China Yuchai International Limited (NYSE:CYD) Q3 2019 Results Earnings Conference Call November 13, 2019 8:00 AM ET

Company Participants

Kevin Theiss - Investor Relations
Weng Ming Hoh - President
Thomas Phung - Chief Financial Officer
Kelvin Lai - Vice President of Operations

Conference Call Participants

William Gregozeski - Greenridge Global
Ke Chen - Shah Capital

Operator

Ladies and gentlemen, thank you for standing by. I would now like to turn the conference over to Mr. Kevin Theiss. Please go ahead, sir.

Kevin Theiss

Thank you for joining us today and welcome to China Yuchai International Limited Third Quarter 2019 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 contain forward-looking statements within the meanings 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 fact are statements that may be deemed forward-looking statements. Within these forward-looking statements, including, but not limited to, statements concerning the company's operations, 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's Form 20-F under the headings Risk Factors, Results of Operations and Business Overview, and other reports filed with the Securities and Exchange Commission from time to time.

All 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 of the nature contained in a release or during the call made today or otherwise in the future.

Dr. Phung will provide a brief overview and a summary and then Dr. Phung will review the financial results for the third quarter and nine months ended September 30, 2019. Thereafter, we will conduct a question-and-answer session.

For the purposes of today's call, the financial results for the third quarter and nine months ended September 30, 2019 are unaudited and they will be presented in RMB and US 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

Thank you, Kevin. For the third quarter 2019, China's GDP growth was 6%, slightly below the expected 6.1% growth consensus. This was the slowest growth since the first quarter of 1992. The economy's slowing trend continued as there were lower exports from China in September and softness was noted in freight shipments, factory power generation as well as in the services sector.

Overall, auto sales in September 2019 reported the 15^th straight month of lower sales. Some economic analysts believe GDP growth will decline in the fourth quarter of 2019 to below 6% as weakening global demand may affect Chinese exports and domestic business [indiscernible].

Automotive sales have been affected by the government's implementation of the automotive emission standards, the National VI, which were implemented on July 1 in some tier 1 cities and gas engines.

These local regulations reflect the early launch of National VI vehicles before the mandatory national implementation date for the diesel engines.

Vehicle dealers were focused on selling the National V inventory before the mandated implementation of higher emission standards, so they will not have unsellable vehicles on their lot.

According to data reported by China Association of Automobile Manufacturers, CAAM, in the third quarter of 2019, sales of commercial vehicles excluding gasoline powered and electric powered vehicles decreased by 30.6% overall compared with the same quarter in 2018. This included a 4.1% decrease in the truck segment and an 8.4% increase in the bus segment.

During the third quarter of 2019, the sales of heavy-duty trucks increased by 3.7%, while the medium-duty truck sales declined by 14.2%. Heavy-duty bus sales increased by 5% and light-duty bus sales rose by 10.7%.

The government's setting out of incentives for electric buses may be helping to increase the sale of buses propelled by internal combustion engines in some Chinese bus markets. We are cautiously optimistic, although the government policies are to continue to promote further electric vehicle penetration of the auto market.

In the third quarter of 2019, our engine sales were 70,140 units compared with 71,062 units in the third quarter of 2018. Engine sales in the first nine months of 2019 were 281,499 units compared with 281,850 units in the same period last year.

For the third quarter of 2019, our truck engine sales were down double-digits, while our bus engine sales increased by 25.4%.

Our overall off-road sales increased by 8.9% in the third quarter of 2019, with double-digit growth in industrial engine sales, offsetting seasonal weakness in engine sales to the agricultural market. Off-road engines sales continue to be a significant sales channel for our sales mix.

We continue with our strategy of being technology leaders through being among the first to introduce engines that meet the new emission standards. And by producing these next-generation engines before the mandatory implementation, we can capture early end users and offer these engines to our current customers as well.

Our model YCK08, Yuchai [indiscernible] actually became the first domestic diesel engine being certified for the National VI-b emission standards in China, which is not expected to be mandated for the next two to three years.

In addition to the 75 new engine models that we have launched, 10 engines complied with off-road tier 4 emission standards, 40 engines comply with on-road National VI emission standards and one complies with National VI-b.

We have also supplemented our engine portfolio with four new energy powertrain systems. We are at the early stages of our new energy products and anticipate launching new energy products in the future.

Since May 2019, when we announced our new energy powertrain system and products at a press conference in Beijing, we've embarked on new growth pathway through our portfolios of powertrain systems – traditional powertrains technology and new energy powertrain technology.

In a recent auto show in Wuhan, we showcased our new energy products which were well received by the industry. These new products adopted different technology designs to complete the seamless integration of electric motors and internal combustion engines to enable vehicles to reach better mileage range and charging efficiency.

