China Yuchai International Limited

I would like now to turn the conference over to Kevin Fish. Please go ahead, Kevin.

Thank you for joining us today and welcome to China Yuchai International Limited's second quarter 2020 conference call and webcast. Joining us today are Mr. Wei-Meng Hou and Dr. Thomas Fung, President and Chief Financial Officer of CYI, respectively. In addition, we also have in attendance Mr. Kelvin Lai, VP of Operations of CYI. Before we begin, I will remind all listeners that throughout this call, we may make statements that may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. The words believe, expect, anticipate, project, targets, optimistic, confident that, continue to, predict, intend, aim, will, or similar expressions are intended to identify forward-looking statements. All statements other than statements of historical fact are statements that may be deemed forward-looking statements. These forward-looking statements include, but are not limited to, statements concerning the company's operations and financial performance and conditions, and are based on current expectations, beliefs, and assumptions which are subject to change at any time. The company cautions that these statements, by their nature, involve risk and uncertainties, and actual results may differ materially depending on a variety of important factors, such as government and stock exchange regulations, competition, political, economic, and social conditions around the world and in China, including those discussed in the company forms 20Fs under the headings Risk Factors, Results of Operations, and Business Overview. and in other reports filed with the Securities and Exchange Commission from time to time. If the COVID-19 pandemic is not effectively controlled, our business operations and financial conditions may be materially and adversely affected due to a deteriorating market for automotive sales, an economic slowdown in China and abroad, a potential weakening of the financial condition of our customers, potential adverse impact to our suppliers and supply chain, or other factors that we cannot foresee. All forward-looking statements are applicable only as of the date they are made, and the company specifically disclaims any obligation to maintain or update the forward-looking information, whether of the nature contained in the release made during today's call or otherwise in the future. Mr. Ho will provide a brief overview and summary, and then Dr. Fung will review the financial results for the second quarter ended June 30, 2020. Thereafter, we will conduct a question and answer session. For the purposes of today's call, the financial results for the second quarter ended June 30, 2020 are unaudited and they will be presented in RMB and U.S. dollars. All the financial information presented is reported using international financial reporting standards as issued by the International Accounting Standards Board. Mr. Ho, please begin your prepared remarks.

