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Morningstar | Scale Back in China's EV Subsidies Weigh Down on Yutong's Bottom Line, FVE Reduced to CNY 16.1

Zhengzhou Yutong once again posts weak quarterly results with top and bottom lines down 24% and 47% year-over-year respectively. Disappointing performance is largely caused by the national government's cuts on EV subsidies. While the subsidy scale back will certainly lead contraction in the company's bottom line over the near term, we view this as a temporary disruption in an otherwise a fundamental industry shift toward new energy vehicles. With this expectation in mind, we think the company will experience some operating deleverage in the near term, but renegotiated pricing and improving product mix should help the business to rebound gradually. As a result, we adjusted our forecasts and slightly reduced our fair value estimate to CNY 16.10 on Yutong.

During the third quarter, total sales volume declined by 24% year over year. Gross profit margin, however, posted a surprising jump to 27.3% versus 26.4% a year ago. We attribute the rise in gross margin to lowered battery cost and better product mix. Despite maintaining a relatively stable level of SG&A in third quarter, research and development expenses jumped 83% as Yutong dedicates more resources in developing higher-end and longer-range buses. Management expects new R&D initiatives to start contributing to the company’s bottom line by the second half of 2019.

With the goal of exporting EVs to the rest of the world, Chinese government will most likely continue to provide subsidies post-2020 for longer range and better EVs in order to solidify the country’s competitive advantages in the industry. Despite to a lesser extent than before, Yutong is still expected to continue benefit from such subsidiaries. Therefore, we believe government support coupled with the firm’s competitive advantages over peers will help Yutong to maintain its position as a leader in new energy buses.