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Analysis EO
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Analysis EO
Oct 10, 2020 03:30 pm ·

BYD – All About Getting the Basics Right

BYD (BYD: HKG 1211) is a Chinese Conglomerate that primarily operates in automotive, batteries, and handset manufacturing and sales, and it also has business activities within transportation and construction. It is listed in both the Hong Kong exchange and Shenzhen exchange, trading at HKD 103.8 and CNY 106.68 respectively. With electric vehicles' rise in popularity in recent years, BYD's strong presence in both EV parts and whole EV sales have brought the company into the center stage. However, with sales growth stagnating in the past year, the true value of BYD has become the subject of controversy.  Based on our analysis of BYD, we see the decline in its auto sales as a short-term countercyclical decline due to COVID-19 and intensified competition. In the long term, we think BYD’s comprehensive technology and vertical integration strategies, the results of years of knowledge and technical accumulations, will set it up as a dominant leader in all streams of the EV manufacturing process. Its solid consumer electronic business will also serve as strong protection for BYD. New Models Continue to Fuel Auto Sales in the Short Run In the short term, we think that BYD’s sales will not experience large falls because of strong demand in its PHEV vehicles and some of its ICE models. From January 2020 to August, five BYD PHEV and EV models were ranked in the top 20 EV sales by volume in China. BYD's ICE SUV Song Pro and Song also gained strong traction and recorded 93,271 units sold until August 2020, a ~70% YoY sales increase compared to its most popular SUV model from 2019.  Here, we want to point out that several factors might continue to yield a short term tailwind in the ICE space: 1. The government policy shift (from subsidy-driven EV market to true demand) discourages tax rebate buying incentives. 2. Mature ICE supply chain provides cost advantages compared to EV and pushes up margins. 3. Charging inconvenience contributes to persistent 'mile range anxiety' among EV users.  Vertical integration making a difference as competition intensifies In about 3-5 years, in our opinion, these aforementioned advantages of ICE will start to grow less significant. As IHS Markit projected, the number of EVs in China will grow from 0.8 million units from 2019 to 4.2 million by 2025. We anticipate that economy of scale and more charging station coverage will accompany this high sales growth. So, in the medium term, the race will rely less on ICE sales, but more on the competitiveness of EVs. In this timeframe, we see BYD’s vertical integration can power it to ride on top of the competition. Through analyzing the success of Model 3 sales in China, we found out that branding and competitive pricing are two crucial factors. Each spike in Model 3 sales was driven by price-cutting activities, which was made possible by its cost control ability. Although the increase in quality in Chinese EV brands can eliminate some branding effects, we think a low price for quality features will still be a deciding driver for purchasing decisions. Among domestic manufacturers, BYD is one of the few that controls all manufacturing stages. As we will take a deeper dive into the next section, BYD's strong cost control ability is a result of its vertical integration – undertaking all process of manufacturing from the raw material collection to whole vehicle delivery, which was made possible through many years of R&D.  Technology ownership dominates in the long run In the long run, we think that BYD’s technological prowess will bring it an even higher economy of scale and possibly expand its sources of revenue. In March 2020, BYD unveiled its newly developed blade battery. Different from the mainstream NCM battery that CATL produces, the 'blade battery' is an LFP battery, which is safer and has a longer lifespan. The short-range of traditional LFP batteries against NCM was also overcome by BYD research. So, now the blade battery and NCM battery provide the same range support to EV. In terms of cost, the blade battery also saves 20-30% compared to NCM batteries. As of now, BYD’s blade battery production capacity is ~ equipping 180k units of vehicle. According to CMB International’s research, BYD will further ramp up its blade battery production this year and aim to sell them to external clients in addition to equipping all its vehicles with it in early 2021. BYD spent more than 10 years researching the LFP battery and ultimately brought it to fruition; we think the technology behind the battery is hard for up and coming EV makers like NIO and Xpeng to achieve, and that BYD in the long run can: 1) further reduce the cost of its EV relative to competitors and 2) generate revenue streams from the battery market in addition to the car market.  