CHINA YUCHAI INTERNATIONAL LTD annual report, Q4 FY2018

China Yuchai International Limited: FY2018 Form 20-F Summary

Business context and reporting period

China Yuchai International Limited, a Bermuda holding company listed on the NYSE, reported audited consolidated results for the year ended December 31, 2018 under IFRS. The Group’s principal asset and operating business is its 76.4% interest in Guangxi Yuchai Machinery Company Limited, which manufactures diesel, natural gas and hybrid engines primarily for China’s commercial-vehicle market. HL Global Enterprises Limited is consolidated as a subsidiary, while the Group also held a 7.7% investment in Thakral Corporation Ltd.

The filing is an annual report, not a standalone fourth-quarter filing. Comparatives for 2016 and 2017 were restated for IFRS 15, and operating data reflects a revised engine classification system implemented in 2018.

Key financial metrics

Metric	FY2018	FY2017	Change
Revenue	RMB 16,263.2 million	RMB 16,197.8 million	+0.4%
Gross profit	RMB 3,092.0 million	RMB 3,356.1 million	-7.9%
Gross margin	19.0%	20.7%	-170 bps
Operating profit	RMB 1,282.5 million	RMB 1,604.4 million	-20.1%
Operating margin	7.9%	9.9%	-200 bps
Profit for the year	RMB 974.4 million	RMB 1,319.9 million	-26.2%
Profit attributable to parent	RMB 695.3 million	RMB 888.8 million	-21.8%
Basic and diluted EPS	RMB 17.02	RMB 21.80	-21.9%
Net cash from operating activities	RMB 670.6 million	RMB 1,420.2 million	-52.8%

Reported U.S. dollar translations use RMB 6.6901 per U.S. dollar and are provided for convenience only.

Total engine sales increased 2.4% to 375,731 units. Commercial-vehicle engine sales were broadly flat at 264,706 units.
Light-duty engine sales increased to 106,644 units, or 28.4% of total units, while medium-duty sales declined to 192,512 units and heavy-duty sales declined to 75,600 units.
Natural gas engine sales fell to approximately 15,865 units from 26,298 units.
Research and development expense declined to RMB 447.7 million, partly because RMB 195.9 million of National VI and Tier-4 development costs were capitalized. Total R&D expenditure, including capitalized amounts, was RMB 643.5 million, or 4.0% of revenue.
Finance costs rose 12.6% to RMB 113.1 million, mainly due to higher borrowings.
Working capital increased to RMB 6,861.6 million from RMB 6,621.2 million. Trade and other receivables totaled RMB 7,785.3 million, including net trade and bills receivables of approximately RMB 7,387.8 million.
Cash and bank balances totaled RMB 6,128.5 million, including RMB 5,015.2 million held in China subject to local foreign-exchange controls.
Total borrowings were RMB 2,016.1 million, comprising RMB 2,001.0 million of current borrowings and RMB 15.1 million of long-term borrowings. Undrawn committed facilities totaled RMB 492.8 million.
Total assets were RMB 21,658.0 million and total equity was RMB 11,147.6 million at year-end.

Material changes versus FY2017

Revenue growth was modest despite higher unit sales, as competitive pricing pressure and a shift toward smaller-capacity engines reduced average profitability.
Gross margin declined from 20.7% to 19.0%, primarily because of lower average selling prices and product mix.
Operating profit and parent-attributable profit declined materially. FY2017 benefited from approximately RMB 324.1 million of gains related to disposals of HLGE hotel assets and other unusual items. Excluding those items, FY2017 operating profit was approximately RMB 1,428.0 million and adjusted parent-attributable profit was approximately RMB 826.7 million.
Operating cash flow declined substantially because receivables increased and trade and other payables decreased.
Capital expenditures increased to RMB 586.5 million from RMB 261.4 million. Yuchai had RMB 774.5 million of contracted capital expenditures not yet paid at year-end, while total committed capital expenditures disclosed by the Company were RMB 1,047.1 million.
Production capacity decreased to approximately 487,500 units from 596,250 units, while 339,800 engines were produced at Yuchai’s Yulin facility.
The Company paid a total FY2017 dividend of US$2.21 per share in 2018, consisting of a US$0.73 final dividend and a US$1.48 special dividend. The corresponding cash payment was RMB 597.5 million. Yuchai’s RMB 307.2 million FY2018 dividend had been approved by its board but remained subject to audited financial statements and shareholder approval.

Outlook, management commentary, risks and unusual items

Management did not provide a specific quantitative FY2019 revenue or earnings forecast in the filing. Management expects cash generated from operations, together with available financing, to support working capital, capital expenditures and other requirements over the following twelve months, but cautions that weaker market conditions could reduce operating cash flow and require additional financing.

Growth opportunities include National VI on-road engines, Tier-4 off-road engines, natural gas engines, hybrid systems, marine engines and power generators. Yuchai introduced 14 National VI on-road models and 10 Tier-4 off-road models, with commercial availability expected in 2019 or early 2020.
Yuchai established a 49%-owned joint venture with Eberspaecher in December 2018 to develop and produce exhaust-emission control systems for National VI applications.
Key market pressures include flat Chinese commercial-vehicle demand, weaker bus sales, reduced government incentives for natural gas and electric vehicles, increasing adoption of electric vehicles, intensified competition, excess industry capacity and upcoming emission standards.
Sales concentration is significant: the Dongfeng Group represented approximately 27.4% of consolidated revenue, and the top five customers represented 37.5% in 2018.
Credit and liquidity risk is heightened by large receivables, including RMB 1,272.4 million of discounted bills receivable and RMB 1,627.5 million of bills endorsed to suppliers, both with recourse obligations.
Other risks include China’s economic and policy environment, Renminbi convertibility and foreign-exchange movements, interest-rate risk, tariffs and U.S.-China trade tensions, environmental regulation, customer concentration, related-party and governance matters, and dependence on dividends from Yuchai.
The Group capitalized RMB 195.9 million of development costs and reported no impairment for National VI and Tier-4 projects. The filing states that a 1% decrease in demand assumptions for the Yuchai goodwill cash-generating unit could result in impairment.
Internal control over financial reporting was assessed as effective as of December 31, 2018, and Ernst & Young issued an unqualified opinion. The filing notes that material weaknesses had existed in earlier years but had not been identified since 2012.
The Group planned to adopt IFRS 16 on January 1, 2019. Preliminary estimates indicated recognition of RMB 89.4 million of right-of-use assets and RMB 108.3 million of lease liabilities.

Most important facts for investors to verify

Whether Yuchai can sustain engine volumes and restore margins amid pricing pressure and the shift toward lower-margin light-duty engines.
Collection quality, aging and concentration of trade receivables and bills receivable, including all recourse obligations.
Availability and maturity of short-term borrowings, compliance with banking covenants and actual utilization of committed facilities.
Whether National VI and Tier-4 products achieve timely certification, commercial launch and acceptable returns on capitalized development costs.
Approval and receipt of the FY2018 Yuchai dividend, and the Company’s future dividend policy after the FY2017 special dividend.
Potential effects of electric-vehicle adoption, emission regulations, Chinese policy changes, tariffs and economic slowdown on demand.
Execution of the Reorganization and Cooperation Agreements, continued control of Yuchai, and the practical ability to repatriate cash from China.
The valuation sensitivity of goodwill and development assets to lower demand, higher discount rates or slower growth.