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China Automotive: Upward Growth Trajectory Ahead (NASDAQ:CAAS)

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China Automotive Systems, Inc. (NASDAQ:CAAS) reported solid numbers in its latest third-quarter earnings report. It beat on revenue and earnings per share while pointing to its negotiations with BYD Company Limited (OTCPK:BYDDY) to provide products for them. It has recently announced it signed contracts for electric power steering systems with the Chinese auto giant.

With its continual growth in the Chinese, North American and Brazilian markets, the addition of these design contracts with BYD is a huge tailwind for CAAS. In its latest earnings report, CFO Jie Li said the deal could represent approximately 200,000 units per year.

Even though its North American sales and margins were down some in the third quarter, that was primarily a result of product mix, which the company expects to rectify in the quarters ahead.

The company is positioned strongly for a nice run over the next couple of years at least, but the biggest headwind it has is the unpredictability of Chinese government leaders in regard to lockdowns associated with COVID-19. That’s why I point out the volatility the share price goes through, as the market will primarily focus on the impact of that rather than the long-term fundamentals of the company.

In this article, we’ll look at some of the recent numbers of CAAS, its geographic diversification, the BYD deal, and what the future probably holds for it in the years ahead.

Some of the numbers

Revenue in the third quarter was $137.2 million, up 26.8 percent from the $108.2 million in revenue generated in the third quarter of 2021, beating by $16.65 million.

Sales in hydraulic products, Wuhu subsidiaries, Brazil, and electric power steering were strong in the quarter, while sales in North America were down a little, primarily from an unfavorable product mix. Its commercial vehicle segment had flat sales in the third quarter, reflecting overall market weakness in that category.

Gross profit in the reporting period was up 24.4 percent, while gross margin narrowed from 15.5 percent last year in the same quarter to 15.2 percent in the third quarter of 2022.

Income from operations was $4.9 million in the third quarter, up from the $0.6 million in the third quarter of 2021.

Net income was $0.24 per share, a significant increase over the loss of $(0.01) per share year-over-year.

Free cash flow in the reporting period was $19.8 million compared to negative $(11.7) million in the first nine months of 2021.

At the end of the third quarter, CAAS had cash and cash equivalents and pledged cash of $131.7 million, with total working capital of $153.4 million.

Diversification across geography

I think CAAS is a stronger company because of its geographic diversification, with sales in Brazil, China and North America.

Of the $137.2 million in revenue in the third quarter, North America accounted for $29.5 million of it, and Brazil another $11.5 million, bringing the total to $41 million.

While sales in North America were down 4.8 percent, primarily as a result of product mix, net product sales in Brazil were up 51.9 percent based upon growing demand.

The company believes it will be able to boost North American sales with a more favorable product mix in the quarters ahead, and Brazil is likely to continue to grow nicely because of demand and the low baseline it’s working from.

Combine that with its growing sales in China and the big win with BYD, and the future of CAAS looks like a good one.

Geographic diversification is especially important when considering the potential for unpredictable lockdowns associated with COVID-19; it provides a floor for the company outside of China.

The BYD deal

China Automotive Systems has been talking about being in negotiations with BYD for a while. On December 12, 2022, it announced it had landed a design contract with the Chinese auto giant for a new series of electric power steering systems.

Included in the win are design contracts for C-EPS, DP-EPS and R-EPS.

Although it appears the electric power steering systems will be for various models designed by BYD, the primary focus seems to be on its higher-end models, where CAAS EPS systems will replace BYD’s more expensive R-EPS.

In the last earnings report, the company mentioned 200,000 units being the potential annual capacity of the deal, but mass production of the DP-EPS could be in the range of 300,000 units annually.

This is an enormous deal for CAAS, and if it can execute at these higher levels, it’s going to boost the performance of the company to historical highs.

There’s no doubt in my mind that if it delivers the goods, the share price of CAAS is going to soar over the next couple of years.

Conclusion

Near the end of November 2020, the share price of CAAS soared to about $8.00 per share, and then dropped over the next 15 months to a 52-week low of $2.20 per share on March 11, 2022.

After trading flat since then, through August 16, 2022, it started to moving up to approximately the mid-$4s before pulling back to about $4.0 per share, once again consolidating until the third-quarter earnings report, which triggered a strong upward move to its 52-week high of $8.13.

After correcting to around $5.00 per share, the company has jumped to trade at close to $7.00 per share.

CAAS chart

TradingView

My point in sharing the price movement is the company, even with strong momentum, is still held back some by the overhand of the potential of more lockdowns in China from COVID-19. The government of China appears to be gradually loosening up its policies, but it can be unpredictable from its zero-COVID policy.

This is one reason its geographic diversity helps, and it is still not able to break out to the degree its performance warrants.

I like China Automotive Systems, Inc. and its management, and its growth trajectory and big win with BYD reinforce the fact that it has a lot of growth ahead of it.

If investors can stomach the uncertainty of lockdowns and volatility that accompanies it, China Automotive Systems, Inc. should be a great addition to a stock portfolio that is looking for growth.

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