Earnings Call Transcript - CYD Q2 2020

Operator, Operator

I would like now to turn the conference over to Kevin Theiss. Please go ahead, sir. Thank you for joining us today and welcome to China Yuchai International Limited’s Second Quarter 2020 Conference Call and Webcast. Joining us today are Mr. Weng Ming Hoh; and Dr. Thomas Phung, President and Chief Financial Officer of CYI, respectively. In addition, we also have in attendance Mr. Kelvin Lai, VP of Operations of CYI. Before we begin, I will remind all listeners that throughout this call, we may make statements that may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. The words believe, expect, anticipate, project, targets, optimistic, confident that, continue to, predict, intend, aim, will or similar expressions are intended to identify forward-looking statements. All statements other than statements of historical facts are statements that may be deemed forward-looking statements. These forward-looking statements, including, but not limited to, statements concerning the Company’s operations and financial performance and conditions, are based on current expectations, beliefs and assumptions, which are subject to change at any time. The Company cautions that these statements, by their nature, involve risks and uncertainties, and actual results may differ materially depending on a variety of important factors, such as government and stock exchange regulations, competition; political, economic and social conditions around the world and in China, including those discussed in the Company forums 20-F under the headings, the risk factors, results of operations and business overview, and other reports filed with the Securities and Exchange Commission from time to time. If the COVID-19 pandemic is not effectively controlled, our business operations and financial conditions may be materially and adversely affected due to a deteriorating market for automotive sales and economic slowdown in China and abroad, potential weakening of the financial condition of our customers, potential adverse impacts to our suppliers and supply chains are other factors that we cannot foresee. Our forward-looking statements are applicable only as of the date they are made, and the Company specifically disclaims any obligation to maintain or update the forward-looking information whether it may contain in the release made during today's call or otherwise in the future. Mr. Hoh will provide a brief overview and summary and then Dr. Phung will review the financial results for the second quarter ended June 30, 2020. Thereafter, we will conduct a question-and-answer session. For the purposes of today's call, the financial results for the second quarter ended June 30, 2020 are unaudited and will be presented in RMB and U.S. dollars. All the financial information presented is reported using international financial reporting standards as issued by the International Accounting Standards Board. Mr. Hoh, please begin your prepared remarks.