In addition to battery technology, BYD’s core competency is further enhanced by its IGBT chip technology. The IGBT chip is an integral component in EV’s motor driver, and the second most costly component of an EV, accounts for about 5-10% of the total cost. BYD launched its IGBT chip research in 2005 and is now the second in IGBT module sales following the Japanese manufacturer Infineon. In the long run, BYD’s ownership of IGBT chip technology will further benefit its EV cost control and is expected to provide a significant competitive edge against other Chinese and foreign players who are unlikely to have mature IGBT chip self-manufacturing capabilities.  Bid on Clean Energy and Transportation Creates Room to Expand BYD was founded as a battery manufacturer, and while the car business has become its highlight in recent years, its secondary battery business has been growing as well. In terms of batteries, BYD has control along the chain, from raw materials like mineral resources to downstream applications. In recent years, BYD has launched its solar power stations, energy storage power stations, etc, completing its whole solution package, encompassing both storages and applications.  In 2019, BYD’s rechargeable batteries and photovoltaics recorded revenue of CNY 10.5 billion, marking a 17.4% YoY growth. According to CMB International, the continued high growth in electrochemical energy storage demand, this segment of BYD’s business will continue to see a ~15% growth in 2020.  Cloud Rail is another segment of BYD’s business and is currently taking ~1% of BYD’s total revenue. Could Rail provides solutions to cities for their above-ground transportation. Compared to subway and traditional transportations. It has a flexible route layout and low construction cost.  Currently, Shenzhen and Chongqing, two of China’s major cities, are constructing cloud rail, and many other cities both domestically and internationally have expressed interest. We believe that cloud rail fits into the Chinese government’s guidance on public transportations, and if it receives positive feedback from Shenzhen and Chongqing, we might see exponential growth in the number of adoptions in other cities, and this will in turn generate high revenue growth for BYD.    Opportunities and Risks within the Conglomerate Model  BYD’s dedication to expanding its sources of revenue upon its core technology has been a key growth driver for its business. So far, we have observed an efficient dynamic among different segments of BYD's business. Going forward, we see that the battery technology and IGBT chip technology will continue to anchor BYD’s competitiveness in its various fields. However, as BYD continues to grow its conglomerate business model, heavily promoting one specific business can come at the expense of other businesses falling behind their competitors. So, it will be important to monitor BYD's change in company structures and the implications of these changes on company resource allocations in the future.  Valuation Considering the discussion above, we drive our December 2020 price target of CNY 113.7 per share from a DCF methodology, assuming a WACC of 6%. Our price target implies a 7.4% upside – therefore, initiate with an overweight rating. The revenue growth forecasts for 2020/21/2022 are -2%/22%/12% reflect BYD's countercyclical impact by COVID-19, and quick recovery as the Chinese economy stabilizes in 2021. We expect short-term gross profit margin will improve due to ramp demand in EV and formation of economy of scale, growing to 16% in 2021 and 17% in 2023 from 15% in 2019. Still, the strategic fleet expansion to higher-end EVs can pose some uncertainties here, and we have reflected this concerns in the revenue model building by selecting gross margin in line with traditional lower to mid tier BYD models. We apply a 1.75% perpetual growth rate. Our bull case and bear case scenario valuations suggest a 31% upside and 18% downside, respectively.

Analysis EO
Analysis · 2
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Analysis EO
Aug 24, 2020 12:11 am ·

Apple and China: A Mutually Beneficial Relationship

► Over 380 suppliers to Apple in China cover almost every section of the American tech giant’s smartphone manufacturing industry chain: from expensive components, such as display panels and chip packaging services, to cheaper elements such as acoustic components and printed circuit boards. ► The Pearl River Delta and the Yangtze River Delta have the highest number of Apple suppliers and are the most technology-intensive regions. ► The central and Northern regions are relatively more labor-intensive locales within Apple’s value chain. ► The Chinese capital market is showing high confidence in firms lying in Apple’s upstream, presenting an average 112% price rise during the past 12 months. ► The bargaining power of Chinese Apple suppliers doesn’t seem to be significantly strong. ► We highlight local companies highly related to Apple’s business:  Luxshare Precision, Lens Technology and AAC Technologies. Apple's (AAPL:NASDAQ) recent moves include encouraging Luxshare (002475:SZ), the 'next Foxconn', to expand its business by acquiring Wistron's (3231:TW) iPhone production lines and Cowell Electronics (01415:HK); these show the American tech titan's intention to deepen its network in the