These powertrain systems can penetrate various end market expectations such as semitrailers, dump trucks, mass transit buses/trucks and rubber tired gantry crane.

Our capability in meeting the National VI emission standard has strong attention among OEMs end users as we find a new strategic partnership with Shaanxi Holdings, a leading producer of heavy-duty trucks in China and new strategic partnership with Foton Motor Group for product support for National VI compliant engines and technologies, overseas market development and new energy product development.

Our joint venture, Eberspaecher Yuchai Exhaust Technology Co., continues to advance our new exhaust emission control systems to meet and exceed National VI six emission standards.

As a further example of this, an important engine leader in China's large commercial vehicle market, coach buses powered by Yuchai high-powered engines carried the prominent veterans and their families who devoted their lives to national independence in the 70^th anniversary celebration in the national day parade in Beijing. Many parade vehicles were propelled by Yuchai's engines, including the first six YCS04N engines in the Beijing market.

Yuchai generators also powered many of the giant electronic screens used in Tiananmen Square for the celebration.

Our balance sheet remained strong at the end of the third quarter of 2019. Cash and bank balances were RMB5.7 billion or US$803.5 million. And trade and bills receivables were RMB8 billion or US$1.1 billion. Inventories were RMB2.4 billion or US$334.5 million.

On July 19, 2019, we shared our success with shareholders with a cash dividend of US$0.85 per share.

In October, our YC4A engine model won the prestigious award at the Annual Agricultural and Farming Equipment Conference in Qingdao. This 2019 agricultural industry gold award speaks volume for our product quality and superior technology. The model YC4A is the best in class 70 horsepower agricultural vehicle engine featuring the largest torque among its peers in the marketplace.

We are pleased with our new advanced engine portfolio that meets both the National VI and Tier 4 emission standards, which will be implemented nationally in China in the near future.

Our best-in-class technology and extensive service network has attracted new OEM partners. We expect increasing contributions from our MTU Yuchai Power Co. Ltd. and Eberspaecher Yuchai Exhaust Technology Company Ltd. operations and our new energy initiative in the future.

We believe the government will further initiate policies to address the decline in the economic growth, although it will take a while for the impact to be realized. Hopefully, the limited trade agreement between China and US will have [indiscernible] positive impact in both country's economies.

With that, I will turn to Thomas to go over the financials.

Thomas Phung

Thank you. Now, let me review our third quarter results for 2019. The net revenue for the third quarter of 2019 increased by 3.7% to RMB 3.3 billion (US$467.7 million) from RMB 3.2 billion for the same quarter last year.

The total number of engines sold by GYMCL during the third quarter of 2019 was 70,140 units compared with 71,062 units for the same quarter last year, a decrease of 1.3%. Higher bus, industrial and other engine sales partially offset by lower truck and agricultural engine sales compared with the same period last year. Total off-road engine sales increased in the third quarter of 2019.

According to data reported by the China Association of Automobile Manufacturers (CAAM), in the third quarter of 2019, sales of commercial vehicles excluding gasoline-powered and electric-powered vehicles decreased by 2.6% overall compared with the same quarter in 2018. This included a 4.1% decrease in the truck segment and an 8.4% increase in the bus segment. During this period, the sales of heavy-duty trucks increased by 3.7% while the medium-duty truck sales decreased by 14.2%.

Gross profit decreased by 13.8% to RMB 524.1 million (US$74.1 million) from RMB 607.7 million in the same quarter last year.

Gross margin was 15.8% compared with 19.1% in the same quarter last year. The decrease in gross profit was primarily attributed to higher production costs on the National VI engines and pricing pressure.

Other operating income was RMB 91.3 million (US$12.9 million) compared with RMB 44.1 million in the same quarter last year. The increase was mainly due to higher government grants and higher interest income compared with the same quarter last year.

Research and development (R&D) expenses increased by 28.7% to RMB 81.8 million (US$11.6 million) from RMB 63.6 million in the same quarter last year. Higher R&D expenses were mainly due to higher consultancy fee and experimental costs. R&D expenses were focused on new emission engines and improving existing engine products.

GYMCL continues to further develop new engines in its expanded portfolio of next-generation National VI and Tier 4 emission-compliant engines as well as improve overall engine quality and performance.

In the third quarter of 2019, the total R&D expenditure including capitalized costs was RMB 165.0 million (US$23.3 million) and it represented 5.0% of net revenue compared with RMB 144.3 million, representing 4.5% of net revenue in the third quarter of 2018.

Selling, general and administrative (SG&A) expenses increased by 6.2% to RMB 357.7 million (US$50.6 million) from RMB 337.0 million in the same quarter last year. The increase was mainly due to higher depreciation and higher repair and maintenance expenses. SG&A expenses represented 10.8% of revenue compared with 10.6% in the same quarter last year.

