China’s economic growth is decelerating and that’s applying the brakes to the automobile sector. Brilliance China Automotive is faced with weak cash flows and falling margins. A StarMine Earnings Quality analysis indicates the company’s earnings may encounter bumps in the road ahead.
As China’s economy slows down (relatively speaking) and as the new leadership that took over in March 2013 demands more austerity measures, demand for luxury goods such as BMW cars may not be as robust as in the recent past. Brilliance China Automotive Holdings Limited (1114.HK), which manufactures and distributes BMWs in China, may well see the effect on its bottom line.
Brilliance has a weak StarMine Earnings Quality (EQ) score of 4. Earnings derived from strong earnings quality are likely to be more sustainable than those that exhibit poor earnings quality.
According to this Reuters report, BMW expects its sales growth in China to be in the single digits in 2013, compared to the robust 40% growth rate it saw in previous years.
In the latest full-year filings, Brilliance chairman Wu Xiao An acknowledged that the company saw “mild” growth in 2012 automobile sales. Sales of minivans and buses are expected to fall in 2013 and 2014 as the company attempts to revamp its offerings.
Cash flow issues
As seen in the chart below, the company has experienced poor cash flows from operations in the last four semi-annual periods. In fact, despite recording strong positive net income in those periods, cash flow from operations has lagged by the amount represented by the red parts of the bars. Cash flow from operations has been negative for two of the last three semi-annual periods. Earnings backed by poor cash flows tend to be less stable than earnings backed by strong cash flows. For the six month period ending December 2012, the company reported net income of 969 million Chinese renminbi (CNY), while cash flow from operations was at CNY -84 million, which represents a cash outflow.
Source: Datastream Professional / StarMine
Operating efficiency declining
Operating margins for the automobile industry in general have been falling, as more car companies jostle for space on the Chinese road. Furthermore, the government has imposed new taxes on gasoline vehicles as a pollution control measure. The chart below shows that median industry operating profit margins have fallen from the highs of 2011. Brilliance has seen operating margins in two trailing semi-annual periods fall much more significantly, to -2.2% in December 2013 from 6.8% in June 2010, and is now more than eight percentage points below the industry median. Operating profit margin is a key component in calculating the return on net operating assets — a measure that has also been falling for the last two years. The company’s operating efficiency is sliding, and that’s one reason for the low StarMine EQ score of 4.
Source: Datastream Professional / StarMine
Analysts are taking note. Just 30 days ago there were 10 Strong Buy recommendations for the stock, and now there are just four. In the last 30 days, earnings estimates have been brought down for the full year to CNY 0.60 from CNY 0.63. The company scores a weak 3 on the StarMine Analyst revisions model, which indicates that further downward revisions are likely.
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