China Automotive Systems: 74% Discount To Book Value, Great Earnings (NASDAQ:CAAS)

Investment Thesis

China Automotive Systems (NASDAQ:CAAS) is one of the largest suppliers of power steering systems and components to China’s automotive industry. CAAS poses an interesting, deep value play. The stock is currently trading at 5.4x EBIT (2025), and a 74% discount to its fully diluted book value of $392MM.

CAAS is set to benefit from strong tailwinds from the rise in electric vehicle demand and its exclusive electric power steering products. I see decent upside in the next 12 months for CAAS. Valuation looks rather cheap in comparison to its peers. All my valuation models (DCF, trading comps, Exit Multiple and GGM) show an implied share price higher than what is currently trading at. I am of the opinion that CAAS is a BUY, and worth at least $7.50 per share.

Financial Position

Cash, cash equivalents and pledged cash of $156.6MM is higher than Thursday’s $106MM market capitalization. Although the company has little to no long-term debt, they do have $40.4MM in short-term loans with a weighted average interest rate of 2.7% which was reduced by $7.6MM from the previous year. Outstanding decrease in debt.

Management has 2024 revenue guidance of $605MM, representing a 5% increase from the previous year. Top line and EBIT margins also showed a robust growth, both expanded significantly by 9% and 7% from the previous year, respectively. The increase in sales can be attributed to the $29.2MM of research & development and engineering activities. Newly developed products accounted for 33.8% of total sales for the year.

Equity Highlight

The Chinese economy had a challenging 2022, the economy’s growth slowed to 3% – significantly lower than 8.4% in 2021. Despite the stagnant economic environment and COVID-19 limitations, CAAS managed to grow their sales and net profit in 2023. Given the future demand for EVs, the company has been expanding its electric power steering products. Over the past two years, CAAS has been designing specific electric power steering systems for clients such as Alfa Romeo, Fiat Chrysler, and BYD.

Advanced driver assistance systems (ADAS) are said to be the future of steering. In 2021, CAAS introduced an exclusive electric power steering product, which has since been adopted by several passenger vehicle OEMs in China. This system adjusts to various road conditions to ensure a safe steering experience. For the commercial vehicle markets, a partnership was formed in early 2022 with SCANIA AB to create an eRCB system for their trucks and buses. This innovative eRCB steering system is the first of its kind to be fully electric and mass-produced for commercial vehicles. With this electric power steering system, their driver-assistance platform L4 can enable vehicles to perform level-4 autonomous driving. To further improve their electric power steering solutions for vehicle movement and autonomous driving, CAAS is currently incorporating additional technologies from their Swedish subsidiary, Sentient AB.

Valuation

My DCF model discounts CAAS’s future cash flows to come up with a company valuation. Using the below assumptions for 2024 onwards, I expect the company to increase its revenues to $684MM by 2028. CAAS is a company in the low single-digit EBIT margins, I expect the company to achieve a plateau margin of 6% by the end of 2028. Taxes were kept at 25% over time as per the PRC corporate income tax standard tax rate of 25%. CAAS has a current market capitalization of $106MM ($3.62/share), trading at a steep discount to my DCF model’s implied equity value of $196MM, or $6.49/share.

Furthermore, CAAS trades at a deep discount to its peers (CVGI, OTCPK:NTXVF, MGA, OTCPK:CTTAF, SMP). The average 2023 PE ratio is almost 14x (vs. 2.9x of CAAS), and the average 2023 EBIT multiple is 9.3x (vs. 1.8x of CAAS).

As per my trading comparable analysis, CAAS should be trading upwards of $13 – $17 per share at current net income levels. CAAS operates in a targeted market where there are only a few players, most of whom trade only over the counter. The overall electric power steering market is projected to grow to $33.4 billion by 2027, and CAAS has expanded its market share in this niche market.

Nexteer Automotive Group (OTCPK:NTXVF) is a company quite similar to CAAS, they are both involved in the design and manufacture of steering systems, advanced driver assistance systems (ADAS), and components for automobile manufacturers. NTXVF trades for a much higher multiple in both net income and EBIT and has less cash ($311MM) relative to its market capitalization ($1.14B) compared to CAAS. If we use NTXVF’s EBIT and net income multiples of 15.6x and 25x, respectively, we see an implied share price between $22 – $32 for CAAS.

My Exit Multiple Method and Gordon Growth Method, also show great upside. Using a 6x exit multiple assumption (which is the industry average), we see an equity value of $234.4MM or $7.77/share, 114% higher than Thursday’s close. The implied share price will be higher if a higher exit multiple is exercised, and the $40.4MM short-term debt is paid off by the end of the year with future cash flows. The Gordon Growth Model, on the other hand, shows an equity value of $229.8MM or $7.61/share, implying an upside of 110% from current levels.

Potential Risks

There has been a reduction in investments in China by American fund managers, partly because of China’s struggling economy. The government is targeting an economic growth rate of approximately 5.0% for 2024. Moreover, there are possible tariffs on imported Chinese products. Following Biden’s withdrawal from the election, there’s a significant possibility that Trump will return to the presidency, and these tariffs could affect sales from CAAS to customers outside China.

Furthermore, the market has undervalued CAAS because of the industry it operates in. Low single-digit margins are normal, with high single-digit margins on the upper side of the industry. CAAS sells such a niche power steering systems and components to a few customers, mostly in China (BYD (OTCPK:BYDDY), Geely (OTCPK:GELYY), Chery, Changan), with steering products to Stellantis N.V. (STLA) in North and South America and Europe. CAAS operates in an industry with very tight margins. The company could potentially experience a temporary drop in sales volumes or a rise in costs, resulting in a negative EPS quarter. Nonetheless, this situation might be short-lived and return to a positive phase in the subsequent quarters.

Conclusion

Although CAAS operates in a very niche market that is characterized by low single-digit margins, it has managed to return steady profits for the past three years. COVID-19 was tough for most auto components companies. However, CAAS has shown decent revenue growth for years after COVID. CAAS had an outstanding first quarter of 2024, experiencing a remarkable 17% growth in EPS compared to the same period last year. On Friday, the company declared a one-time dividend of $0.80 per share, that represents 22% of its market capitalization.

CAAS is extremely undervalued, trading at 5.4x EBIT (2025) and a 74% discount to its fully diluted book value of $392MM. Further, its cash position of $156.6MM is higher than Thursday’s $106MM market capitalization. The company’s management has set revenue expectations for 2024 at $605 million, marking a 5% growth from the previous year. Both sales and EBIT margins have seen significant growth, expanding by 9% and 7%, respectively, from the year before. $29.2MM investment in R&D helped develop new products that accounted for 33.8% of total sales for the year.

With the anticipated growth in both revenue and profit margins, favorable market conditions driven by the increasing demand for EVs and the company’s unique electric power steering solutions, I believe there is considerable potential for CAAS to perform well in the next year. Based on my valuation models (DCF, trading comps, exit multiples, and GGM), I believe CAAS represents a unique BUY opportunity, worth at least $7.50 per share.

Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.