Operating profit decreased by 30.0% to RMB 175.8 million (US$24.9 million) from RMB 251.2 million in the same quarter last year. The operating margin was 5.3% compared with 7.9% in the same quarter last year.

Finance costs increased by 57.4% to RMB 47.0 million (US$6.7 million) compared with RMB 29.9 million in the same quarter last year. Higher finance costs were mainly due to the higher amount of trade bills discounted.

Net profit attributable to China Yuchai's shareholders was RMB 50.3 million (US$7.1 million) compared with RMB 128.5 million in the same quarter in 2018.

Basic and diluted earnings per share were RMB 1.23 (US$0.17) compared with earnings per share of RMB 3.15 in the third quarter of 2018.

Basic and diluted earnings per share in the third quarter of 2019 and 2018 were based on a weighted average of 40,858,290 shares.

Now, I will go over the first nine months result of 2019. For the first nine months ended September 30 2019, net revenue increased by 5.1% to RMB 12.3 billion (US$1.7 billion) from RMB 11.7 billion in the same period last year.

The total number of engines sold by GYMCL in the first nine months of 2019 was 281,499 units compared with 281,850 units in the same period last year.

According to data reported by CAAM, in the nine months ended September 30, 2019, sales of commercial vehicles excluding gasoline-powered and electric-powered vehicles decreased by 6.8%, with lower sales in the truck and bus segments compared with the same period in 2018.

Gross profit decreased by 10.4% to RMB 2.0 billion (US$282.5 million) compared with RMB 2.2 billion in the same period last year. Gross margin was 16.2% compared with 19.0% in the same period last year. The decrease was mainly attributable to higher costs incurred in the production of National VI engines and pricing pressure.

Other operating income increased by 82.4% to RMB 234.1 million (US$33.1 million) compared with RMB 128.3 million in the same period last year. The increase was mainly due to higher government grants and higher interest income.

R&D expenses were RMB 264.3 million (US$37.4 million) compared with RMB 340.0 million in the same period last year. Lower R&D expenses were mainly due to the higher capitalization of development costs for National VI and Tier 4 that met the IFRS capitalization criteria. The ongoing R&D program is focused on new and existing engine products as well as continued initiatives to improve engine quality.

In the first nine months of 2019, total R&D expenditure including capitalized costs was RMB 461.3 million (US$65.2 million) compared with RMB 420.7 million in the same period last year. As a percentage of revenue, R&D spending was 3.7% in the first nine months of 2019 compared with 3.6% in the same period last year.

SG&A expenses were RMB 1.1 billion (US$161.6 million), similar to RMB 1.1 billion in the same period last year. SG&A expenses represented 9.3% of revenue for the first nine months of 2019 compared with 9.1% in the same period last year.

Operating profit was RMB 825.3 million (US$116.7 million) from RMB 949.9 million in the same period last year. Operating margin was 6.7% in the first nine months of 2019 compared with 8.1% in the same period last year.

Finance costs were RMB 104.7 million (US$14.8 million) compared with RMB 82.0 million in the same period last year. Higher finance costs were mainly due to higher amount of trade bills discounted.

Net profit attributable to China Yuchai's shareholders was RMB 395.3 million (US$55.9 million) compared with RMB 503.5 million in the same period last year.

Basic and diluted earnings per share were RMB 9.68 (US$1.37) compared with RMB 12.32 in the same period last year.

Basic and diluted earnings per share in the first nine months of 2019 were based on a weighted average of 40,858,290 shares compared with a weighted average of 40,858,290 shares for basic earnings per share and a weighted average of 40,872,254 shares for diluted earnings per share in the same period in 2018.

Some of the balance sheet highlights as of September 30, 2019. Cash and bank balances were RMB 5.7 billion (US$803.5 million) compared with RMB 6.1 billion at the end of 2018.

Trade and bills receivables were RMB 8.0 billion (US$1.1 billion) compared with RMB 7.4 billion at the end of 2018. Inventories were RMB 2.4 billion (US$334.5 million) compared with RMB 2.5 billion at the end of 2018. Trade and bills payables were RMB 5.3 billion (US$755.0 million) compared with RMB 4.6 billion at the end of 2018.

Short-term and long-term borrowings were RMB 1.6 billion (US$228.4 million) compared with RMB 2.0 billion at the end of 2018.

With that, operator, we are ready to begin the Q&A session.

Question-and-Answer Session

Operator

[Operator Instructions]. We have the first question coming from the line of William Gregozeski of Greenridge. Please go ahead.

William Gregozeski

Hi. I have a few questions. Regarding the National IV engines, can you talk about how the sales have been and what the outlook is you're seeing from your customers for those engines?