Weng Ming Hoh, President

Thank you, Kevin. In the second quarter, the Chinese economy resumed growth as GDP increased by 3.2%, far below historical trends, but a strong rebound from the 6.8% economic contraction in the first quarter of 2020. This was severely impacted by the COVID-19 pandemic. The aftermath of the COVID-19 pandemic created major interruptions in the Chinese economy and automotive industries as it affected customers, suppliers, workers, distributors, service networks and other auto-related occupations. The national and interprovincial travel restrictions negatively impacted many supply chains in the automotive industry. Following the reopening of the Chinese economy, the government introduced economic growth catalysts, including higher fiscal spending, more approved infrastructure projects, and lowering lending rates and bank reserve requirements. Manufacturing activity increased since May and China's exports grew partially because China was among the first to ease lockdown actions. According to data reported by the China Association of Automobile Manufacturers (CAAM), in the second quarter of 2020, sales of commercial vehicles, excluding gasoline-powered and electric-powered vehicles, increased by 50.5%; truck sales increased by 56.1%, with heavy-duty truck sales up by 64.9%, medium-duty truck sales rose by 32.5%, and bus sales increased by 1.8%. Part of this growth was attributable to the pent-up demand from the first quarter of 2020 as much of the economy was essentially shut down, with lockdowns and travel restrictions implemented to inhibit the spread of COVID-19 infections. Our operational and financial results during the second quarter reflected the rebound from the disruptions in the first quarter of 2020 due to the COVID-19 outbreak. Our total unit sales improved by 32% year-over-year, our overall truck engine and bus engine unit sales grew by 23.3% in the second quarter of 2020, with heavy-duty truck reduced sales rising by 14.3% and medium-duty costs up by 33.3% year-over-year. Our gross engine sales increased an impressive 51.7%, led by a 78.5% growth in the seasonal agriculture machinery market. As a result, our revenue increased by 34.7% to RMB6.5 billion or $935.2 million. The growing sales of our National VI engines in the Chinese heavy-duty truck engine market are directly related to the growing acceptance of our natural gas engine product. We have already established a position as one of the leading suppliers of heavy-duty National VI engines to the truck and bus market in China. Operating profit increased by 53.6% to RMB448.7 million or $63.4 million, and basic and diluted earnings per share rose by 66.4% to RMB5.99 or $0.85. In the second quarter of 2020, the total R&D expenditure including capitalized costs was RMB218.3 million or $39.6 million, and for the six months ended June 30, 2020, total R&D was RMB402.7 million or $56.9 million. R&D represented 4.3% of net revenue in the second quarter of 2020 and 4% of net revenue for the six months ended June 30, 2020. We continue to improve our National VI and Tier-4 technologies and production techniques as we are progressing on our products for the new energy markets. We see continuing national implementation of these more stringent National IV emission standards; our portfolio of National VI compliant engines, including products powered by natural gas, positions us well with our existing customers and attracts new ones as well. In 2019, we established a strategic partnership with Guangxi Automobile Holding Group, a leading producer of heavy-duty trucks in China, and the Foton Motor Group, a market leader in the on-road vehicle segment. We also entered into a new strategic partnership in the second quarter of 2020 to become a strategic OEM supplier to Sany Truck, part of the Sany Group Company Limited, which is China's leading machinery equipment maker and has a worldwide presence. This new partnership will further improve our market position in the future. We have used newly developed technologies to build or modify engines for specific markets. During the 2020 first quarter, an advanced high power marine engine was introduced to penetrate the growing demand for vessels in the yacht class. This segment has historically been dominated by imported engine models. Innovative technologies have increased the engine power and reduced the dry weight of the YC6MJ marine engine to make it competitive for the engine. During the first half of 2020, GYMCL announced that its YCA05175-S500 engine has met European Stage V emission standards and this Yuchai engine can now be marketed in the European Union for off-road applications. We retained our financial strength despite the disruptions in sales and operations for the first half of 2020, with cash and bank balances of RMB6.6 billion or $931.5 million at June 30, 2020. We paid a cash dividend of $0.85 per share on July 31, 2020. Similar to the rest of the world, the Chinese economy still faces significant uncertainty. However, as China successfully reopened its economy and the automobile industry has already experienced a rebound beginning in April, we remain cautiously confident that the Chinese economy is on the recovery path for the remainder of 2020. With that, I turn to Thomas to go over the financials.

