China Yongda: Uncertainty Over Additional Dealer Rebates Is Key Risk For BMW-Focused Automobile Dealer – China Yongda Automobiles Services Holdings Limited (OTCMKTS:CYYHF) No ratings yet.

Elevator Pitch

I like Hong Kong-listed automobile dealer China Yongda Automobiles Services Holdings Limited (OTC:CYYHF) [3669:HK] as a proxy for BMW (OTCPK:BMWYY) sales in China and its growing ancillary businesses. The company’s recent acquisition also helps it increase exposure to key luxury brands and lower-tier cities.

China Yongda trades at 5.4 times consensus forward FY2020 P/E which represents a discount to most of its Hong Kong-listed Mainland China automobile dealer peers.

I assign a “Neutral” rating to the stock, as the potential reduction in additional dealer rebates from BMW in 2H 2019 could pose downside risks to the company’s future earnings. While China Yongda’s mid-single-digit forward FY2020 P/E seems attractive, the company’s share price (+30%) has outperformed the benchmark Hang Seng Index (+7%) by a wide margin year-to-date. If BMW or other luxury car brand sales are below expectations in the coming months or quarters, China Yongda’s share price could be due for a correction.

Company Description

Started in 1992 and listed on the Hong Kong Stock Exchange in 2012, China Yongda is an automobile dealer primarily operating in the eastern coastal regions of China which offers a range of automobile brands like BMW, Porsche (OTCPK:POAHF) (OTCPK:POAHY), Audi (OTCPK:AUDVF) and Jaguar/Land Rover (NYSE:TTM), among others. The company has 245 outlets in 4 municipalities and 19 provinces in China as of end-June 2019. China Yongda derived approximately 82%, 14%, 3% and 1% of its 1H 2019 revenue from passenger vehicle sales, after-sales services, finance & insurance services and automobile rental services, respectively.

China Yongda’s Key Automobile Brands

Source: China Yongda’s 1H2019 Results Presentation

BMW Play With Dealer Rebates Being Key Risk

BMW is China Yongda’s most important automobile brand. As of end-1H 2019, close to a quarter, or 57 of its 245 outlets were BMW dealerships. China Yongda’s BMW sales accounted for a third of the company’s total new vehicle sales in 1H 2019. More importantly, China Yongda is also an important partner for BMW, as China Yongda’s BMW sales (including MINI) accounted for 8.9% of total BMW sales in China for 1H 2019.

As one of the largest BMW automobile dealers in China in terms of sales and the number of outlets, China Yongda is a proxy for growing BMW sales in China. China’s total automobile sales fell -4.3%, -6.9%, and -5.2% YoY in July, August, and September 2019, respectively. But BMW, China’s third largest premium car brand after Mercedes and Audi, saw its new vehicle sales volumes buck the industry trend, and grow +3.6% YoY in 3Q 2019 and +14% YoY in 9M 2019. China Yongda’s total new passenger car sales volumes were up by +9.8% YoY in 9M2019.

Looking ahead, new car models by BMW already launched or to be launched in 2019/2020 such as BMW 3 series, BMW 8 series, BMW X3M/X4M and BMW iX3 are expected to be a growth driver for China Yongda. The launch of BMW X3M and BMW X4M, the automaker’s first mid-sized sports activity vehicles, in September 2019, was responsible for BMW’s strong +5.8% YoY new car sales in China in the same month.

The key risk for China Yongda’s BMW automotive dealer business lies with its gross margin, which is affected by the amount of dealer rebates the company receives from BMW.

China Yongda’s new vehicle sales gross margin expanded by 56 basis points from 1.83% in 2H 2018 to 2.39% in 1H 2019. This was largely attributable to extra rebates offered by BMW to its dealers to motivate them to clear the existing inventories of cars that were built on the old “China V” vehicle emission standards, versus the new “China VI” vehicle emission standards introduced to curb air pollution in the country. It is uncertain if such extra rebates from BMW will remain in place for 2H 2019. If China Yongda and other BMW dealers do not receive the additional rebates from BMW in the second half of the year, China Yongda’s new vehicle sales gross margin and overall earnings for 2H 2019 could be lower-than-expected.

Increasing Exposure To Key Luxury Brands And Lower Tier Cities With Recent Acquisition

On October 2, 2019, China Yongda announced that it acquired Inchcape Asia Pacific Limited for RMB830.0 million. Inchcape Asia Pacific owns a Porsche dealership and an authorized Tesla (TSLA) repair center in Nanchang City, Jiangxi Province; a Mercedes-Benz dealership in Jiujiang City, Jiangxi Province; and a Lexus 4S dealership in Shaoxing City, Zhejiang Province.

The acquisition price of RMB830.0 million implies acquisition valuation multiples of 1.4 times P/B and 13.2 times P/E, based on Inchcape Asia Pacific’s adjusted net asset value of RMB590.9 million and FY2018 net profit of RMB62.9 million. Adjusting for Inchcape Asia Pacific’s net cash position of RMB344.9 million, China Yongda paid an ex-net cash P/E of approximately 7.7 times for the acquisition company, which is slightly below the stock’s trailing twelve months P/E of 8.0 times.

There are two key positives associated with China Yongda’s acquisition of Inchcape Asia Pacific.

