Riding in the Fast Lane in the Throes of a Slowdown

While there’s no question that businesses are struggling amid these tough times, not all are. Contrary to the stream of negative news coming out of the markets, some companies continue to expand their product lines, capture new clients and grow rapidly.

One glaring example can be found in China, which is dealing with an economic slump of its own that has dragged the nation’s factory output to its worst level on record.

China’s auto industry has grown by leaps and bounds since the country joined the World Trade Organization in 2001. Annual sales of passenger vehicles doubled between 2003 and 2007, driving China past Japan into the spot of the world’s second-largest vehicle market after the United States. The Chinese now produce some 10 million cars every year.

But this fall, after six straight years of 20% plus annual growth, automobile sales were between flat and slightly negative, shocking an industry in a market once thought to have an insatiable appetite for cars. Faced with slowing economic growth, plunging real estate prices and a sagging stock market, Chinese consumers have pulled back on their spending, hurting the domestic auto industry. Adding to their woes, fuel prices in China remain high despite the recent decline in global oil prices. And Chinese auto exports are on the decline.

Mirroring efforts being made by U.S. auto executives in Washington, albeit in a more low-key style, China’s car industry is nudging Beijing for bailout-type assistance to help it cope with the effects of a weakening economy. The industry brass are asking the government for more attractive tax rates on new vehicles, lower fuel prices and more research grants for new innovation (hybrid cars, etc.).

One auto-related company is growing in the face of the recession by filling a niche providing must-have parts to the battered industry. Meet China Automotive Systems, Inc. (Nasdaq: CAAS), a leading supplier of automotive steering systems and components to Chinese automakers and, to a lesser extent, the American market.

Operating through seven Sino-foreign joint ventures from its base in the south-central city of Jingzhou in Hubei province, nine-year-old China Automotive has grown to become a major player in its specialty, supplying the expanding mainland passenger and commercial vehicle market. As an original equipment manufacturer (OEM), the company produces over 1.1 million power steering systems as well as steering columns, steering pumps and steering hoses. Its customer base is primarily comprised of Chinese auto and truck manufacturers including Chery Automobile Co., Ltd., Beiqi Foton Motor Co., Ltd., Dongfeng Auto Group Co. and China FAW Group, Corp. In total, it has forged relationships with over 60 vehicle manufacturers, including joint ventures established by General Motors (NYSE: GM) and Volkswagen. The company also markets parts and provides after sales service and R&D support in North America through its subsidiary, Henglong USA Corporation, based in Troy, Mich., a suburb of Detroit.

China Automotive raced through the first six months of this year, before putting on the brakes a bit, but the company has still managed to clock growth in a slow market. The third-quarter saw a 18.4% increase in net sales, which rose to $36.9 million, and a nearly 170% spike in net income, which improved to $2.8 million, reflecting 7.2% year-over-year growth. Chief Executive Officer Mr. Qizhou Wu was quick to point out that the company’s most recent results were negatively impacted by what he call “the normal seasonality” of the business and the after-effects of the Beijing Olympics—many OEMs reduced production and held off on filling orders during the summer.

Earlier this month, the china Automotive celebrated its first shipment of its power steering gears to the Dongfeng Peugeot Citroen Automobile Company Ltd., a Sino-French joint venture. China Automotive views the first shipment as a milestone in its quest to become a top supplier of power steering systems and gears to world auto giants. The company also recently reported it received an initial order from an unnamed global automotive manufacturer headquartered in North America, the result of an agreement to supply power steering gears to a “well-known automobile brand.”

While some industry watchers have expressed concerns over the state of China’s economy, the mixed signals being sent by Chinese consumers, and surging production costs being faced by auto manufacturers, others are anything but fearful about the health of the Chinese auto market. Ant indicator of the long-term prospects of China’s automotive industry can be gleaned from Warren Buffet’s recent purchase of a 10% stake in Chinese car maker BYD Co. (for $230 million).

According to Indian research firm RNCOS, publishers of the China Automobile Industry Forecast (2006-2010), even with the high domestic fuel prices and slower-than-expected growth in the Chinese auto market , once consumer confidence is restored in the markets, the continuing increase of discretionary income among the Chinese should translate to ongoing growth in auto sales, thus China Automotive’s bottom line.

Without a doubt, China Automotive’s fortunes are inseparably linked to the performance of the overall domestic auto market (if the sector is being squeezed, auto parts suppliers feel the pinch in their bottom line). And while there’s no question that the Chinese auto business faces serious obstacles to achieving growth on par with the lofty numbers seen in recent years, a slowdown was inevitable given the sheer size of the market.
 
According to the latest report released by the China Association of Automobile Manufacturers, industry business has fallen off considerably. In the first 11 months of this year, growth in both production and sales of vehicles in the mainland slowed to a single-digit rate, the first time growth rates have dipped below 10% since 2006. Even so, auto-industry analysts in Beijing say the market for passenger vehicles is far from being saturated and will continue to grow in the long run.

The most recent figures notwithstanding, for its part, China Automotive has robust supply agreements with leading original equipment manufacturers and it is poised for greater things going forward, bolstered by the long-term prospects for expansion of the domestic auto market in China. The company should continue to generate robust top-line growth in the next couple of years, fueled by rising domestic sales and foreign exports. If the assessment proves to be accurate, China Automotive is well on its way down the road to continued success.

Currently in the $3 range, the stock has traded between $2.01 and $8.49 over the past 52 weeks. Analysts at Merriman Curhan Ford and Global Hunter Securities are both bullish on China Automotive, maintaining “buy” ratings. The one-year target price is set to $9.

Shannon Roxborough
Analyst, Wall Street Elite