Thank you, Kevin. In the second quarter, China economy resumed growth as GDP increased by 3.2%, far below historical trend, but a strong rebound from the 6.8% economic contraction of the first quarter of 2020, which was severely impacted by the COVID-19 pandemic. The aftermath of the COVID-19 pandemic created major disruptions in the Chinese economy and automotive industries as it affected customers, suppliers, workers, distributors, service networks, and other auto-related occupations. The national and interprovincial travel restrictions negatively impacted many supply chains in the automotive industry. Following the reopening of the Chinese economy, the government enacted economic growth catalysts including higher fiscal spending, more approved infrastructure projects, and lowering lending rates and bank reserve requirements. Manufacturing activity increased since May, and China's export grew partially because China was among the first to ease lockdown action. According to data reported by the China Association of Automobile Manufacturers , in the second quarter of 2020, sales of commercial vehicles, excluding gasoline-powered and electric-powered vehicles, increased by 50.5%. Truck sales increased by 56.1%, with JVDT truck sales up by 64.9%, medium-duty truck sales rose by 32.5% and bus sales increased by 1.8%. Part of this growth was attributable to the pent-up demand from the first quarter of 2020 as much of the economy was essentially shut down with lockdowns and travel restrictions implemented to inhibit the spread of the COVID-19 infection. Our operational and financial results during the second quarter reflected the rebound from the disruptions in the first quarter of 2020 due to the COVID-19 outbreak. Our total unit sales improved by 32% year-over-year. Our overall truck engines and bus engine unit sales grew by 23.3% in the second quarter of 2020, with heavy-duty truck engine sales rising by 40.8%. and medium-detached truck engines up by 53.3% year-over-year. Off-road engine sales increased an impressive 51.7%, led by a 78.5% growth in the seasonal agricultural machinery market. As a result, our revenue increased by 34.7% to RMB 6.5 billion, all U.S. dollars 925.2 million. The growing sales of our National 6 engines in the Chinese heavy duty truck engine market is directly related to the growing acceptance of our National 6 natural gas engine products. We have already established a position as one of the leading suppliers of heavy duty National 6 engines to the truck and bus market in China. Operating profit increased by 53.6% to RMB $448.7 million or USD $63.4 million and basic undiluted earnings per share rose by 66.4% to RMB 5.99 or USD 85.10. In the second quarter of 2020, the total R&D expenditure, including capitalized costs, was RMB 280.3 million or USD 39.6 million. And for the six-month ended June 30, 2020, total R&D was RMB 402.7 million or USD 56.9 million R&D represented 4.3% of net revenue in the second quarter of 2020 and 4% of net revenue for the six months ended June 30, 2020. We continue to improve our National 6 and Tier 4 technologies and production techniques as we are progressing on our products for the renewable energy market. With the continuing national implementation of the more stringent National 6 emissions standards, our portfolio of national six compliant engines, including products powered by natural gas, positions us well with our existing customers and attracts new ones as well. In 2019, we have established strategic partnership with Sunsea Automobile Holding Group, a leading producer of heavy-duty trucks in China, and the Photon Motor Group, a market leader in the on-road vehicle segment. We also entered into a new strategic partnership in the second quarter of 2020 to become a strategic OEM supplier to Sanyi Truck, part of the Sanyi Group Company Limited, which is China's leading machinery equipment maker and has a worldwide presence. This new partnership will further improve our market position in the future. We have used newly developed engine technologies to build or modify engines for specific markets. During the 2020 first quarter, an advanced high-powered marine engine was introduced to penetrate the growing demand for vessels in the yacht class. This segment has historically been dominated by imported engine models. Innovative technologies have increased the engine power and reduced the engine drive weight of the YC6MJ marine engine to make it competitive with the imported engine. During the first half of 2020, GIL MCL announced that its YCA05175-S500 engine passed European Stage 5 emission test, and this EHI engine can now be marketed in the European Union for off-road applications. We retain our financial strength despite the disruptions in sales and operations in the first half of 2020, with cash and bank balances of RMB 6.6 billion at June 30, 2020, and we pay the cash dividend of US$0.85 per share on July 31, 2020. Similar to the rest of the world, China's economy still faces significant uncertainties. With China successfully reopened its economy and automobile industry already experienced a pronounced rebound beginning in April, we remain cautiously confident that Chinese economy is on the recovery path for the remainder of 2020. With that, I will turn to Thomas to go over the financials.