One key positive is that this increases China Yongda’s exposure to luxury brands, specifically, Porsche, Mercedes-Benz and Lexus. With the completion of this acquisition, China Yongda would own and operate 19 Porsche, 3 Lexus and 2 Mercedes Benz outlets. As evidenced by BMW’s positive new car sales growth year-to-date highlighted in the preceding section of this article, luxury brands have outperformed other competing brands in China. For China Yongda, the company’s sales of new luxury and ultra-luxury cars (in terms of number of units) grew +12.2% YoY in 9M 2019, compared with a +9.8% growth in the company’s overall new car sales over the same period.

Over the long term, increasing exposure to the luxury car segment is the right strategy for China Yongda, as China’s luxury car penetration in China was only 10% in 2017, implying significant room for growth versus the global average penetration rate of 15%.

Another key positive is that China Yongda has acquired new outlets in lower-tier cities, namely Nanchang City, Jiangxi Province, Jiujiang City, Jiangxi Province, and Shaoxing City, Zhejiang Province. China Yongda had the most number of outlets (63) in first-tier city Shanghai as of end-1H 2019, but lower-tier cities in China are where growth potential is the strongest in the country.

A February 2019 South China Morning Post article highlighted that retail sales in lower-tier Mainland China cities grew in the double digits in the past couple of years, at a faster growth rate compared to first-tier cities. This was primarily because Chinese consumers in lower-tier cities were more willingly to spend vis-a-vis their first-tier city counterparts. Consumers in lower-tier and first-tier Chinese cities were estimated to spend 70%-75% and 60%-65% of their disposable income, respectively. On the contrary, luxury brand penetration in China is lower than what is widely perceived. McKinsey estimates that luxury brands’ current store footprint in China captures less than half of the country’s affluent households, referring to those with annual income exceeding RMB300,000.

Growing Ancillary Businesses Supported By Steady New Store Expansion

Although new passenger vehicle sales accounted for 82% of China Yongda’s 1H 2019 revenue, they only contributed 18% of the company’s gross profit in the first half of the year. After-sales services, finance & insurance services and automobile rental services contributed the remaining 59%, 21% and 2% of China Yongda’s 1H 2019 gross profit.

Ancillary businesses such as after-sales services, finance & insurance services and automobile rental services are deemed as more recurring and stable sources of earnings compared with relatively more volatile and cyclical new passenger vehicle sales.

China Yongda’s gross profit from after-sales services increased +13.9% YoY from RMB1,717 million in 1H 2018 to RMB1,956 million in 1H 2019. The after-sales services segment gross profit as a percentage of total gross profit increased from 57% in 1H 2018 to 59% in 1H 2019. The after-sales services segment has maintained a steady 46% gross profit margin for the FY2018 and 1H 2019 financial periods. The company’s automobile rental services business also saw gross profit increase +23% YoY from RMB49.7 million in 1H 2018 to RMB61.1 million in 1H 2019, driven by a +2.8% YoY increase in the sales volume of pre-owned vehicles to 19,800 units over the same period.

In contrast, the gross profit from China Yongda’s finance & insurance services declined by -5% YoY to RMB155.0 million in 1H 2019, as the company has adopted a more conservative approach in growing the loan book for its automotive finance business to avoid assuming excessive credit risks. But the long-term potential for China Yongda’s automobile finance business remains intact, with China’s automobile finance market expected to grow at 18.4% CAGR between 2019 and 2023 to RMB3.26 trillion, according to research by China Investment Advisory Network.

China Yongda’s growing ancillary businesses are also supported by the company’s growth in the number of outlets, which allows it to handle a greater volume of after-sales services and have more consumer touch-points for automobile rental, finance & insurance services. China Yongda opened eight new passenger vehicles sales and services outlets focusing on luxury and ultra-luxury brands in 1H 2019. Taking into account the acquisition of Inchcape Asia Pacific Limited, China Yongda has added 12 new outlets year-to-date, in line with the company’s target of 10-15 new store additions every year.

Valuation

China Yongda trades at 6.6 times consensus forward FY2019 P/E and 5.4 times consensus forward FY2020 P/E based on its share price of HK$6.12 as of November 22, 2019. As per the peer comparison table below, China Yongda is valued by the market at a discount to most of its Hong Kong-listed Mainland China automobile dealer peers.

Hong Kong-listed Mainland China Automobile Dealer Peer Comparison

Stock Consensus Forward FY2019 P/E Consensus Forward FY2020 P/E
China MeiDong Auto Holdings (OTCPK:CMEIF) [1268:HK] 16.8 12.9
Zhongsheng Group (OTCPK:ZSHGY) [881:HK] 13.4 11.2
China Harmony New Energy [3836:HK] 8.2 7.2
China ZhengTong Auto Services (OTCPK:CZASF) (OTC:CZASY)[1728:HK] 4.9 3.7

Source: Author

China Yongda offers consensus forward FY2019 and FY2020 dividend yields of 5.0% and 6.1%, respectively.

Variant View

The key risk factors for China Yongda are lower-than-expected BMW and premium car sales in China, lower-than-expected dealer rebates from BMW, aggressive new store expansion leading to self-cannibalization, a failure to integrate newly-acquired dealerships, overpaying for new acquisitions, and credit risks associated with the company’s automotive finance and leasing business due to higher-than-expected non-performing loans.

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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