Dr. Thomas Phung, CFO

Thank you, Weng Ming. Now let me review our second quarter results for 2020. Revenue for the second quarter of 2020 has increased by 34.7% to RMB6.5 billion, or $925.2 million compared with RMB4.9 billion in the second quarter of 2019. The total number of engines sold by GYMCL during the second quarter of 2020 was 145,278 units, an increase of 32.0% compared with 110,059 units in the second quarter of 2019. The increase was mainly due to higher engine sales to the market and off-road segment, particularly unit sales to both the heavy and medium-duty truck markets, which more than offset an overall sales decline in the bus engine segment. According to data reported by CAAM, excluding sales of gasoline-powered and electric-powered vehicles, in the second quarter of 2020, sales of buses increased slightly by 1.8% while truck sales rose by 56.1%. According to CAAM in the second quarter of 2020, commercial vehicle sales, excluding sales of gasoline-powered and electric-powered vehicles, increased by 50.5% compared to the second quarter of 2019, while GYMCL sales to the on-road commercial vehicle market increased by 23.3%. GYMCL's unit sales to the off-road market increased by 51.7% compared with the second quarter of 2019. Gross profit increased by 33.0% to RMB948.1 million, or $133.9 million compared with RMB712.9 million in the second quarter of 2019. Gross margin was 14.5% compared with 14.7% in the second quarter of 2019. Other operating income was RMB61.8 million, or $8.7 million, compared with RMB98.8 million in the second quarter of 2019. The decrease was mainly due to lower government grants in the second quarter of 2020. Research and development (R&D) expenses increased by 24.0% to RMB137.0 million, or $19.4 million compared with RMB110.5 million in the second quarter of 2019. Higher R&D expenses in the second quarter of 2020 were mainly due to higher development costs for National VI and Tier 4 engines on testing and experimental costs. In the second quarter of 2020, the R&D capitalization amount was RMB143.3 million, or $20.2 million. The Company continues to further develop its new National VI and Tier 4 engines for the on- and off-road markets, respectively. In the second quarter of 2020, the total R&D expenditure including capitalized costs was RMB280.3 million, or $39.6 million, and it represented 4.3% of net revenue compared with 3.6% in the second quarter of 2019. Selling general administrative (SG&A) expenses increased by 3.7% to RMB424.1 million, or $59.9 million, from RMB408.9 million in the second quarter of 2019. The increase was primarily a result of higher warranty expenses and our freight expenses in the second quarter of 2020. SG&A expenses represent 6.5% of revenue compared with 8.4% in the second quarter of 2019. Operating profit increased by 53.6% to RMB448.7 million, or $63.4 million from RMB292.2 million in the second quarter of 2019. The operating margin was 6.9% compared with 6% in the second quarter of 2019. Finance costs decreased by 17.4% to RMB26.7 million, or $3.8 million from RMB32.4 million in the second quarter of 2019. The lower finance cost was mainly a result of reduced deal discounting amounts compared with the second quarter of 2019. Net profit attributed to China Yuchai shareholders increased 66.4% to RMB244.7 million, or $34.6 million compared with RMB147 million in the second quarter of 2019. Basic and diluted earnings per share rose 66.4% to RMB5.99, or $0.85 compared with RMB3.60 in the second quarter of 2019. Basic and diluted earnings per share in the second quarter of 2018 and 2019 were based on an average of 14,858,219 shares. Now, I will go over the first six months' results of 2020. Revenue was RMB10 billion, or $1.4 billion compared with RMB9 billion in the same period last year. The total number of engines sold by GYMCL in the first half of 2020 was 213,182 units compared with 211,359 units in the same period last year. The increase was mainly due to higher engine sales in the heavy-duty truck and off-road segments, particularly agricultural engines, which more than offset the sales decline in the bus segment. Gross profit was RMB1.5 billion, or $208.8 million, compared with RMB1.5 billion in the same period last year. Gross margin decreased to 14.8% compared with 16.3% a year ago. The decline in gross margin was mainly attributable to product mix. Other operating income declined by 26.0% to RMB105.7 million, or $14.9 million compared with RMB142.8 million in the same period last year. The decrease was mainly due to lower government grants compared with the same period last year. R&D expenses increased by 16.8% to RMB213.0 million, or $30.1 million compared with RMB182.4 million in the same period last year. Higher R&D in the first half of 2020 was mainly due to higher development costs for National VI and Tier-4 engines from testing and experimental costs. In the first half of 2020, the R&D capitalization amount was RMB189.7 million or $26.8 million. The Company continued with its initiative to develop new engines compliant with China's next emission standards, National VI and Tier-4, and to improve engine performance and quality. In the first half of 2020, the total R&D expenditure including capitalized costs was RMB402.7 million, or $56.9 million, representing 4% of the revenue compared with 3.3% in the same period last year. SG&A expenses decreased by 3.5% to RMB757.4 million, or $107.0 million from RMB785.1 million in the same period last year. The decrease was mainly due to lower warranty expenses and reduced outward freight costs, particularly in the first quarter of 2020 compared with the same period last year. SG&A expenses represented 7.6% of revenue for the first half of 2020 compared with 8.7% in the same period last year. Operating profit decreased by 5.6% to RMB613.2 million, or $86.6 million, from RMB649.4 million in the same period last year. The operating margin was 6.2% compared with 7.2% in the same period last year. Finance cost increased to RMB63.2 million, or $8.9 million from RMB57.6 million in the same period last year, an increase of approximately RMB5.5 million. Higher finance costs mainly resulted from an increase in borrowing compared with the same period last year. Net profit attributed to China Yuchai shareholders was RMB305.7 million, or $43.2 million, compared with RMB345.0 million in the same period last year. Basic and diluted earnings per share were RMB7.48, or $1.06, compared with RMB8.44 in the same period last year. Basic and diluted earnings per share for the first six months of 2020 and 2019 were based on an average of 40,858,290 shares. Now, let me walk you through our balance sheet highlights as of June 30th. Cash and bank balance were RMB6.6 billion, or $931.5 million compared with RMB6.4 billion at the end of 2019. Trade and bills receivable were RMB9.2 billion, or $1.3 million, compared with RMB7.8 billion at the end of 2019. Inventories were RMB4.0 billion, or $565.0 million, compared with RMB2.8 billion at the end of 2019. Trade and bill payable were RMB7.9 billion, or $1.1 billion, compared with RMB6.2 billion at the end of 2019. Long-term and short-term bank borrowing were RMB2.7 billion, or $377.4 million compared with RMB2.1 billion at the end of 2019. Now, I'll turn the call over to Kevin for the comments before we begin our Q&A.

