Hitching a Ride on China's Growth in Trucking

05/27/2010 11:56 am EST

Focus: STOCKS

Robert Hsu

Editor, China Strategy and Asia Edge

Robert Hsu, editor of China Strategy, finds a Chinese auto parts company that supplies commercial vehicles, is growing strongly, and whose stock trades at a discount.

China's automotive industry has grown nearly 2,000% in the past 20 years to a whopping 13.6 million total vehicles sold in 2009—surpassing the US to become the world's number one auto market.

Unlike the passenger vehicle market, the Chinese commercial vehicle market is led by domestic Chinese companies. Heavy truck sales grew by an astounding 141% while medium truck sales grew by 54% in 2009. Truck sales will continue to grow over 15% a year for the next several years.

[Also,] beginning in March 2009, auto part exports started to improve. And as the global auto market stabilizes and major automakers increase their sourcing from China, I expect this growth to continue to improve.

Sorl Auto Parts (Nasdaq: SORL) [is] the largest manufacturer of automotive air brake systems for commercial vehicles (trucks and buses) in China.

SORL's brake systems are primarily used for large trucks and buses weighing over three tons. Sales of air brake systems account for 75% of the company's total revenue while air control systems account for 16%.

Currently, domestic Chinese sales make up 76% of Sorl's total revenue, with exports responsible for the remaining 24%.

SORL is a well-recognized brand name in China with longer and more in-depth experience in the Chinese auto parts market. [It] has the most established sales network in both domestic and foreign markets, [and] covers all major truck makers in China, providing higher-quality parts than competitors. SORL also has [a] lower-cost supply network [than] its competitors.

And SORL has a strong track record of sales growth of 21.7% compounded annual growth rate from 2004 to 2009—significantly higher than the 17% annual growth of the truck industry.

The growth will drive an estimated 20% to 25% annual earnings growth in the next five years, due to a combination of strong economic growth, favorable government policies, expanding export markets, and growing aftermarket parts business.

For the second quarter of 2010, SORL's management is expecting sales to be approximately $47 million and net income to be approximately $4.3 million, a sharp 42% jump from the $29.7 million in sales and $3 million in net income a year ago.

In addition, the company has a very healthy balance sheet, with $18.6 million cash. This strong cash position can support its capacity expansion as well as new product development.

The company's shares have sold off more than 35% from its January highs. Currently, the stock is trading at about ten times this year's projected earnings, which is much cheaper than the average valuation of listed Chinese auto part companies, [which change hands at] about 14x their 2010 earnings.

I recommend that you take advantage of the recent sell-off and buy SORL below $10.00.  My six month target for the stock is $13.50, based on 15x this coming year's earnings per share.

(SORL is a small-cap company, with market capitalization under $200 million. It closed above $9 Wednesday—Editor.)

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