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China's big auto-parts makers may do fine as road turns bumpy

Bai Lin From Wall Street Journal| June 02 , 2008

SHANGHAI, China -- After years of rapid growth, many of China's auto-parts makers seem to be hitting a speed bump as they cope with climbing wages, an appreciating local currency and rising raw-materials prices. But, analysts say, some of the industry's most established players remain good buys.

Among the companies facing the biggest challenges are wheel makers, such as Zhejiang Wanfeng Auto Wheel, and producers of the myriad molded plastic parts used to make cars -- in part because the soaring price of commodities like oil and aluminum are jacking up their costs. Auto-glass makers, such as Shanghai-traded Fuyao Group Glass Industries and Hong Kong-traded Xinyi Glass Holdings, on the other hand are likely to fare better because of solid market shares, analysts say.

"This year is a correction year for auto parts," says Yao Hongguang, a Shenzhen-based analyst for Lianhe Securities. "The strong will be stronger, the weak, weaker."

Profit growth for China's auto-parts industry has slowed this year. Total industry profits grew 37% in the first two months of 2008 from the same period a year earlier, compared with more than 90% growth in January and February 2007, according to China's National Statistics Bureau. Export growth has also throttled down. In the first quarter of this year, auto-parts exports grew 24%, down from 33% in the same period a year earlier and from 35% for all of 2007.

"The general situation for exports is definitely not good," says Wang Mingcun, a Beijing-based analyst for TX Investment Consulting. Ms. Wang recently downgraded the auto-parts stocks she covers to "neutral" from "overweight." "With the booming cost of raw materials like steel and aluminium, the rising labor cost and the yuan appreciation, China won't have the same export advantages as before."

Mr. Yao of Lianhe Securities has a neutral rating on Wanfeng Auto Wheel, which lists A shares -- denominated in Chinese yuan and available mainly for domestic investors -- in Shenzhen. The company is heavily dependent on exports in an era of rising costs and an strengthening local currency, he says. About two-thirds of Wanfeng's sales go overseas. "I don't see any room for its share price to rise soon," says Mr. Yao.

While Wanfeng's revenue slipped 4.6% in the first quarter from a year ago to 383.5 million yuan ($55.2 million), its net profit jumped 81% to 18.5 million yuan, which one analyst believes resulted from the company concentrating on orders with higher margins. On Thursday, shares of Wanfeng fell 3% to close at 8.20 yuan.

China's currency has appreciated more than 14% against the U.S. dollar since the government began liberalizing the exchange rate in July 2005 -- much of that in the past year. The currency hit 6.94 against the dollar on Monday, a record high. A stronger yuan makes Chinese goods relatively more expensive in foreign markets.

"Yuan appreciation has a big impact on our enterprise. We just try our best to survive," says Xu Xiaofang, an official in the investor-relations department at Wanfeng.

Still, some analysts think concerns about the auto-parts sector are overblown, especially for the industry's top companies. "I see a bright future for Chinese auto parts," says Charles Cheung, an analyst at Citigroup in Hong Kong. "Compared with India and Mexico, China still has advantages."

Mr. Cheung says labor-cost increases are unlikely to hurt the better auto-parts companies. In China, labor accounts for only about 5% of the cost of producing parts, compared with 20% to 30% in the U.S. or European Union. Chinese companies can also shift production away from more expensive coastal cities to lower-wage areas in western China, he says. As for rising raw-material prices, Mr. Cheung points out that it is a global phenomenon affecting producers everywhere, making it possible for manufacturers to pass along the added costs to their customers.

The Citigroup analyst has a buy on Xinyi Glass. The company, which makes laminated windshields and tempered side windows, is China's largest auto-glass exporter by volume. It has had steady growth in sales for the replacement-parts market and has been increasing original-equipment sales to Chinese domestic auto manufacturers, Mr. Cheung wrote in a report. He gave the stock a one-year target price of HK$10.30 -- 50% above Thursday's close of HK$6.86 (88 U.S. cents).

Wang Yusheng, an analyst with Bank of China International, likes Ningbo Huaxiang Electronic, which lists A shares in Shenzhen. Huaxiang's main business is in the domestic market, so it is less susceptible to currency fluctuations or weakening demand from the U.S. and Europe. In addition, Huaxiang took a 49% stake in a subsidiary of China FAW Group Corp., one of China's biggest car makers, giving it preferred access to a big customer. Ms. Wang has a target price as 16 yuan for Huaxiang shares, which finished Thursday at 13.68 yuan, down 2.5%.

Overall, the current situation "is not negative for auto-parts exporters," says Sun Muzi, an analyst for Shenzhen-based Essence Securities. In his view, if a consolidation of Chinese business forces out some companies that depend heavily on keeping labor costs low, then better-managed ones with innovative technologies will get stronger.

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