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What happened to China Automotive Systems?

China Automotive Systems (CAAS) reported 3rd quarter earnings on November 9 and the stock promptly sank.

I have written about the stock previously. The post was titled (with high expectations) "China Automotive -- looking for another good quarter." What went wrong?

Chart Breakdown --

CAAS had been caught in the general market downturn that began in the first few trading days of November. This derailed what was looking like a nice pattern forming that indicated the stock might be bouncing off support and getting ready to start running up again. The support didn't hold and the stock has been trading in a choppy manner before dropping further today. It now looks like the stock could take another leg down before bottoming.

The Numbers --

For the most part, it appears that 3rd quarter earnings were actually quite good. The day earnings were actually announced, the stock ran up nicely but fell back before the end of the day. Here is a rundown of the numbers:

-- Total net sales for the period increased to US$31.2 million, reflecting 39% year-over-year growth;

-- Net sales from steering components for passenger vehicles increased to US$20.2 million, reflecting 49% year-over-year growth;

-- Net sales from steering components for commercial vehicles increased to US$8.11 million, reflecting a 26% increase year-over-year;

-- Operating income increased to US$6.6 million, reflecting 95% year-over-year growth;

-- Net income rose to US$2.6 million, reflecting 68% year-over-year growth;

-- Diluted earnings per share were US$0.11, an increase of 57% year-over-year

Why didn't these numbers kick the stock into overdrive? First, note that all the results listed above are year-over-year numbers. Compared to the previous year, the results are indeed excellent. Looking at the numbers from a sequential point of view, however, not everything is so wonderful.

The first thing that jumps out is that sequential revenue is actually lower compared to the 2nd quarter. This has the downstream effect of causing a quarter-over-quarter decline in gross profit. Operating income was only 5% higher in the 3rd quarter than it was in the 2nd quarter.

A decrease in unit cost was partially offset by a decrease in selling prices which in the end resulted in the decrease in gross profit. Gross margin slipped a bit year-over-year which also contributed.

The company received an income tax refund of $801,059 for domestic equipment purchased during the 3rd quarter, which was reflected as a reduction of income tax expense in the company's consolidated statements of operations. Overall financial results would have been worse if this one-time tax benefit had not occurred.

Not everything is negative. The company did manage to keep a tight rein on costs.

Conclusion --

With the agreement with Volkswagen in place, I had expected to see an accelerated improvement in China Automotive's numbers. Though management pointed to the 3rd quarter as historically a slow season in the Chinese automotive market, I had the expectation that it would be able to overcome the slowdown due to increases in manufacturing and partner agreements. That just didn't happen.

Still, the company claims to be growing faster than the market, specifically the Chinese market. On an annual basis, results should be clearly better than the previous year. Unfortunately, it appears that the Chinese government is trying to cool off the entire economy by putting limits on bank lending. This will not bode well for the automotive sector as the vast majority of vehicles are purchased via auto loans. As a result, CAAS will, for now, only merit a place on our watchlist.

Disclosure: author no longer holds shares in CAAS

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