This report discusses the details of the Geely Automobile Company and an analysis of its financial statements in the past 5 years. The purpose of the report is an application of the knowledge learnt from the Financial Statement Analysis course, and tries to give recommendations. Rather than giving simple suggestions like buy, sell or hold the stocks, it is hoped that by analyzing the financial statements, the data can provide support for the recommendations such as the future profit and loss of Geely.
As one of the four largest independent private automobile manufacturers in China, Geely Auto has been expanding rapidly. The sale of Geely has increased from 200 units in 1998 to 329. 100 units in 2009. In addition, in 2010, the purchase of Volvo greatly increases the reputation of Geely. Although the acquisition just happened few months ago, it is believed that it will beneficial to increase the market share. Further SWOT analysis shows that, the well-established sales network and the emphasis on R&D capabilities will have a positive effect on the future growth of Geely.
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Moreover, the external environment such as the continuous growth in Chinese market and government policy support shows a promising future for Geely. However, there are also threats exist outside the market and weaknesses inside Geely. It is really hard to give any suggestions by simply analyzing the industry and outside environment. Therefore, the report mainly focuses on the analysis of the financial statements. Analysis includes the capital structure and solvency, liquidity, operating performance and profitability, and cash flow statements.
By using common-size analysis, ratio analysis and trend analysis, taking the rapid expansion in recent 5 years into consideration. Though some results turn out to be either not satisfactory or below industry average, the overall performance of Geely is quite good. Geely was using its money effectively and investing the money in the right place in the past 5 years. It is recommended to buy Geely Stocks, with the potential growth in their production and profitability. It is quite pessimistic that the earnings of Geely is going to increase and therefore the stock price in future. . 0 Introduction Geely Automobile Holdings is a Chinese automaker and is with BYD, Chery, and Great Wall, one of the four largest independent private automobile manufacturers in China. Geely is now headquartered in Hangzhou, Zhejiang, and operates six car assembly and power-train manufacturing plants in China that are located in Lanzhou (Gansu province), Linhai (Zhejiang province), Luqiao (Zhejiang province), Ningbo (Zhejiang province), Shanghai and Xiangtan (Hunan province). These facilities enable a production capacity of approximately 300,000 cars per year. 2. Brief History Geely (Jili, meaning "auspicious, lucky") was founded in 1986 as a manufacturer of refrigerators, and then moved to manufacturing decoration materials in 1989, and by 1992, motorcycle parts. In 1994, Geely began manufacturing motorcycles. By 1996, Geely had produced over 200,000 motorcycles and scooters. Automobile production started in 1998. Geely began exporting its first cars in 2003. Geely had its IPO on the Hong Kong Stock Exchange in 2004. Purchase of Volvo Geely was reported to have approached Ford in mid-2008 about a possible takeover of Volvo Cars.
On October 28, 2009, Geely was named as the preferred buyer of Volvo Cars by Ford. On December 23, 2009, Ford confirmed that all substantive commercial terms for the sale to Geely had been settled. A definitive agreement was signed on March 28, 2010 worth $1. 8 billion, and the deal was completed on August 2, 2010. Management
- Mr. Li Shu Fu, Mr. Gui Sheng Yue, Mr. Yang Jian, Mr. Ang, Siu Lun, Mr. Yin Da Qing, Mr. Liu Jin Liang, Mr. Zhao Jie, Dr. Zhao Fuquan
- Non-Executive Directors:Mr. Xu Gang
- Independent Non-executive Directors: Mr.
From common-size analysis, we know leverage rate of Geely is stable for year 2006 and 2007, declines sharply for year 2008, and then rebounds strongly to 62% in year 2009. Then look at the absolute value, it's not difficult to find out a great rise in both liability and equity capital. In 2009, the total liability is more than a trilion. Referring to its investment and operation in recent years, we think Geely is trading on the equity, which indicates it is using equity capital as a borrowing base in a desire to reap excess returns.
