This past month Benj purchased a bowlful of shares of China Automotive Systems at US$3.26. Despite the possible downside, he feels quite confident that the initial sell target of US$8.64 is eminently reasonable.
CAAS produces and sells numerous automotive systems and components. Its key markets outside of China are North America and Brazil. It has over 200 patents, both domestically and overseas, for power steering and works with more than 60 vehicle manufacturers, including some of the largest in China. Other customers include Citroen, General Motors, Stellantis and Volkswagen.
This is one of those few companies that ticks virtually all of the positive boxes that we use at the Contra the Heard Investment Letter. CAAS has been around for more than the 10-year minimum that Benj wants to see – about 25 years, actually – and the more history we have, the easier it is to assess the company.
Revenues are trending upward, hitting US$529-million last year and its bottom line has been profitable in eight of the past 10 years. The most recent quarterly profit of US$10.2-million is up 108 per cent from the year before. Book value per share is almost US$11, better than triple the stock price. Cash and cash equivalents are a robust US$135-million. That works out to about US$3.59 a share, which also is well above the trading value. Insiders are well aligned with shareholders, as they hold around 65 per cent of the stock. Meanwhile the total debt is a lowly US$38.6-million.
An essential element of being a successful major company in China is that the government likes you and, in this case, the powers that be want to see the country become the dominant player in the EV field. That appears to be the case on both counts. Last year, China produced almost 60 per cent of the world’s battery electric vehicles and plug-in hybrids and is the biggest exporter of autos in the world. It also boasts the largest charging infrastructure, which at the end of 2021 was a total of 1,147,000 locations, or almost 65 per cent of the global total. At the same time, CAAS has enough capacity to fulfill 75 per cent of EV demand.
Worth noting is that a key raw material for EV batteries is graphite, and in 2021, China produced 82 per cent of the worldwide supply. It also has about 25 per cent of the world’s reserves, which bodes well for fulfilling future market needs.
The major negative for this stock is political risk. China and the West, particularly the United States, are not exactly cozying up on the couch watching movies, eating popcorn and talking about their future together. It is not unforeseeable that the relationship could quickly turn very inhospitable, like that of Russia and the United States. This would almost assuredly happen if an invasion of Taiwan occurs. If that transpires, all bets are off on a future close association between these countries for what could be many years. Decades even.
Another question mark is accounting risk. Chinese companies are renowned for the creativity of their financial statements. Thus, it is difficult for investors to distinguish between what is fact and what is not. As best as we can discern, China Automotive Systems has legitimate financial statements.
This year, the global EV market is projected to be greater than US$623-billion, with a growth rate estimated at better than 9 per cent a year over the coming years. Investors should be aware that the company has a spiky price chart, with shares jumping quickly to US$10.50 in 2020 and US$8.65 in 2023, before tumbling swiftly both times. Anyone playing this enterprise should prepare to be nimble on the sell side.
Benj Gallander and Ben Stadelmann are co-editors of Contra the Heard Investment Letter