Warren Buffett's BYD Down (A Lot) But Not Out

Author's Avatar
Mar 27, 2012
Things weren’t always so bad for BYD Co. Ltd. (1211:HKG, Financial). The company at one point so passed Warren Buffett’s rigorous selection process that he bought 10% of it. Yet after several disappointing quarters, on Monday it issued a profit warning with the grim news that investors should expect a 65% to 95% drop in first-quarter net profit. But Buffett has yet to lose on the stock and the company still appears to have great potential.

BYD Co. Ltd. began as a supplier of rechargeable batteries, and quickly grew to become the largest company of its kind in the world. Along the way, it created the wholly owned subsidiary BYD auto in 2003 after acquiring Qinchuan Automobile Company and began selling the world’s first mass-produced plug-in hybrid vehicle, the BYD F3DM. The BYD F3DM was a game-changer. It had a range of 100 km (62 miles) on battery power alone and a top speed 160 kph (99mph). It came out three years before the GM Volt and had the advantage of close association with a battery maker. BYD began selling the car on Dec. 15, 2008, for 149,800 yuan (about $21,900).

It was about this time that Warren Buffett took notice. Through his subsidiary MidAmerican Energy, he bought 225 million shares of the company for HK$1.8 billion ($230 million or $1.02 per share) on Sept. 30, 2008, representing a 4.76% discount to its closing price of HK$8.4 the previous Friday, according to the Financial Times. The news precipitated a 42 percent increase in the stock that Monday.

Then-chairman and chief executive of MidAmerican, David Sokol, said, “BYD is at the cutting edge of battery technology and we believe electric vehicles are ultimately where all technologies will go.”

Later it came to light that Buffett’s partner, Charlie Munger, who Warren Buffett has described as “encyclopedic about almost everything,” was a driver of the BYD investment. Munger, on a Fox Business interview in May 2009, insisted that the numbers were what really convinced Buffett to invest in a company he didn’t thoroughly understand. “What BYD has already done is ridiculously difficult to do, and they’ve done it anyway, so, it’s a very remarkable company and Warren could see that from the numbers,” Munger said.

The numbers Charlie referred to in 2008 showed a growing company. Its gross profit had increased from $1.7 billion RMB in 2004 to $5.2 billion in 2008. Total assets had also increased from $8.7 billion RMB to $32.9 billion RMB in the same span of time, and automobiles accounted for 32% of product turnover in 2008, compared to 23% in 2007. BYD’s annual report touted the launch of the F3DM as an event that “fully addressed the highly concerned global warming environmental issues of the world, new energy and environmental friendly electric automobiles will also be the global trend in future.”

As far as sales, the company sold only 48 F3DM plug-ins to government agencies and corporations in China from Dec. 14, 2008 to its first year on the market. From when the model went on sale to the general public in Shenzhen in March 2010 to the end of the year, it sold only 417 units. By October 2011, it had sold 1000 of that model. Overall in 2010, it sold 519,800 cars, making it the sixth largest Chinese car maker by sales, with an estimated production capacity of 700,000 units per year.

Sales continue to be a problem at the company. In 2011 BYD sold 437,000 vehicles, 13.3% fewer than the previous year. Offerings now include an SUV-S6, a medium-to-high-end sedan G6 and the group’s first all electric e6. In September 2011, it had sold 300 e6 taxis in Shenzhen and introduced an all-electric K9 bus, selling 200 and 250 e6 taxis to the 26th Summer Universiade.

The stock price has also imploded 40% in 2010 and 51.2% in 2011, along with earnings per share, which fell from RMB1.11 in 2010 to RMB0.60 in 2011. But the worst news came on March 25, 2011, when the company warned that net profit for the first quarter is estimated to fall another 65 to 95%. In a statement, BYD cited problems in the solar business under the rechargeable battery business as the reason for the decline, saying that the automobile and handset components and assembly business would remain equivalent to the previous year.

There are still positive sides to the business and potentially for Buffett’s investment. First, the drop in profit stems from its solar segment, rather than vehicle sales. Further, it expects car sales to grow over 10% in 2012 as it launches new car models. U.S. sales will probably help. The company just opened a U.S. headquarters in Los Angeles in October 2011, with Charlie Munger in attendance. All fleet sales for North America will be based in the new headquarters, and the e6 should begin selling there in 2012. The company is also busy upgrading existing models and introducing new ones, accelerating the industrialization pace of electronic vehicles and exploring overseas markets.

Finally, Buffett bought his BYD stake at approximately $1 per share, meaning things for the company would have to get much worse for the stock to go below his purchase price. The stock closed on Tuesday near $3 per share after going up 20% year to date, placing him near a 150% profit. At this point it seems unlikely he can lose.

See more of Warren Buffett’s stock picks here. Also check out the Undervalued Stocks, Top Growth Companies, and High Yield stocks of Warren Buffett.