This can be confirmed by its step-by-step acquisition of many assembly line and investment on new factories financed by bond and bank borrowing, which is conversely based on increasing equity (stock price stimulated by expansion). Those investments are revalued and taken into asset as a new backup.
Since the ratio of debt to equity capital is relatively high, we need to take a further look of its financial condition. Before assessing long-term solvency we want to be satisfied about the near-term fiancial survival of Geely. Unfortunately, Geely's short term debt to equity ratio is 1. 40, quite high in the most recent year. Although it can raise capital from HK listed market, equity is apparently not enough to make up its shortage of capital in short term. According to NOTE, Geely has discounted notes receivable to banks in exchange for cash with recourse in the ordinary course of business.
Therefore, the risk resulting from its speeding expansion not only depends on its own performance, but its customers' financial distress. Interest coverage ratio is satisfactory, which means payment of the interest liability Geely has incurred on its long-term borrowing is in a less pressure. The accounts receivable turnover is much worse than industry average. However, an increase of accounts receivable may due to rise in sales or difficulty in collecting quite timely.
Referring to NOTE, we know that receivables are guaranteed by established banks in the PRC and have maturities of six months or less. So the likelihood of timely collection is in less question. The inventory turnover is exaggeratedly higher than industry level, especially after its installment of P-SCM supply chain management system, which integrates ordering, producing, selling, and distributing. So we can conclude that Geely is doing excellence in inventory management and is enjoying a growth in market demand of its products 3. Analysis of Operating Activities To be able to make a comprehensive analysis of Geely’s activities, both the income statement and the balance sheet have been restated in appendix A and B, such that it is possible to identify operating and non-operating income, assets and liabilities. Assumptions regarding classifications are also available in the appendixes. Figure 2: illustration of revenue and operating income, Source Geely annual report 2007 -2009 Figure 2 illustrates how dramatic the development in especially revenue has been the last three years.
Net sales are up by almost 200 percent from 2008 to 2009, while only a 60 percent increase in volume is reported in the annual report. Mainly the large growth is a result of full consolidation of the Groups manufacturing Operations. Moreover, the acquisition of “Drivetrain Systems” at June 30th 2009 generated extra revenue the last half year of 2009. Further the notes reveal that 95 percent of sales are within China in 2010, in 2009 it was only 81 percent. A decline in export can in a future growth perspective be a concern.
Geely have improved profit margin over the last three years (18 percent In 2009), while the operating margin have been rather volatile (Appendix 1). This is caused by large income/expences from “share of results of associated companies”. It is expected that this account will be less important in the future as some associates now are fully consolidated. A large increase in distribution and selling expenses in 2009 (increase more than 200 percent) is worth to note. It raises questions as can Geely manage all the new acquisitions without getting less effective and the level of earnings quality.
No extraordinary or unusual are identified in the financial statement. It is a good sign since these accounts often are subject to earnings management. Comprehensive income is nicely increasing and no unusual increase in unrealized gains/losses of currency is identified.
Analysis of Return on Common Equity
This analysis show that the drivers behind the increasing return to common equity is mainly due to heavy increase in asset turnover and an equal percentage increase in leverage. The adjusted profit margin has unfortunately been declining heavily over the period.
Geely is therefore relying on Non-operating activities to reach the growth in ROCE. From a shareholder perspective is an increase in ROCE due to leverage not sustainable. However it must be noticed that it was only last year the increase in leverage was heavy, while the increase in asset turnover has been for longer. From a financial point of view it can be argued that taking up debt while it is cheap, since the interest rate is currently low, is in the long run better for the shareholders, if the alternative was to finance expansion with more expensive equity.
What is critical is if Geely is strong enough to turnaround their adjusted profit margin to keep growing healthy. 3. 5 Cash Flow Analysis It is useful to construct a summary of cash inflows and outflows by major categories because we can evaluate a firm's sources and uses of cash from operating, investing and financing activities directly. Geely Automobile Holdings LimitedSummary of cash inflows and outflows.