vast Chinese market. As US-China tensions might obstruct the transactions between the two countries, the importance of the localized manufacturing of Apple products in China has been pushed to a new peak of significance. And the Chinese companies along Apple's value chain in return will be strongly related to the Apple products' market performance and the escalating geopolitical tension. Firms standing along the industry chain are all exposed to such risk. Chinese firms are in most sectors of Apple's industry chain Apple suppliers based in mainland China did not have a huge share in its upstream structure in 2019, with 19 out of the total 193 companies. Though the quantity of suppliers is not that considerable, the coverage is quite extensive in terms of component costs – running the length of the scale from the most expensive ones (cameras and touch panels) to the cheaper parts (batteries and audio components). In the higher-valued components segment, China's Ofilm (002456:SH), which earlier acquired SONY's (SNE:NYSE) Chinese subsidiary Sony Electronics Huanan, is the supplier of camera models for iPhones and iPads. TechInsight reported that Apple's 2019 flagship iPhone 11 series are all built with SONY camera modules. Ofilm can be reasonably considered the Chinese representative of the Japanese company. Another costly component of Apple products – display panels – also depends on Chinese firms as key suppliers. BOE Technology (000725:SH), as the supplier of one of Apple's strongest rivals (Huawei) is also paid by Apple as a supplier to restrict Samsung's (005930:KR) monopoly in Amoled display supply. Though the Amoled market is still largely occupied by the Korean company with around 80% of the total, BOE could expand and conduct better R&D with Apple's large volume of orders. Besides BOE, Ofilm and BIEL Crystal also stand in the high cost segment with glass lens offerings. In the 'middle-cost' area lies BYD Electronics (00285:HK) which is responsible for the final assembly and testing. It is certain that BYD participated in the assembly procedures for the latest iPhone 11 Pro series – in fact, the company was once and will be in the iPad/iPod Touch assembly lines. Besides, with the recent acquisition of Wistron's iPhone production lines, China's Luxshare will be in the final assembly sector as well. China-based firms are apparently more crowded in the lower-valued components, including batteries, connectors, audio components and other supporting materials. However, the lower cost of the product does not equal lower profitability. Take AAC technology (02018:HK) for example,  the acoustic components provider for Apple's AirPods and audio components in iPhones – their gross profit margin reached 29% in the fiscal year of 2019. As the market of true wireless stereos (TWS) and other IoT-concept consumer electronics blooms, a demand generally involving requirements for audio quality and long battery life, these companies may keep the rising trend for both market cap and the real earnings. Where the mainland’s companies are absent among high-valued components is in the processors and memories sectors, which are currently dominated by US companies such as Apple and Qualcomm (QCOM:NASDAQ) and South Korean companies like Samsung and SK Hynix (000660:KR). Processors and memory as the key performance drivers for device up-grading; Chinese suppliers are not deeply engaged in these key components. Among Apple's top 200 suppliers, which accounted for 98% of the total procurement expenditures for materials in 2019, 19 are based in the mainland of China, while 43 have headquarters in Taiwan. The coverage of Taiwanese suppliers is as broad as that of the mainland, but with better involvement of the higher-valued components – e.g. the chipset foundry business of TSMC (TSM:NYSE). Two Chinese Deltas support Apple the most Though the Chinese companies (including Taiwan) only account for around 30% of companies' total numbers along Apple's supply chain, manufacturing branches /factories are more significant in quantity terms. Among 830 branches related to Apple products, 380 are based in mainland China, weighing in at around 46%. The map above presents the geographic distribution of Apple's manufacturing branches. Among China's 34 provincial-level administrative regions, 19 are involved with the US company's supply chain. Though many of the factories are the suppliers of suppliers along the complex value chain, and are of comparably high fungibility, Apple's business performance or policies that would affect the bilateral transactions and the economies of these regions are still highly correlated. The 380 branches that participate along the supply chain are concentrated in the Yangtze River Delta and Pearl River Delta, which account for 46% and 38% of the total number in China, respectively. The Yangtze River Delta area, as the country's most important economic region, which contributed around 20% to China's total GDP in 2019, is deeply drenched in the US firm's supply chain as well. With 173 related branches rooted, the region is not only distinguished in quantity, but also in technology advancements