Description

SAIC Motor (600104 CH) 

Note: Because SAIC Motor is only traded in Shanghai, this idea is limited to institutional investors.  But at US$26 bn market cap and ~US$46 mm daily liquidity, this is big enough for many institutional investors.

Thesis: SAIC Motor owns 50% of the SAIC-General Motors and SAIC-Volkswagen joint ventures in China.  GM and VW are very strong brands in China and SAIC Motor is #1 with ~24% market share.  SAIC grew revenues 18% in 2013 and consensus expects ~9% revenue growth in each of 2014, 2015, and 2016.  SAIC trades at 3.5x trailing earnings ex-net cash*, 6.5x with cash.  On 3/27/2014 SAIC announced a substantially higher dividend payout than expected (50% payout ratio vs. 30% previous), representing a 16% yield ex-cash and 8% yield on current market cap. 

*Cash includes ~US$2 bn held at the JV level, 50% interest.  There is $14 bn cash at the parent and $2 bn debt.

This company is extremely misvalued, but it may be hard to convince you on face of the merits of a US$26 bn Chinese SOE.  I will start with a quote from Buffett on why he invested in PetroChina (from the excellent site Buffettfaq.com):

“PetroChina is not opaque. It’s very similar to big oil companies elsewhere in the world. It’s the 4th most profitable oil company in the world – it produces as much crude as Exxon. It’s not complicated – it’s a big integrated oil company, so it’s fairly easy to get your mind around the economics of the business.

The annual report will tell you more about the business than [the annual reports of] other oil giants. They tell you they’ll pay out 45% of their earnings, barring the unexpected. I like knowing that that cash will come to Berkshire.

It was bought because it was very, very cheap by any metric – far cheaper than Exxon, BP, Shell... You could say it should be cheaper, given that it’s 90% owned by the government of China, which is a factor, yes, but not so big for me. If you read the annual report of PetroChina, you’ll have as good an understanding of the company as reading the annual report of any other oil company. Then, you can think about risks such as a disruption of US-China relations.

[Munger: I think if it’s cheap enough, you can afford more country risk or regulatory risk. It’s not complicated.]

There’s Yukos, the big oil company in Russia. In evaluating country risk, you can reach your own judgments. In our view, PetroChina had less risk.

[Later in the meeting, Buffett and Munger returned to the discussion of this company:]

You don’t need any blinding insights to invest in PetroChina. They’re producing 2.5% of the world’s oil, it’s priced in US dollars, they control a significant part of the refining in China, and they pay out 45% of their earnings in dividends. If you’re buying something like that at 1/3 the valuation of comparable companies, it’s not hard. You just have to do the work.

[Munger: But when you were buying, no one else was. It required uncommon sense.]”

Buffett began buying PetroChina in 2002 (first disclosed on 4/30/2003) and finished with an average cost of $22 per share (I’m using the New York ADS price) and sold in September-October 2007 for ~$160-170 per share.

PetroChina earned $3.30 per ADS in 2001 and $3.42 per ADS in 2002.  Thus, Buffett’s cost of $22 represented 6.7x 2001 earnings and 6.4x 2002.  PetroChina paid out half of its earnings in dividends, so Buffett was buying at a 7.5% trailing dividend yield on market cap.

On face SAIC has very similar metrics: 6.5x 2013 earnings and 8% dividend yield.  However, SAIC is far cheaper on a cash-adjusted basis: adjusted for the >50% of market cap in net cash (mostly on balance sheet, but also at the JVs), SAIC trades for 3.5x 2013 earnings and 16% dividend yield.  Nonetheless, Buffett was undoubtedly buying at a far better growth point in China’s economy.

The bull investment case, which would be more relevant if this were at a normal valuation

China had 71 cars per 1000 people in 2012 vs. 787 for the US—an order of magnitude difference.  There are many reasons why this gap will not converge fully even with time (already-congested cities, car ownership limits) and there may be cyclical factors that depress demand (like a possible hard landing) but there is no doubt that the mature number will be materially higher than present.  Even within China there is a lot of room for convergence: nearly 20% of Beijing households have a car, whereas that number for most other provinces is <5%.  Buying a (foreign-brand) car signals prosperity, face, that one has made it in life.  China’s car market is already the largest in the world at 22 mm total autos sold in 2013 (vs. 15.6 mm in the US).  CLSA predicts an 8% CAGR through 2018.

There is a major inconsistency here—investors in VW and GM generally capitalize the Chinese JV earnings at 8-10x, not 3x.  These are great assets.  SAIC also owns a large chunk of its supply chain, stretching from upstream parts suppliers to financing companies to downstream aftersales service companies—a competitive advantage and a way to ensure quality in an otherwise chaotic market.

Why is SAIC Motor so cheap?

Some explanations we've heard:

• SAIC is a SOE.
  • Response: Plenty of other SOEs, including other carmaker SOEs, trade at decent multiples.  Most SOEs are far worse managed than SAIC, which has very good management.  
    • On an EV/2014E EBIT basis (consensus numbers): Dongfeng Motors (Honda/Nissan) trades at 5.0x, First Auto Works (Toyota/VW) at 9.2x, Geely (not a SOE) at 5.7x, vs. SAIC Motor at 1.8x.
    • SAIC is widely regarded as one of the two best-managed car companies in China (the other being Great Wall), with a dynamic and hardworking President (Chen Hong) who loves the car business.  We spoke to an ex-GM China executive who regularly worked with and knew Chen Hong well. 
• China macro is weak.
  • Response: This is true but SAIC’s valuation is not a market issue—the average stock on the Shanghai exchange trades at ~11x P/E.  The average stock on the Hong Kong exchange also trades at ~11x P/E.  Hedge tail risk if you’re worried, such as via puts on the CNH (pitched by Shumway at Ira Sohn last week).
• Various cities are putting in car ownership restrictions, an effort that has gained urgency given China’s severe pollution problems.
  • Response:
    • SGM and SVW benefit from a powerful offsetting factor: when people are limited to only one car, they trade up to foreign brands and want to “buy the most car” they can.  We have seen this already in Beijing.  Bernstein has some good reports on this topic.
    • All Chinese car companies are affected by this, domestic brands much more than SAIC; but there is a big valuation gap between SAIC and everyone else.
• SAIC is directed by the government to spend money on developing its own brands, which lose money.
  • Response:
    • Net losses at self-developed brands are not significant compared to earnings from SGM and SVW.  In 2012, SAIC lost ~US$370 mm after including R&D expense on its own brands vs. ~$1.5 bn in proportionate profit from SGM and ~$1.6 bn from SVW.
      • The R&D expense should leverage.  The company hopes to break even before R&D (2012: ~$50 mm loss) by 2015.
    • We heard that SAIC management is very rational about balancing its development mandate with maximizing profits (quote pasted at the bottom).  It will not go crazy with spending.
    • Of all the Chinese self-developed brands, SAIC has some of the better quality cars (MG and Rowe). 
• SAIC is too big (US$26 bn) for A-share investors who like speculative smaller companies that show more earnings growth.  Foreign investors have major barriers to accessing the A-share market.
  • Though unsatisfactory, I think this is the most likely explanation.  According to KPMG in 2011, retail conducts ~60% of A-share trading by volume and owns ~40% of shares by value.
  • In October 2009, when growth was much higher, SAIC traded at 29x forward P/E.  Clearly, there has been huge compression in the multiple.
  • The proposed late-2014 opening of large-cap A-share stocks to foreign investors may have some impact.  This event and other potential catalysts are discussed below. 

Potential Catalysts

• Market opening of A shares to Hong Kong investors in ~October 2014.
  • On 4/10/2014, the Chinese Securities Regulatory Commission announced (and further flagged in a speech by premier Li Keqiang, which shows high-level backing) a plan to allow cross-market stock investment between mainland and Hong Kong investors.  The trial plan will begin in late 2014 and allow Hong Kong investors to put up to ~US$48 bn into large A-share stocks, which includes SAIC.  This trial program expands the current QFII quota ($86 bn) by nearly 50% and opens the door to further liberalization.
  • There is foreign interest in SAIC: SAIC IR says foreign funds currently hold ~16% of the float via QFII (float is ~3 bn shares out of 11 bn) despite the heavy barriers the government throws up to doing so.
• Dividend payout has just been increased from 30% to 50%, which takes the dividend yield to 8% on market cap.  Management has guided to increasing the dividend payout; they clearly have too much cash.
  • The payout has already steadily increased: from 15% in 2011 to 30% in 2012 to 50% in 2013 (announced 3/27/2014).  The move to 50% payout came even quicker than we anticipated, but the stock only rose ~8% when the news was announced.  One thinks of Maximus: “Are you not entertained?”
• Continued earnings growth at high single digit or greater. 
• If the stock does not move then 3x earnings ex-cash turns into 2x earnings then 1x earnings then free – at some point people will realize that it would be ridiculous for the owner of SGM/SVW to turn into a near-net-net.
  • The low valuation provides considerable downside protection no matter what happens to the Chinese economy or car market.  There is convexity when the multiple gets really low—the payback period shrinks by increasing percentage amounts for every multiple point down (3x-->2x is far more significant than 14x-->13x). 
• We heard from another investor who said management said that it may consider buying back stock if it fell below book value.  Book value will be ~12.5 RMB by year-end 2013 and the stock is at 14.72 RMB.
• Possible longer-term catalysts that we are not counting on:
  • Management has a small equity incentive plan for the first time in 2013, though it is so small that we are not placing much hope on it. (can discuss details in Q&A if asked)
  • Eventual Hong Kong listing?  IR told us that they are considering a Hong Kong listing in the long term, but there is no timeline for it.
  • SOE reform was a key area of the Third Plenum—to make SOEs more market-oriented and accountable to shareholders.  To the extent and timeline to which this happens, this could benefit SAIC.  We’re not counting on it.
    • "We need to improve the management of state-owned capital and raise the proportion of profits that are paid out.” – Huang Shuhe, vice chairman of the State-Owned Assets Supervision and Administration Commission, news conference in Dec 2013.

Nonetheless, there's no hard catalyst that guarantees a rerating.  But longer term, it's hard to see this not working out to some degree.

Governance?

“The Chinese government owns 90% and we own 1.3%, so if we vote with them, together we control the business.” – Buffett, speaking about PetroChina

The Shanghai government directly and indirectly holds a 77.3% stake in SAIC Motor Stock Holding Company, the public company; the public holds 18.9%. 

We had a very helpful conversation with a former executive at GM China:

“Of all SOE joint venture partners, SAIC is by far the most Western and most progressive. They run all of the operations on a pretty strict capital return basis.  Their understanding of key metrics and market forces is very strong.  They’re very hard on the organizations to deliver long-term financial targets they’re committed to.  They make excellent decisions: if they don’t see good returns on a project, Chen Hong [President] is very disciplined about cancelling.”

“I know they pay a lot of attention to their stock, they watch the stock price very closely, it’s definitely a key measure for the government – if it’s listed and SAIC doesn’t grow with the rest of market, it’s an embarrassment.  Great Wall’s performance is a bit of a marker for SAIC.”

How to trade this?

Ask major investment banks for QFII.

Catalyst