The summary of cash flow chart shows that during fiscal year 2005~2007 Geely experienced negative operating cash flow. Besides that it has used cash to finance increase in inventory and receivables, the 'Share of results of associates' turnaround profits before tax from a positive position to a reverse one as it contributes more than 100% negatively before 2008 to Geely's profit after tax. This may be due to its stage of growth since total capital expenditures by its operating associates amounts to approximately RMB1 billion, which are mainly funded by the operational cash flow generated by associates.
The insufficient operating cashflow part is made up by financing activities through issuing debt and securities and borrowing from banks. From fiscal year 2008 Geely was able to begin generate positive operating cashflow . However, positive operating cashflow may due to the decrease in its working capital. The cash flow statement shows that payables decreased significantly after 2008, which raises doubt on a possibility that Geely delayed payments to suppliers until its operating cash flow before adjustment of working capital become healthier.
The major cash outlay is investing activities, corresponding to its funding for the research and development of new vehicle models, new engines and gearboxes, the construction and expansion of plants. Concerning financing activities, one point should be mentioned here is that Geely borrows with its receivables as collateral, the inflow of cash is reported as a financing activity in the cash flow statement. The second doubt come up when comparing with income statement.
Earnings are significantly exceeding operating cashflow, this may be an indication of aggressive accounting choices, such as recognizing revenues too soon or delaying the recognition of expenses. Take a look at the free cash flow statement. From free cash flow to equity (FCFE) we know the cash flow availabel for distribution to common shareholders is sufficient. Along with its satisfactory reinvestment ratio, Geely proves that it is taking care of investors. Geely automobile Holdings LimitedFree cash flow statement.
Continuously Increasing Revenue Geely’s gross profit margin has continued to grow over the past few years due to successful company expansion and increasing market shares. The total sales for various kinds of Geely vehicles has accumulated to over 800,000 since 2001, and the Geely trademark has been recognized as a well-known mark in China. It has established over 200 sales service bases overseas, and performed SKD/CKD assembly production and sales in Ukraine, Russia and Indonesia and other countries. 2. Emphasis on Research ; Development Capabilities
By the end of 2009, Geely owns a total of 1,600 technology patents. Geely has a professional research and development team, the staff number of which exceeds 1,400, representing 12% of the total staff of the Group With its extensive investment in research and development, the group’s R;D team is capable of launching four to five new models every year, reflecting its leading position in R;D and technology innovation capabilities in China’s automobile sector. 3. Acquisition of Volvo and Enhanced Green Technology
New energy-powered vehicle is the latest trend and it will be the future of the world’s auto industry. Ford and Volvo have already invested millions of dollars over the past decade in terms of new energy technology. Acquiring Volvo may enhance Geely’s technology in new energy-powered vehicle area, help Geely take a step forward in competing with other homegrown brands, and pave the way for Geely to enter the global auto market.
Accounts Receivables Worse than Industry average Geely’s average turnover ratio of accounts receivables from 2005 to 2009 is 1. 3, which is substantially lower than the industry average, 19. 47. Although the previous analysis has shown less possibilities of payment collection problem, a low accounts receivable turnover ratio still indicates that there is an opportunity cost of holding receivables for a longer period of time. Image of Lower-end Brand Although Geely has a well-established sales network and growing competence in core technology, it is hard for Geely to alter its lower-end brand image, since its original target market is low cost vehicle.
But branding is about value and perceived quality, so price alone can never facilitate a victory. Enhancing quality and ensuring that its cars are on par with the global leading brands are still a major challenge for Geely. Less Advanced Technology Despite the vast amount of investment in research and development, capital and talents for automobile core technology are limited, and it is hard for Geely to compete with the advanced technology of foreign automobile manufacturers. Unsatisfactory Sales in Export Markets Motor vehicles sales in most parts of the world market remains fragile.