Thank you, Winmin. Now let me review our second quarter result for 2020. Revenue for the second quarter of 2020 had increased by 34.7% to RMB $6.5 billion, US$925.2 million, compared with RMB $4.9 billion in the second quarter of 2019. The total number of engines sold by GMCL during the second quarter of 2020 was 145,278 units an increase of 32.0% compared with 110,059 units in the second quarter of 2019. The increase was mainly due to higher engine sales to the truck market and off-road segment, particularly unit sales to both the heavy and medium duty trucks market which more than offset an overall sales decline in the bus engine segment. According to data reported by the China Association of Automobiles, CAAM, excluding sales of gasoline-powered and electric-powered vehicles, in the second quarter of 2020, sales of bus increased slightly by 1.8%, while truck sales rose by 56.1%. According to CAAM, in the second quarter of 2020, commercial vehicle excluding sales of gasoline-powered and electric-powered vehicle increased by 50.5% compared to the second quarter of 2019, while GM cell sales to the on-road commercial vehicle market increased by 23.3%. GM cell unit sales to the off-road market increased by 51.7% compared with the second quarter of 2019. Gross profit increased by 33.0% to RMB $948.1 million, US dollar $133.9 million compared with RMB $712.9 million in the second quarter of 2019. Gross margin was 14.5% compared with 14.7% in the second quarter of 2019. Other operating income was RMB $61.8 million, US dollar $8.7 million compared with RMB $98.8 million in the second quarter of 2019. The decrease was mainly due to lower government grant in the second quarter of 2020. Research and development expenses R&D expenses increased by 24.0% to RMB $137.0 million compared with RMB $110.5 million in the second quarter of 2019. Higher R&D expenses in the second quarter of 2020 were mainly due to higher development costs for National 6 and Tier 4 engines on testing and experimental costs. In the second quarter of 2020, the R&D capitalization amount was RMB $143.3 million, US dollar $20.2 million. The company continued to further develop its new National 6 and Tier 4 engine for the on and off-road market, respectively. In the second quarter of 2020, the total R&D expenditures, including capitalized costs, was RMB $280.3 million, $39.6 million, and it represents 4.3% of revenue compared with 3.6% in the second quarter of 2019. Selling General Administrative, SG&A expenses, increased by 3.7% to RMB $424.1 million from RMB $408.9 million in the second quarter of 2019. The increased primary result from higher warranty expenses and outward freight expenses in the second quarter of 2020. SG&E expenses represent 6.5% of revenue compared with 8.4% in the second quarter of 2019. Operating profit increased by 53.6% to RMB $448.7 million, $63.4 million from RMB $292.2 million in the second quarter of 2019. The operating margin was 6.9% compared with 6.0% in the second quarter of 2019. Finance cost decreased by 17.4% to RMB 26.7 million, USD 3.8 million from RMB 32.4 million in the second quarter of 2019. Lower finance cost was mainly result from reduced bill discounting amount compared with the second quarter of 2019. Net profit attribute to China East High shareholder increased 66.4% to RMB $244.7 million, US dollar $34.6 million, compared with $147.0 million in the second quarter of 2019. Basic and diluted earnings per share rose 66.4% to RMB $5.99, US dollar $0.85, compared with RMB $3.60, in the second quarter of 2019. Basic and diluted earnings per share in the second quarter of 2020 and 2019 were based on a weighted average of 14,858,290 shares. Now I will go over the first six months results of 2020. Revenue was RMB $10.0 billion compared with RMB $9.0 billion in the same period last year. Total number of engines sold by GM Shell in the first half of 2020 was 213,182 units compared with 211,359 units in the same period last year. The increase was mainly due to higher engine sales in the heavy-duty trucks and off-road segment, particularly agriculture engine, which more than offset the sales decline in the bus segment. Gross profit was RMB $1.5 billion, US dollar $208.8 million, compared with RMB $1.5 billion in the same period last year. Gross margin decreased to 14.8% compared with 16.3% a year ago. The decline in gross margin was mainly attributed to product mix. Other operating income declined 26.0% to RMB $105.7 million, US dollar $14.9 million compared with RMB $142.8 million. in the same period last year. The decrease was mainly due to lower government grants compared with the same period last year. R&D expenses increased by 16.8% to RMB $213.0 million compared with RMB $182.4 million in the same period last year. Higher R&D in the first half of 2020 was mainly due to higher development costs for National 6 and Tier 4 engines on testing and experimental costs. In the first half of 2020, the R&D capitalization amount was RMB $189.7 million, US dollar $26.8 million. The company continued with its initiative to develop new engines compliant with China's Emission Standard, National 6 and Tier 4, and to improve engine performance and quality. In the first half of 2020, the total R&D expenditure, including capitalized costs, was RMB $402.7 million, US$56.9 million, representing 4% of the revenue compared with 3.3% in the same period last year. As G&A expenses, decreased by 3.5% to RMB $757.4 million, US dollar $107.0 million from RMB $785.1 million in the same period last year. The decrease was mainly due to lower warranty expenses and reduced outward freight costs, particularly in the first quarter of 2020 compared with the same period last year. SG&A SG&A expenses represent 7.6% of revenue for the first half of 2020 compared with 8.7% in the same period last year. Proprietary profit decreased by 5.6% to RMB $613.2 million, USD $86.6 million. from RMB $649.4 million in the same period last year. The operating margin was 6.2% compared with 7.2% in the same period last year. Finance costs increased to RMB $63.2 million from RMB $57.6 million in the same period last year. The increase of approximately RMB5.5 million. Higher finance costs mainly result from an increase in borrowing compared with the same period last year. Net profit attributed to China Yichai shareholder was RMB305.7 million, USD43.2 million compared with RMB345.0 million in the same period last year. Basic and diluted earnings per share was RMB 7.48, USD 1.06 compared with RMB 8.44 in the same period last year. Basic and diluted earnings per share for the first six months of 2020 and 2019 was based on a weighted average of 40,858,290 shares. Now let me walk you through our balance sheet highlight as of June 30th. Cash and bank balance were RMB $6.6 billion, USD $931.5 billion compared with RMB $6.4 billion at the end of 2019. Trade and bill receivable were RMB $9.2 billion, USD $1.3 billion compared with RMB $7.8 billion at the end of 2019. Inventory will RMB 4.0 billion, USD 565.0 million compared with RMB 2.8 billion at end of 2019. Trade and build payable will RMB 7.9 billion, USD 1.1 billion compared with RMB 6.2 billion at end of 2019. Short-term and short-term bank borrowing were RMB 2.7 billion, U.S. dollar 377.4 million, compared with RMB 2.1 billion at the end of 2019. Now I'll turn the call over to Kevin for the comments before we begin our Q&A.

