price they got in at? I imagine it was significantly less than the recent close of approx HK$ 15.4 but it would be interesting to know for certain.

ken_hoang
Ken_hoang - 2 years ago
LwC: not sure when you know the article, that we can search for the related news online?

@Mr: In the CNBC report, it's : "Buffett's investment of about $230 million in 2009 for 225 million shares put BYD on the global map. The 9.6 percent stake was valued at as much as $2.47 billion in 2009 when the stock peaked at HK$85.5, but is now worth just $564 million." (_http://www.cnbc.com/id/46852197/BYD_Seeks_to_Soothe_Investors_After_Profit_Warning)

So Buffett pays $230 million for 9.6% of the stake, so at that time the market capitalization is around $2.34 billion, converting to HKD at 0.1288, it's around HK$18.5 billion. At the current market price, google finance shows that the current market cap is HK$36.25 billion.
Cornelius Chan
Cornelius Chan - 2 years ago
'I would be very interested to see the NYT times stating the recent 40% in sales in China?"

NYT link here

rollingstone0329
Rollingstone0329 - 2 years ago
Thanks for the link.

The article does not mention a 40% slide in sales. It does mention a decline of 43% in stock price.

A better source are the annual reports dating back to 2004. YoY sales were slightly down from 2010 to 2011, but what caught my eye was the 20% decline in gross profit, the first time BYD recorded a decline as well as the first time its sales didn't manage to increase in the data series (since 2004).

This is backward looking. At the moment, their plan is to extend into the hybrid market, but this may mean spending more, so perhaps their cost of sales will have to increase further for the time being.

Their main competitive advantage is low cost using "process innovation". What this means is that they use cheap labor to assemble instead of using machines.

How long can this last remains to be seen. It would be great if Li Lu or CTM gave a lecture, just to hear their thoughts. They are probably thinking super long term.

Think Japanese cars when they just entered the world market. I think they were unreliable.

Then Korean cars entered the markets, and they are catching up or have already caught up to their Japanese counterparts (only in the last few years; Korean cars a decade ago were terrible or so some taxi drivers have told me). Now, Chinese vehicles are behind the technology curve, but that too will change in time as they adapt.

With hardcore extreme leadership, it will happen in time.

LwC
LwC - 2 years ago
Thanks for the correction Rollingstone0329. Unfortunately I was working from memory because I had discarded the paper. Regardless of that mistake, IMO my skepticism about BYD is well found.

Good luck.

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