We selected CYD because it’s one of the select few that fits our model! Our goal is to select, purchase and monitor companies in an effort of gaining outstanding performing investments while minimizing risk for our clients. We will cover part of our review and selection process as well as explain why CYD has currently become one of our selections.
China Yuchai has an excellent reputation among vehicle manufacturers and customers for performance, reliability and customer service, earning Chinese Brand of the Year 2008.
They have a diversified product line of engines that are used in everything from passenger cars to large buses and from marine to generators. They have been quoted as “The Cummins Engine” of China, with an outstanding brand name and exceptional reputation for reliability and service.
China Yuchai International has built a rock solid balance sheet, delivered great quarters and has become extremely well positioned in a very desirable, almost monopolistic industry. Additionally, CYD has an extremely low valuation for it’s enterprise.
Step 1 – We first search for companies with pristine balance sheets.
China Yuchai International has $535.7 million in cash. Minus their debt of $129.5 million, this gives them a total of $10.67 cash per share. They have an enterprise value, where there’s over $2 billion in sales, of only $235 million, or just $6.33 per share (this enterprise value does not include the hidden $2 of value, which we will discuss later). This is an outstandingly strong, low balance sheet for such a large manufacturer.
Step 2 – We like extremely low values.
China Yuchai International is one of the lowest value companies that we have identified.
The enterprise value per share is only $6.33, but last quarter’s profits was $1.07 per share — that gives CYD a yearly earning potential of around $4, giving them a future PE of around $4.25. If you take the cash out like some buyouts do, it’s only about 1.58 times enterprise profits.
CYD’s last quarter sales was $742 million, or just under $20 per share, which gives CYD a stock sales value of only 8 cents per share. The last quarter sales of $742 was about three times the entire enterprise value of $235.
Last year, CYD increased cash by $416 million (mostly through improved accounting, which we will touch on later in Step 3). Again, cash improvement was almost double the value of the underlying enterprise asset that created the cash improvement.
We believe China Yuchai International Limited (CYD) should be compared to Cummings Inc. (CMI):
|Cash minus debt per share||$10.76||$1.34|
|Enterprise value per share||6.33||70.6|
|Sales per share||60.05||54.78|
|Sales per share||0.08||1.28|
|Last Qtr profit per share||1.07||0.75|
|Price||CYD 16.30 [ -0.06 ]||CMI 64.24 [ -0.58 ]|
The value of CYD is about 80% below CMI.
Step 3 – Is the operation or enterprise driving value to their shareholders?
CYD had Year-over-Year growth of:
- 72.2% in revenues.
- 3.7% in gross margins.
- 345.6% in operational profits.
Here are some of their major improvements:
1. Partnership with Caterpillar.
The 49-51% respectively joint venture between Caterpillar-Yuchai with initial funding of $20 million. In addition, they also partnered with Jirui United Heavy Industry.
2. New CEO.
In August of 2009, the board appointed a new President with significant experience in the industry having a background with Cummins.
3. New Accounting.
Their change in auditors from KPMG, Hong Kong, to KPMG, Singapore, led to a dispute, and then they moved again in March 2009 to Ernst & Young LLP, Singapore, with a new CFO. They seem to have finally gained great improvements in their accounting, because the cash gained from improved inventory and billing has been simply superb.
4. Paid Dividend.
CYD re-initiated .25 cents per share in the first quarter, while still growing cash during the same time period.
5. New Generation of Products for a Green-er Future.
They have developed a diesel-electric hybrid system, and that is the first innovation in China for an urban bus power market.
A diesel-natural gas hybrid is also being developed for buses in metropolitan areas given them more flexibility than a natural gas system.
Step 4 – Is this a good business?
Very much so, yes.
This is a very valuable and almost a monopolistic market judged by Cummins’ success. There are large barriers to entry and few global competitors. The cost to design, source the parts, build a factory that will build the engines, find chaises companies or services companies, like Caterpillar, and the need of proper logistics to help supply all of the services on time, altogether make this a very difficult industry to enter. Even though there are only a few real world competitors, this is a needed and growing market.
Since the diesel engine is much more efficient than a similar horsepower gas engine, the cost to run, maintain, fuel and service diesel engines are lower — not to mention the environmental improvement. The fact is that the diesel engine markets should continue to grow. When adding the additional hybrid capabilities to the more advanced diesel efficiencies, you can understand why so many car manufacturers are launching more new efficient categories in Europe.
The Obama administration has directed the U.S. Environmental Protection Agency and the National Highway Traffic Safety Administration to set the first-ever national mileage requirements for medium- and heavy-duty vehicles beginning with the 2014 model year. That will help increase the need for newer, better run engines, possibly hybrid engines, and thus increase the values of top of the line engine producers.
CYD is a company listed on the NYSE with over $2 billion in revenues and we couldn’t find a single reporting analyst that covers the company. This is the largest company, we could identify, that basically has no coverage. The lack of coverage could help to explain why, with billions in sales, CYD has such a remarkably low enterprise value.