Weng Ming Hoh

For the National VI engines, as you'll probably know, some of the major cities have implemented it and gas engines has been – also been implemented since 1 July, 2019. We're getting some orders. In fact, it's increasing. So, we expect this year to [indiscernible] a good number of units sold. And we'll be ready for next year to sell quite a bit of National IV engines. I think up to the end of this year, we expect we should reach at least between 15,000 and 30,000 engines.

William Gregozeski

Okay. And are you still – on the gross margins, you mentioned the National VI. Are you still doing them in the batch production and when will you switch to the commercial production for these engines?

Weng Ming Hoh

Some of them are still in batch production and some of them are in what we call volume production. So, we're seeing improving trend of gross margins for National VI products. So, actually, in the last few months, it's been on increase as to volume of National VI engines sold increase as well.

Gross margin for the remaining engines for National V and below, the gross margins are basically at about the same level as previous year, perhaps a little bit lower.

William Gregozeski

Okay. And then, on the new energy technology development, can you talk more about kind of where you are in that cycle? Obviously, there's a lot more – not even just buses, but now there's other vehicles moving to electric. Where are you in the development of these? And when do you think you might have something on the market that you can compete with?

Weng Ming Hoh

Okay. We're selling some electric power systems. Those that we have launched in May in Beijing, we got awarded especially in particular for the range extender. We're getting a lot of very good inquiries for that particular, let's call it, the system. We are at a stage where we're actually selling the prototypes to some of our OEMs for them to pack on their vehicles and put in their vehicle.

So, now for other LDB, like the four fuel cells units that we have, [indiscernible] a bit more longer before you get to the stage where we can actually say we have commercial sales.

William Gregozeski

Okay. When do you think you'll be getting more commercial size orders for the electric motor systems?

Weng Ming Hoh

The electric motor systems, I think, we are doing some integrations. We have full time integrated systems right now. But we don't see that we'll have it in a big way yet. It's going to take us a little while, I think, to build it up. We're still in the early stage of the electric vehicle segment of the market, whereas for the range extender, we are a little bit further ahead. So, we should see some sales, I think, maybe in the year 2021.

William Gregozeski

Okay. All right. Thank you.

Operator

Thank you, sir. [Operator Instructions]. We have our next question coming from the line of Ke Chen from Shah Capital. Please go ahead.

Ke Chen

Yes. What's the operating cash flow in your third quarter?

Thomas Phung

Ke Chen, this is Thomas. We're almost neutral. We are slightly under by minus RMB 40 million. So, we're almost breakeven.

Ke Chen

Okay.

Thomas Phung

Compare with Q3 of last period, we're very much better. Last Q3 was a huge negative. It is mainly due to strong collection for the third quarter.

Ke Chen

That's great. Please talk about to the MTU JV related revenue and profit in your third quarter. And more importantly, what's the outlook for this JV?

Kelvin Lai

Mr. Chen, this is Kelvin. Regarding the MTU joint venture, we have sold around 60 units in the third quarter of 2019. And our forecasts for the next years are not finalized yet, but we expect it in the range of range of 200 to 250 units for 2020.

Ke Chen

What's the revenue range?

Kelvin Lai

Revenue is around in the range of above $85 million or 60 engines.

Ke Chen

I see. With the better legal environment in Hong Kong, are you guys considering listing Hong Kong, like what Alibaba did recently?

Weng Ming Hoh

We haven't thought about it yet. Yeah, at this point, we don't like to do so, no.

Ke Chen

You mean, you will consider it? Are you going to think about it or…?

Weng Ming Hoh

Well, we haven't discussed it. We haven't really given it much thought. So, no. At this point in time, there is no plans right now.

Ke Chen

Okay. My last question about gross margin, again, to trend actually is improving from second quarter. Do you see this gross margin go back to 19% overall, like you did for the last couple of years? Do you see that trend eventually?

Weng Ming Hoh

Yes, it is. We're seeing an improving trend now because as the volume increases, the gross margin also improve for the National VI. So, going to next year, when the government starts to buy only National VI engines in the middle of next year, we should see a substantial increase in the unit sales for next year. So, over time, yes, we do expect to go back to the same kind of gross margin.

Q – Ke Chen

Okay. So, with this higher emission standards and higher technology requirement in China, do you see more engine market consolidation going forward?

Weng Ming Hoh

Well, it's hard to say. I don't know, to sort of comment on our competitors, but we hope that there'll be some [indiscernible].

Ke Chen

Okay. Thank you. That's all.

Operator

Thank you. [Operator Instructions]. We do not have any further questions at the moment. We have now reached the end of our Q&A session. I will turn the call back to Mr Hoh. Please go ahead, sir.

Weng Ming Hoh

Thank you all for participating in our conference call. We look forward to speaking with you again soon. Thank you.

Operator

Thank you, sir. Ladies and gentlemen, that concludes our conference for today. Thank you for your participation. You may disconnect now.