Thank you, Thomas. Please note that due to the COVID-19, the officers of China Yuchai are remotely calling into the conference room. This may result in a slight delay in providing answers to some questions. We apologize for any inconvenience and thank you for your patience. With that, operator, we're ready for the Q&A session.

Thank you so much. Ladies and gentlemen, it's if you wish to ask a question. One moment, please, for the first question. And the first question comes from the line of William from Greenbridge. William, your line is now open. It seems that William disconnected his line or canceled his question. So your next question comes from the line of Don Espy from Share Capital. Don, the line is now open.

Good morning, all. Nice quarter. Thank you. A few questions here.

Yep.

Please provide more color on GYMCL's EV powertrain, both current sales and future prospects, and fuel cell development program.

Okay, we launched the NEV products last year. The products are still in development stage except for the range extender. So the range extender, we have sold very few, about 17 sets. The amount in terms of dollar value is not material. So as far as the fuel cell is concerned, we are still in development stage. We have gotten out one prototype, which is a 35 kilowatt fuel cell. And then we are working with one of our OEM partners to have that installed in their vehicle.

GYNCL was number three in market share in national six HD truck engine market in the first half of 2020. How long before you see this metric improving to number two?

That's a good question. We'll do our best. As you know, this industry in China is a highly competitive industry. And there are many players in there. So I think you have to wait and see. I'm sorry I can't give you a definite answer or even any indications of that.

OK.

Switching gears, does the current US administration's accounting and audit proposal affect CYD, assuming the company does not move its main listing to China or Hong Kong?

Well, we are monitoring the development in China, in the U.S. very closely. So we will update our investors as and when there's further development. And as and when we have, what we call, further thoughts on it, where we believe that it's appropriate to share with our shareholders, we will do so then. As it is, all we can do is wait out the U.S. situation right now and monitor the events closely.

Okay. As a long-term shareholder, we're curious why Weichi and Cummins have so massively outperformed CYD over the last 1, 3, 5, and 10 years. We'd like to hear your view on this dynamic and, you know, maybe how you plan on changing this.