as most of the Apple-related products there are technology-intensive. The major categories are display panels, semiconductor components, final assembly and other components related to antenna and acoustic modules. The second most involved region is the Pan-Pearl River Delta, with 144 Apple supplier branches. In this region, Guangdong province contributed the most, as Guangdong and Shenzhen have been engaged with the technology industry since 1978, the period of Economic reform, and have nurtured considerable technology giants such as Huawei, ZTE (00763:HK), Tencent (00700:HK), the BBK group and countless promising startups. As a causal trait, Guangdong harbors the most comprehensive electronic industry chain. Apple's supporters in the PPRD area lie in a similar range of panels and screens, with the Yangtze River Delta, but with fewer assembly lines while more low-valued electronic and non-electronic components. The central region that comprises Shandong, Shanxi and Henan, is comparatively more labor-intensive as Shandong and Henan are the second and third populated provinces in China. Businesses along the Apple supply chain are mainly related to Foxconn's (2354:TW) final assembly lines and Goertek's (002241:SH) audio components. Investors' confidence is high in Apple suppliers in China The chart below presents the financial and stock performances of 11 Chinese public companies that are in Apple's value chain, which are mostly classified in the electronic equipment manufacturing industry. For the most recent year, from August 2019 to 2020, the selected companies achieved an average price rise of 112%. As the US 'tech war' against China rages on, the Chinese government has pushed favorable policies, injecting capital into upstream firms in the technology industry. Consequently, there has been a great deal of hype around technology-related stocks since the beginning of 2020. Though the overall market caps of Chinese public firms are on the rise, companies that are in Apple's value chain delivered particularly eye-catching results. Led by Lens Technology's (300433:SZ) 266% rise in price per share (without changes in outstanding shares), the average percentage change of Apple supplier stocks reached 112%, which is 32% higher than the industry average. The prior reason for the outstanding performance may not be directly related to Apple, as most of the companies listed above also provide components for other consumer electronics vendors such as Huawei and Xiaomi (01810:HK). The investor confidence for the overall electronics market driven by the 5G commercialization is the context. However, Apple, as the highest valued tech firm around the world to some extent endorsed the capacity of its suppliers and empowered them by the considerable volume of orders. Though the market is giving  positive feedback, the profitability of those suppliers is hardly above the average. Over 60% of the suppliers presented gross margin lower than the industry average level at 15.69%, indicating a relatively plain bargaining power. Highlighted companies Luxshare Precision Luxshare (002475:SZ) has been closely working with Apple’s supply chain, providing precision components for Apple's consumer products. In 2019, the company became the biggest manufacturer of Apple’s Airpods. The cooperation with Apple has brought Luxshare a rich margin at 20% and a soaring stock price with a 179% rise. By acquiring 100% equity of the Taiwan-based iPhone manufacturer Wistron Corporation’s (3231:TW) assembly businesses Wistron (Jiangsu) Co., Ltd and Wistron (Kunshan) Co., Ltd, the company becomes mainland's first iPhone assembler. As the conflict between the Eastern and Western intensified, Luxshare is in high possibility to shoulder more of Apple's supply in Asia.  Lens Technology As the company with the highest stock price rise at 268%, Lens Technology (300433:SH) is the provider of cover glass for Apple's iPad, iWatch and possibly the iPhone. With the impact of the pandemic, the rocketing sales of PC and tablets with 26% year-on-year growth in the second quarter of 2020 drove the company's revenue from large-sized glass up by 40%. As the research institution Canalys forecasts, the demand for PC and tablets will increase for the following quarters. The favorable situation is similar for smartphones and smart wearables due to the economic rebound and the 5G rollout, which will simultaneously drive Lens Technology's revenue. AAC Technologies AAC Technologies (02018:HK) has long been cooperating with top vendors like Samsung (005930:KR), Apple, Huawei and Xiaomi within its acoustic components business. Known for its MEMS microphones and speakers, the company has clouted both domestically and overseas as one of the top three companies in the global acoustic component market. In the first quarter of 2020, its revenue shrank by 5.1% year-on-year, affected by the oversaturated smartphone market and the COVID-19 outbreak in China. Nonetheless, its deep roots in China make the firm be greatly supported locally: for one, Xiaomi and OPPO invested in AAC’s optics arm in July 2020, joining the list of its ‘industrial’ backers. 