2 dollars of hidden value per share not included in peer valuations.
CYD owns 46.4% of HL Global Enterprises Limited (HLGE). This company has about a $96 million market cap, giving CYD an additional prorated value of about $1.18 per share.
CYD also owns 13.4% of Thakral Corporation Limited (THAK.SI). This company has about a $222 million market cap, giving CYD an additional prorated value of about 79 cents per share.
These two companies, HL Global and Thakral, aren’t considered part of CYD’s core business. We haven’t included them in our valuations to peers below (even though their stock is trading in very liquid markets). One must realize that these two values added together equal about 11% of CYD’s current stock market value.
Step 5 – Is the Train Wreck and then the fog from the Wreck clearing?
When finding companies with a negative enterprise, or in this case extremely low enterprise values, often a “Train Wreck” is needed to drive value close to cash. We identified 4 major issues that has kept the value so low:
1. Accounting mess/nightmare.
3. China company.
4. Inside control using “golden shares”.
The accounting now has it’s third outside auditing firm and a new CFO. The SEC has just settled all accounting issues with CYD with no monetary penalty, nor have fines been imposed or any individual in connection with the SEC settlement. This officially ends the accounting issue, and, judged by no fines or penalties, it appears the SEC found nothing egregiously wrong — nor with CYD showing great execution and cash management over the last few quarters, including resumed:
- Current filings.
- Quarterly conferences.
Even though many thought that the management as a whole was under-performing, we believe the weakness was financial management more than with the operations. With their outstanding improvement and execution in profits, sales, margins and cash in a globally rough economy, it appears that their management for the last three quarters have outperformed most, if not all, of their peers and made management a strength, not a weakness.
Yuchai has been the number one diesel engine maker in China for almost a decade with an above average growth rate. The year-over-year revenues have gown at over 70%, with an increase exceeding 60% in unit volume. These statistics also help point out that the value per earning is improving along with the volumes.
CYD is based in China with Bermuda as it’s official headquarters. We often see China based companies trading at a 25% discount to their American peers, but we can’t identify why CYD is trading at about an 80% discount to Cummins (CMI) and other companies in it’s field including Chinese based companies.
Over 26% of CYD common shares are controlled by the Kwek family of Singapore through their holding company, Hong Leong Asia (H22.SI). Their stake is a “golden share”, which affords them veto power over common shareholder votes. The ownership structure is similar to many B shares in the United States and gives the Kwek family a higher level of control. Hopefully, the Kwek family will give up their control if the right offer comes in. With that said, this issue has not been resolved and should still hold values down some.
We enjoy companies that can provide outstanding short term execution — turning weaknesses into real strengths, while at the same time bringing down the costs to increase cash flow substantially and attempt to greatly enhance both their growth prospects and business model position with many new green-er solutions driving their future success.
We believe CYD has value, execution and a balance sheet like those past companies that fit our model (e.g. TBBK, OIIM, SONS, SGI, LAB, DIVX,KHD, HCII and WCG). So, we’re hopeful that CYD will have a similar outcome knowing other companies that fit this model have performed well. They have completed excellent quarters and have already attained growth of assets.
We have provided some ratios to help value CYD:
|Peer Valuation CMI CYD Industry Sector||S&P 500|
P/E Ratio 26.24 4.25 19.82 22.91 19.25
1. Revenue Based.
When trying to base the value of the enterprise, knowing CYD stock price is based with about 60% cash, the underlying enterprise value disparity greatly increases. If you want to compare CYD to it’s peers in sales values, assuming CYD will achieve about $3 billion in revenues, you get a per share value of $107.32 (their current run rate times the lowest “sector” quoted peer, price to sales for the industry of $1.38) — plus the $10.67 of cash, you get a combined value of $117.99 per share.
2. Earnings Based.
Again, using the “industry” quoted lowest value of it’s peers, with a run rate of $4 a share, times the $19.82 industry peer PE, this gives a value of $79.28 a share — plus the $10.67 cash, this places earnings at $89.95.
3. Return on Buyout.
Since past buyouts have been able to strip out the cash, as occurred in the DivX merger, with the enterprise valued at $6.33 and the CYD enterprise being able to generate around $4, that’s about a 63% return without taking advantage of any merger cost savings due to duplication or redundancies that would be removed by the acquiring firm. Plus, for added return, it would be easier for a purchasing firm to just sell the $2 in stock CYD owns that is listed on other world exchanges. In today’s low interest environment, we believe many of these low or negative enterprise companies could provide very high returns and a platform of profit growth, especially for acquiring firms.
We believe simply that CYD is trading at about an 80% discount to many of it’s American based peers and well below most Chinese companies in their field. We find CYD’s valuation surprisingly low, with the belief that they have both a very solid business and franchise and that their improvement in cash and earnings have been outstanding.
Durig Capital owns CYD for itself, clients and related client accounts. When we published this article the stock was $16.56 per share.
Financial Investment Advisor
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