Wheel could be turning again for Weichai
For the adventurous investor, the truck engine maker is back in the driving seat, says Henry Chan
The heavy truck industry in China is highly correlated with economic growth and is closely related to the property development, infrastructure and transport sectors. Demand for heavy trucks often exhibits clear industry cycles, accelerating for a few years and then decelerating; in extreme cases, demand even shrinks for a year or two.
The industry is dominated by a handful of manufacturers - Dongfeng, First Auto Works (FAW), China Heavy Duty Truck Group (CHDTG), Shaanxi Heavy Duty, Futian, Hongyan and North Benz. There are three categories of products - heavy trucks, tractors and chassis. Each has roughly comparable volumes and they all have diesel engines.
Most heavy trucks made by Dongfeng and FAW have smaller loads of eight tonnes, while the other manufacturers headed by CHDTG and Shaanxi make 'really heavy trucks' with loads of 15 tonnes or above. The 'really heavy truck' industry is dominated by two camps - the mighty CHDTG, and Shaanxi and its smaller peers. Shaanxi, Futian and their peers get their engines from Weichai Power, who holds about half of the really heavy truck engine market.
Wheel loaders, diesel-powered vehicles used to move mud and sand, are a similar industry. Demand is related to construction and infrastructure. Most carry loads of five tonnes. This industry is also dominated by a handful, headed by Liugong, Longgong, Xiagong, Lingong and Xugong, which get most of their engines from Weichai, which commands a 70 per cent market share.
Both industries experienced spectacular growth between 1999 and 2004, with rates reaching up to 50 per cent year on year. But good times do not last. In 2004, demand was 371,000 heavy trucks, up 43 per cent year on year; things began to slow in the first half of 2005 when oversupply was aggravated by macroeconomic austerity measures against repetitive infrastructure and illegal coal mines, state policies that regulated dimensions and specifications of heavy trucks, and ineffective implementation of policies that were to penalise truck overloading by charging highway tolls for trucks by weight.
Even worse, anticipated congestion at container ports on the American west coast in 2005 failed to materialise, leading to the redundancy of some trucks. These misfortunes led to a 36 per cent fall in the first reduction in years.
Given robust economic growth, the redundant trucks should be digested in a year or two and demand should resume growth by 2007. Likewise, demand for wheel loaders also decelerated sharply in 2005 to only 112,000 vehicles.
Not surprisingly, last year Weichai sold 63,490 heavy truck engines, down 24 per cent year on year; and 50,690 wheel loader engines, roughly unchanged. Truck engines sales were 2.84 billion yuan, down 24 per cent; wheel loader sales were 2.45 billion yuan, almost unchanged. These numbers implied stable average selling prices, a proof of bargaining power.
Operating profit was 453 million yuan, down 43 per cent, and net profit was 315 million yuan, down 41 per cent, or 96 fen per share. CHDTG stopped buying truck engines from Weichai and boosted its own engine production to support its heavy trucks business. The good news is that during the first quarter this year, sales volume of Weichai was 41,000 engines, up 6.5 per cent year on year and a happy surprise given that demand for heavy trucks dropped about 15 per cent year on year in the first quarter; that wheel loader demand grew by 15 per cent also helped.
Furthermore, heavy truck customers of Weichai such as Shaanxi and its peers outperformed the industry by selling many more trucks than expected at the expense of Dongfeng and FAW; wheel loader customers also did well, especially Longgong, which sold 52 per cent more vehicles in the first quarter.
This year, assuming fewer truck engine sales and some 22 per cent more wheel loader sales, full year sales value could be 5.95 billion yuan, up 13 per cent; operating profit could be $504 million, up 11 per cent; net profit including share of profit of the newly acquired Torch Auto could be 355 million yuan, up 12 per cent or 1.08 yuan a share.
A share price of $14.45 could imply a 2006 price/earnings ratio of only 14 times, which is not demanding if demand for heavy trucks and wheel loaders continues to revive next year. The worst is probably over for Weichai. However, major risks are a price war and higher raw material costs. This counter is only suitable for adventurous investors.
I reduced holdings in Manulife, Wing On and Swire B in the $10 million simulated portfolio to make way for shares of Cosco Pacific and Weichai Power.
Henry Chan is the head of research at Quam (IA) Limited. He owns shares of Weichai Power