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Analysis EO
Feb 26, 2020 06:16 pm ·

The Story Behind the Mask: A Racing Game For All Suppliers

It has been over a month since the outbreak of coronavirus in early January. While most manufacturers are suffering due to the suspension of work, some nimble companies are seeking new opportunities for timely adjustments. On February 14, the Chinese car-maker, General Motor Wuling Auto (00305: HK), handed over one million self-produced masks to the government and the medical team on the front line. It only cost the car manufacturer two weeks to reorient from an auto producer to a mask supplier. Five days later, Wuling took off its first mask production equipment from the assembly line within 76 hours. Car manufacturers started to produce masks The car industry, as a highly integrated system, could be one of the most affected industries amid the continued spread of the plague. The previous SARS event provided some hints about the potential impact on the mobility industry (see the analysis). Pressured by a lack of dynamics from upstream and downstream, the car sales are forecast to slump 5%-10% in 2020 based on a BCG report. This agile reorientation not only saves car factories from severe financial stress but also spurs their commitment and social contributions towards the anti-virus war. Wuling decided to rebuild the auto assembly line into 14 mask production lines, including four N95-type lines and others for general medical uses, expecting a 1.7 million daily output. BYD (1211: HK), the new energy electronic vehicle company, planned to produce 5 million daily and 50 thousand bottles of disinfectant by the end of February. Claiming the move is not for economic return, these new transformed providers are de facto implementing a win-win strategy. When BYD announced this cross-industry plan on February 8, the market responded positively, applauding its share price up to HKD 59.04 by 9.64% within a day.  Are masks produced by car-makers effective? By function there are four types: the gauze mask, surgical mask, daily protection mask and industrial dust mask. In the context of coronavirus, surgical and N95 ones are the two types that can help prevent infection. Considering the medical standard and hygienic production environment, many people cannot help but wonder about the efficacy of this kind of protection from non-medical factories. Indeed, it is not a popular idea that car-producers make masks, but it is not unprecedented either. For example, the German brand Volkswagen has run its sausage business for nearly five decades. So, auto production is a business of strong adaption capability, with flexible potential to expand the business. The surgical or N95 mask is mainly made of polypropylene, a high-specification material with melt mass-flow rate (MFR) at 33-41 g/min, which is the same material applied to the soundproof cotton in car manufacturing. Plus, the car-coating workshop can provide dust-free production space with constant humidity and temperature, exactly satisfying the production standards for simple medical supplies.  With these pre-set technical advantages, no wonder many car manufacturers are actively engaging in mask production, publicizing the brand and injecting productivity into the slumping market. The only issue is how much the public accepts this concept and how long the companies will stay committed before getting back to their usual business. Why are other players joining the mask business? Following the wind raised by the car manufacturing industry, big names from other industries started to jump on the bandwagon. Sinopec (0386: HK), one of the Big Oils, cooperated with medical partners to produce masks and more names are expanding the list. Companies such as Foxconn (electronics contract manufacturing company), Daddy Baby (diaper company) and Gree Electric (000651: SZ) have joined. But why are these companies reorienting their businesses? One drive is the push from the sluggish market; the other is the pull from the considerable demand. Take the car industry as an example.  A push out of options Hubei Province, the most suffered area amid the Covid-19, is also the most crucial supply base of auto parts. It houses some exclusive auto-part providers, playing an irreplaceable role in the industry of Original Equipment Manufacturer (OEM). The long-term suspension of work is inevitably volatile to the global auto-parts supply chain, as pointed in a previous analysis. Even the auto giants face the risk of sizable economic losses. Mercedes Benz (Beijing), applied on February 6 to resume work, stating it would lose CNY 400 million every day if it uses up its one-day secure stock. BCG report expects a domestic capacity loss of eight days. A pull for long-term hope Meanwhile, the market sees a surging demand for masks for general use and medical use. Some target cities, like Wuhan, announced on January 23 that according to the “Infectious Disease Prevention Act” citizens must wear a mask in public or face criminal liability in extreme cases. Hua Chuang Securities provided a cursory look into the current situation of medical supplies. Based on China’s Fourth National Economic Census (2019), there is a total population of 533 million working people, including 200 million in the secondary industry and 330 million in the third. If all companies resume work at full capacity nationwide, at least 530 million pieces would be needed, presuming every employee consumes one per day.  How many masks do we need? Not even close. The reality is that the supply is still far below the need. As of February 22, China’s domestic capacity can provide 54.8 million masks every day, almost three times of February 1, accumulating 570 million within 20 days. But it is still far from estimated 530 million on daily average if counting on the 5.6 million imported for weekly use. Not to mention that workers in the critical areas such as manufacturing, medical and transportation are required to change more frequently (every four hours). The fast-spreading virus has heightened concerns in other neighboring countries. As of February 24, Korea has an accumulated record of 833 identified cases, including 231 newly added and Japan totaled 838 cases. The increasingly heated anxiety is affecting the market price of masks, with a typical surgical one sold at nine-fold of its original price in South Korea, or 6000 surgical ones prices at USD 456. Moreover, the housing industry, travel business and logistics, as the key economic drivers, are all struggling while anxiously waiting for the turning point. The outbreak of Covid-19 has put the nation’s economy and public health in danger, while raising awareness of public health. Mask, a basic medical protection resource, has proven to be an asset.