China-based SORL Auto Parts (SORL, Financial) reported 37% sales growth to $73.9 million and an impressive 442.8% profit growth to $7.7 million – a 10.5% margin in the first quarter vs. 2.6% in first-quarter 2016.
As observed, SORL recorded a 17.8% decline in overall operating expenses, which helped further bolster the company’s bottom line.
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"We are pleased to announce another quarter of robust performance as we posted growth in all lines of our business and achieved margin expansions from top to bottom. Since the Chinese government introduced rigorous regulations on overloading in the truck market to reduce emissions and improve safety, we have been gaining market share with our advanced new products and superior performance. On the cost side, we continued to exceed our goals due to significantly improved economy of scale, strengthened receivables collections and better-than-expected cost control results."Â –Â Xiaoping Zhang, SORL's CEO and chairman
Outlook
For the fiscal year 2017, SORL management has increased annual guidance of net sales to $315 million and net income to $27.5 million. SORL would deliver 16% sales growth and 29% net income growth when compared to its fiscal 2016 operations.
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"We continue to roll out new advanced braking products which immediately gain traction in the market due to their enhanced performance, added features and improved reliability. We have implemented stricter cost controls, purchased more advanced machinery and moved into new facilities to improve our efficiency and increase our profitability."Â – Jinrui Yu, chief operating officer
SORL shares jumped 29% to a five-year high post earnings release.
Valuations
Despite the half-decade share price highs, SORL is markedly undervalued compared to its peers. According to Reuters data, SORL had a trailing price-earnings (P/E) ratio of 6 times vs. a 24.5 times industry figure, a price-book (P/B) value of 0.8 times vs. 2.5 times and a price-sales (P/S) ratio of 0.4 times vs. 2.9 times.
SORL has not provided any dividends in the past decade.
Average 2017 sales and earnings-per-share expectations indicated forward multiples of 0.4 times and 6.4 times.
Total returns
SORL delivered enormous returns to its shareholders in the past year with 256.4% total gains vs. S&P 500’s 18.7% total gains. In the past five years, SORL still underperformed the broader market with 14.3% total gains vs. 15.05%.
SORL Auto Parts
According to filings, SORL Auto Parts was incorporated on March 24, 1982.
Through SORL’s 90% ownership of the Ruili Group Ruian Auto Parts Co., SORL Auto Parts develops, manufactures and distributes automotive brake systems and other key safety-related auto parts to automotive original equipment manufacturers and the related aftermarket both in China and abroad.
Further, SORL’s products are used in different types of commercial vehicles, such as trucks and buses. Automotive brake systems and other key safety-related auto parts are critical components that ensure driving safety.
Also, SORL believes it is the largest manufacturer of automotive brake systems in China for commercial vehicles such as trucks and buses.
The company operated in two reportable business segments: commercial vehicles brake systems and passenger vehicles brake systems.
In first-quarter sales SORL’s Commercial vehicles brake systems grew by 37.7% to $60.7 million, which was 82% of total company sales, and delivered gross margins of 27% –Â similar profitability as the same period a year earlier.
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Our high quality, low cost products continued to generate higher sales and further penetrated into the commercial vehicle market, which impacted the sales of the commercial vehicle brake systems. – SORL 10-Q
In the recent quarter, sales in the passenger vehicles brake systems grew by an outstanding 35.5% to $13.2 million and delivered a gross margin of 31.4% vs. 25.4% in the first quarter of 2016.
On three-year averages, SORL had a sales growth figure of 9.3%, a profit growth figure of 27.1% and a profit margin figure of 6.3% (Morningstar data).
Cash, debt and book value
As of March SORL had $11.5 million in cash and cash equivalents and $48.9 million in debt with debt-equity ratio of 0.29 times vs. 0.17 times in December. As observed, SORL added almost twice its short-term bank loans to $21.5 million in the recent quarter compared to previous.
Intangible assets were negligible in SORL’s assets while having a book value of $171 million vs. $162 million in the previous quarter.
Cash flow
Despite impressive profitability, SORL’s cash flow from operations were -$3.5 million in the first quarter. As observed, SORL logged significant cash outflows in its inventories and accounts payables in the recent quarter.
Capital expenditures were $14.3 million leaving SORL with -$17.8 million in free cash outflow vs. -$1.7 million free cash outflow in first-quarter 2016. As mentioned earlier, the company also took in $21.2 million in debt in the recent quarter.
Conclusion
SORL seemed to be a valuable pick in terms of having exposure in the China automotive market: admirable balance sheet, solid business growth (despite a perceived slowdown domestically and internationally), very cheap valuations and more importantly a confident expectation of continuous growth headed into this fiscal year.
Some of the things that could deter a prospecting investor were that SORL’s current valuations – the 6 times earnings multiple and low sales multiple –Â have been at par of what the company has had in recent years on average. This means that the recent highs could only mean that investor (market) attention has already peaked and a little hiccup (weak growth deliverance in the succeeding quarters) could bring SORL’s share price down –Â which would just mean only great opportunities to accumulate the company for a suitable long-term investment.
Meanwhile, an analyst that covers SORL had a price target of $6 per share –Â 2.4% upside from a share price of $5.97 (at the time of writing). Applying three-year average sales growth and multiples followed by asking a 20% margin would indicate $3 per share –Â this just shows how the market has not appreciated SORL’s impressive operations in recent years but has began to recognize it more recently.
Nonetheless, given the recent very, very strong runup in share price, SORL would be a hold.
Disclosure: I do not have shares in the company mentioned.
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