Well, I mean, each has its own, right? I mean, you know, Cummings is a huge, it's a multinational with a global presence. They are very strong in certain segments, and they also have their OEM plant as well. We operate a bit differently from both of them. In our case, we have a very broad range of products that we sell, and our sales are mostly from the domestic market in China. Although we will, of course, explore our export market, which we have done quite a bit in the last couple of years, this year we are affected by the COVID-19 pandemic. So going forward, I think our strategy will still be the same. We will, of course, move on to explore more export markets, which is a big market out there, and have a better product that we currently develop with our national six. In fact, right now, our after-sales service network is still a huge advantage to us right now still in servicing our end users right now in China. So we will do what we can to maintain or to compete with our customers in both domestic market as well as in the international market.

Okay. Thank you. That's all from us. All right.

Thank you so much. Once again, ladies and gentlemen, it's star and one. If you wish to ask a question. And the next question comes from the line of William from Greenbridge.

Hi, guys. Great quarter. Just kind of going off Don's last thing about the export. Are you guys seeing, I mean, much demand, you know, COVID or not COVID environment on the export side? And is there any, are you guys having any issues with your supply chain?

Okay, now we have no issue with the supply chain, but I think the export market has been affected by COVID-19, as I mentioned earlier. So we actually saw a decline, a drop in our export sales for this year so far.

Okay, can you quantify about what percent of your sales are export?

Now it's dropped to perhaps about less than the... 10% about 10% or less than 10%.

Okay, and where do you think that was about a year? You know, same period last year?

Last year is about 12 to 12 to 14%.

Okay. On the on the margin side, it looks like you know, gross margins are down quite a bit. How do you see that trending for the for the remainder of the year?

Okay, I think this one, if you look at the second quarter, it's basically similar to last year's second quarter. So it's largely due to product mix. And also, I think with the next six that are starting to sell, national six engines that are starting to sell, as and when the units of national six sales go up, we will see improvement in the gross margin when we get what I call... economy at scale. And also we are now working hard to bring down the cost of the new product to a level where we have now for those products that have already matured. So we hope to see that in the next half of this year and hopefully next year, some improvements.

Okay. So do you think getting to around 18% next year is still feasible?

Yeah, we're working towards that. I don't think we're too far away.

Okay. And the last question was, obviously, you know, sales have been very strong since kind of the restart in China. How are you seeing that, you know, trending the rest of the year?

I believe for the rest of the year, it will be better for us compared to the similar period last year. We are actually seeing quite a good number coming in for the month of July for ourselves. So we think the second half, although it will be slower than the first half, which is normal in our business, It's seasonally lower, but we believe it will be better than the previous year's second half.

Okay, great. Thank you, guys.

Thank you.

Thank you so much. Once again, ladies and gentlemen, if you wish to ask a question, it's star and one on your telephone. Again, it's star and one if you wish to ask a question.

Okay, there's a question here from the webcast. Can you please give us more color on the Sun-Yid Strategic Partnership? Any guidance on the number of incremental units? This will bring the strong Second Q 2020 results benefited from the Sun-Yid Partnership. now the sunny partnership is it's a very new partnership uh no sales that we have not had any sales from them and not much sales from them yet so uh i'm sorry you can't give any guidance but uh going forward we expect it to to improve uh maybe in the next year or so okay

And the next question comes from the line of David Redden from Eversport. David, your line is now open.

Yes, hello. I'm sorry. It's hard to hear you. Can you hear me?

Oh, yeah, yeah, perfectly, David. How are you?

Oh, wonderful. How are you? And I apologize. I was on another call, so I might be asking a question that was already asked. Can you give us a little bit of a timeline of the NS6 rollout? and some sense of the price points of the NS6 product versus the existing product. Thank you.

The rollout, I think the gas engine for National 6 was implemented in the middle of last year. In the middle of this year, the government vehicles have to be all National 6, and it will be fully implemented by middle of next year. So in terms of price point, we are having a higher unit selling price for National 6, somewhere in the region of maybe over 10% so far, you see. So a lot of it is still under negotiation with our customers right now. So I can't give you more specific than that.