Kevin Theiss, Vice President

Thank you, Thomas. Please note that due to COVID-19, the officers of China Yuchai are remotely calling into the conference. This may result in a slight delay in providing answers to some questions. We apologize for any inconvenience and thank you for your patience. With that, operator, we're ready for the Q&A session.

Operator, Operator

Your next question comes from Don Espey from Shah Capital. Don, the line is now open.

Don Espey, Analyst

Good morning. Nice quarter. A few questions here. Please provide more color on GYMCL's EV powertrain, both current sales and future prospects and fuel cell development program?

Weng Ming Hoh, President

Okay, we launched the NAV, we call the product, last year. The products are still in the development stage, except for the range extender. So the range extender, we have sold very few, about 17 sets. The amount in terms of dollar value is not material. So as far as the fuel cell is concerned, it's still in the development stage. We have got one prototype, which is for 35 kilowatts fuel cell and then we're looking at one of our OEM partners to have that installed in their vehicle.

Don Espey, Analyst

GYMCL was number three in market share in the National VI HD truck engine market in the first half of 2020. How long before you see this metric improve to number two?

Weng Ming Hoh, President

That's a good question. We'll do our best. As you know, this industry in China is highly competitive, and there are many players involved. So I think you'll have to wait and see. I'm sorry, but I can't provide a definite answer or any indications on that.

Don Espey, Analyst

Okay. Switching gears, does the current U.S. administration's accounting and audit proposal affect CYD assuming the Company does not move its main listing to China or Hong Kong?

Weng Ming Hoh, President

Well, we're monitoring the developments in the U.S. very closely. So, we will update our investors when there is further development. And as when we have further thoughts on it, we believe that if it's appropriate to share with our shareholders, we will do so. As it is, all we can do is wait, how the U.S. situation unfolds and monitor it closely.

Don Espey, Analyst

Okay. As a long-term shareholder, we're curious why Yuchai and Cummins have so massively outperformed CYD over the last 1, 3, 5 and 10 years. I'd like to hear your view on this dynamic and maybe how you plan on changing this?

Weng Ming Hoh, President

Yuchai has its own strengths, and Cummins is a large multinational with a global presence. Yuchai excels in certain segments and operates its own OEM plants. We have a different approach, offering a wide range of products primarily focused on the domestic Chinese market. While we've done some exploration of the export market in recent years, this year has been impacted by the COVID-19 pandemic. Our strategy moving forward remains unchanged as we aim to explore more export opportunities, given the significant market potential. We are developing better products aligned with our National VI standards. Currently, our extensive asset sales service network is a considerable advantage for us. We are engaging with our end users in China and will strive to maintain competitiveness both domestically and internationally.

Operator, Operator

And your next question comes from the line of William Gregozeski from Greenridge. William, your line is now open.