It’s been a rough year for erstwhile poster child of the Chinese electric vehicle (EV) movement, BYD (1211.HK). The company says the initialism BYD stands for "Build Your Dreams," but many investors in BYD’s dream are waking to some harsh realities.
The company leaped into the spotlight in 2008 when famed investor Warren Buffett bought a 10% stake in the firm for US$231 million. Buffett’s money is still well in the black, but those who jumped in later have been hurt: The stock is now trading only slightly above its 52-week low at HK$46 (US$6) compared with a high of HK$84.
Many investors were excited by BYD’s projection that it would sell 800,000 cars in 2010, approaching sales of domestic auto giants like SAIC (600104.SH). But when summer arrived, sales were still sluggish, and dealers began loudly quitting the network, complaining that BYD was saddling them with unsellable inventory. The company subtracted 200,000 units from its annual sales target, but rattled the market again in September, when it announced that third-quarter earnings declined 99% quarter-on-quarter.
Adding insult to injury, in October the central government fined the automaker US$500,000 for building seven manufacturing facilities on unlicensed agricultural land. The implication that BYD had lost its influence in the halls of government added to shareholder gloom. In the same month, vehicle sales declined for their third straight month, down 13% year-on-year.
Driving blind
There’s little doubt that company management got a bit carried away by the Buffett hype. John Zeng, head of automotive intelligence and forecasting services for JD Power & Associates, said that BYD managers’ first mistake was letting ambition and optimism blind them to market realities.
"BYD was talking about 800,000 units for this year, more than double last year’s figure. You cannot expect such growth in a single year. But with this target in hand, BYD expanded its dealer network very aggressively to over 1,000 dealers in China. That’s the largest dealer network of all the car manufacturers here." This investment and its associated costs caused BYD’s net profit margin to decline to 1.3% in the third quarter, down from 10.33% in 2009. The company did not respond to requests for interviews.
To be fair, predictability has never been BYD’s strength. It has regularly beaten or missed analyst consensus forecasts – nine times since 2005. And despite the stock’s recent battering, managerial optimism is not groundless, just overdone. After all, BYD still has a unique position. It holds the third-largest share of the world’s rechargeable battery market. And its ability to reverse-engineer entire manufacturing lines has produced a unique vertically integrated automotive operation that keeps costs down. While GM’s Chevy Volt hybrid sells for US$41,000. BYD’s similar F3DM sells for US$22,000.
"BYD produces 90% of their components internally, which allows BYD to launch vehicles faster," said Yale Zhang, independent auto analyst and former director of auto sales forecasts at CSM. "You don’t have to deal with that lengthy, difficult liaison with big suppliers."
Unfortunately, the intensity of BYD’s commitment to conventional car manufacturing is in doubt. The company appears easily distracted by fads and is at risk of over-diversifying. It already has a complex corporate structure. BYD’s popular image is largely associated with autos and batteries, but the company has a second listed unit, BYD Electronics (0285.HK), which concentrates on handset components such as touchpads, casings and other electronic parts.
Both of BYD’s listed units are set to spawn even more product lines. While the electronics subsidiary is venturing into tablet PCs and flat screen televisions, the parent is accelerating its move into the solar power sector, specifically polysilicon wafer manufacturing. In October the company signed a US$300 million supply agreement for polysilicon with LDK Solar (LDK.NASDAQ). Media quoted CEO Wang Chuanfu saying BYD’s ultimate goal is to build a "zero-emissions ecosystem" in which BYD electric vehicles (EVs) are charged by BYD solar panels installed outside houses lit by BYD LED lights.
While weaning Chinese electric cars away from dependence on coal-fired electricity is desirable, it doesn’t follow that BYD needs to make its own solar panels. Dylen Liu, solar power expert and vice president at Pacific Epoch, expressed reservations about the initiative. The solar manufacturing sector is expected to run into severe overcapacity problems next year, he said, and BYD will face stiff competition from large established players like Yingli Green Energy (YGE.NYSE) and Suntech Power (STP.NYSE).
However, Liu does not believe either factor is likely to discourage BYD: "BYD thinks [solar] is a long-term business. It doesn’t care about the near term." Environmentalists may smile at this, but investors are more likely to wince.
Still charging up
The same logic goes for EVs, where BYD is making another long-term gamble, though medium-term prospects for the vehicles are still weak. A November report by JD Power & Associates predicts that EVs – both hybrids and purely electric vehicles – will comprise only 7.3% of the global passenger vehicle market by 2020. Consumers are still put off by their high cost and the difficulty of charging them.
"The infrastructure is not there yet," said Zeng of JD Power. "Charging stations are not available, so driving and parking EVs is a pain for most drivers."
The situation is even worse in China, where green consumer cachet and private garages for charging are both lacking.
This helps to explain why BYD has sold only around 200 EVs to date – almost all of them to the Shenzhen government. Plans to sell electric and hybrid cars in the US by the end of the year will also likely be delayed, due in part to slackening demand. US sales of Toyota’s (TM.NYSE, 7203.TYO, TYT.LSE) hybrid Prius fell 12% year-on-year in October.
In the meantime, auto analyst Zhang suggested that BYD should focus on research. The battery segment, for example, is ripe for growth, and BYD is taking steps to hold on to its lead. It is starting to sell large-scale storage batteries to grid projects in China and California, and has been developing a new battery chemistry that it says will make widely used lithium ion technology obsolete.
Revamping its auto strategy may prove more vexing. The biggest question BYD faces is whether it should innovate in conventional car manufacturing.
"You cannot rely on reverse engineering for [the next] 10 years," said Zeng of JD Power. "BYD believes that the electric car will bypass the conventional engine and transmission, so they aren’t investing in that technology … But if EV technology does not mature in 10 years, how will they survive?"
BYD recently developed its own conventional engine, but still relies on third-party engines for some models and cannot produce conventional transmissions internally. So far, both its conventional F3 and F0 models are selling well. For the next five years, these cars will remain BYD’s bread and butter. The more attention it pays to its less sustainable but more marketable conventional vehicle fleet, the more profitable it will be.