Well, thank you. In the past, as you know, some of the Deadlines sort of get moved around, especially in some of the non-major cities. But at this stage, you're not seeing any change in the application of the deadlines, is what I'm hearing.

Yeah, not for national sales. Okay. Not that we are very open.

And when do you think the majority of the trucks will have NS6 for your sales? Do we need to get to end of 21, middle of 21?

I think by the middle of 21, it should be. The new truck sales should be mostly National 6, especially for heavy and medium duty trucks.

And given the 10% higher price point, would you argue even at the initial ramp up, the transition, that the margins are higher for those engines for you than the existing? Or does it take a little while, the typical higher warranty expense on a new engine to Does the margin help not show up until, say, 2022, just for a sense of mixed modeling?

Okay. You're right. Right now, we are not seeing, we are not having, the margin is not as we had hoped for, and it's not as good as the national five margin. A lot of, there's still a lot of work that needs to be done to improve on our cost base. So going for the rest of this year, second half of this year, we expect to see improvement. And then I would say it will take until 2021, maybe even 2022, to reach the level of the margin that we hope to achieve.

Thank you very much. I appreciate it.

Okay.

Thank you so much. Once again, ladies and gentlemen, it's star and one. if you wish to ask a question. Again, it's a star and one if you wish to ask a question. One thing, ladies and gentlemen, if you would like to ask a question, you can just press a star and one on your telephone keypad. Again, it's star and 1 if you wish to ask a question. And we have a follow-up question. It comes from the line of David Russell from Evercore. David, do you mind to ask a question?

Thank you for the time for the follow-up. And again, I apologize if this was asked earlier. Given the strength you're seeing on highway and obviously even off highway, what are your thoughts about next year? I know it's early, but obviously the strength this year has been fairly dramatic. So, you know, folks do get a bit nervous about the tough comparison, 21 versus 20. Anything you're seeing in your order books, off or on highway, to at least set some baseline for how we should think about 21 on and off highway? Thank you.

Yes. We do not have much visibility on our order books for 2021. But for this year, I think there are a few factors that we should talk about. One is that because of the COVID-19, especially in the first quarter where China had a kind of bad quarter, there was a pent-up demand, so to speak, for the business, right? So that's why the second quarter turned out to be very strong for us. And in addition to that, to stimulate the economy, the government came up with a few measures which also helped in our case. So some of these measures will continue into the next quarter and hopefully for the rest of the year as well. So this year, we believe it will be better than last year overall. But going to next year, if we had a good year this year, then it's going to be very difficult to expect the same kind of growth or even same kind of performance sequentially to next year. So I'm sorry, David, I can't give you a more specific answer, but it's actually very hard to actually have any visibility right now. I don't have too much visibility right now.

No, I appreciate that. I'm just trying to figure if I'm modeling a down 10 to 15 off of a tough comp is that just some sense of no one's expecting the same kind of growth, obviously. I think most people are figuring it's got to be flat to down unless there's new levels of stimulus specific, but people just get nervous when they see how high it is. Could it drop 30%? I just wanted to give you a chance to level set people a little bit on how to think about it. But it just feels like your order book doesn't have enough visibility or there's enough conversations with customers to really know at this stage.

Yeah, it's a bit early for us right now. And then next year we still have the issue of the next six implementations nationwide as well. So that's the other factor that's going to come into play.

Yeah. Okay. Well, I appreciate it very much. Thank you so much

Thank you.

Thank you so much. Once again, ladies and gentlemen, it's star and one if you wish to ask a question. Again, if you wish to ask a question, you can just press star and one on your telephone keypad. Again, it's star and one. We have now reached the end of our Q&A session, and I will turn the call back over to Mr. Ho.

Thank you very much for joining us in our conference call. We wish each of you good health and please be safe during this crisis. We look forward to speaking with you again. Goodbye.

That does conclude the conference for today. Thank you for participating. We all now disconnect.