As a result, Geely exports business could continue to face major challenges given the fierce competition and the short history of operation in its major export markets. Opportunities 1. Continuous Growth of China Sedan Market China's passenger vehicle market ended last year with a 59 percent year-on-year sales increase to surpass the United States as the world's largest auto market for the first year. According to estimate of Goldman Sachs Global ECS research report, growth in China car market will be remained for the next 10 years and the industry GDP growth will be 11. % in 2010 and 10% in 2011. Goldman Sachs Global ECS research teams forecasts that China will further boost its No. 1 position in the car market with sales reaching 30 million units per year by 2020. 2. Government Policy Support In the past few years, the focus of Chinese government policies for automobile industry is to boost sustainable growth in the economy with auto industry as one of its pillars and to support domestic participants and industry consolidation.
Fierce Competition from both Domestic and Foreign Brand The huge profit potential of China car market brings about fierce competition among both local and foreign automobile manufacturers. In the luxury automobile market, foreign manufacturers are in leader position due to their sophisticated technology and high brand recognition. While in lower end automobile market, local brands are strong competitors. Possibility of Overcapacity in China Auto Market Some industrial experts concern that China's market may one day face vercapacity problems. A report from the official news portal of China's eastern Zhejiang province showed that, based on the production plan of China's 12 major auto manufacturers for the next five years, China's auto production would reach 32. 5 million units in 2015, far exceeding the forecast of 22 million units in the blue book of China's automobile industry. If Overcapacity problems occur, serious overproduction capacity will lead to negative market competitiveness a loss in enterprise efficiency, factory stoppages and other problems. . 0 Analyses of management discussion and analyst’s opinion Appendix C summarizes some Analysts view of Geely. However, not all Analysts agree upon whether you should sell, hold or buy the stock. Several reasons are discussed in the respective reports; though all analysts agree that Geely is a healthy company with a stable revenue base, increasing volume and satisfactory margins. What analysts do not agree upon is whether Geely can maintain their growth potential and gain market share in both the domestic and export market.
The penetration in the Chinese passenger car market is extremely low compared to USA and Europe (JP Morgan, 2010) and as the Chinese people are getting wealthier the market potential will increase the upcoming years. Loads of Automobile manufacturer will compete to gain market share and earn extraordinary profit. Credit Suisse and CIMB are representing the negative analysts who believe that domestic market competition will increase as the nearest competitors have invested heavily in the industry and developing of new brands (CIMB, 2010).
Geely Management has not commented upon this in their report, but instead they emphasize they have sufficient funds to cover investments and R&D expenses to facilitate their own growth. Additionally, Credit Suisse (2010) emphasize that every auto manufacturer in the Chinese market are currently investing in production facilities. Credit Suisse is therefore worried it will result in an oversupply and consequently make inventories to rice. To bring inventories down a price war on vehicles can arise. This will affect margins negatively.
JP Morgan represents a positive analyst that strongly believe that the current acquisition of Volvo will result in synergy effects and a technology platform that no one else can imitate in the near future. Further JP Morgan is confident that the low penetration of vehicles in the domestic market will ensure future growth, and therefore recommends buying the stock. DBS, Deutche Bank and Yuanta are recommending holding the stock, since they believe there are too many uncertainties connected to Geely and the future. Especially they all emphasize the lack of a clear growth catalyst to outperform the market.
Further, the acquisition of Volvo seems to have longer prospects before profiting than expected at first hand (CIMP, 2010). As expected Geely’s management discussion is very positive towards the future and leaves the shareholders with the impression of a highly growing company with a healthy economy and a clear defined strategy, although it is noticed that very little space is used to comment upon the current competition in the market. Instead Geely Management has chosen to focus at their new strategic platform and how they can develop brands and product lines into a competitive advantage (Geely, 2010).
It can be interpreted as an indirectly method to cope with the market competition without discussing the situation in detail. Shareholders, however, must be aware of this matter when evaluating the business. Even though current revenue is increasing heavily one must consider how sustainable this growth rate is in the future. It can be concluded that Geely Management are slightly taking a too positive approach towards the current market conditions, since these are not discussed in depth and analysts report emphasize different issues than Geely.
This analysis facilitate that there are no universal answer to trading with stocks. We all wants to buy the stocks that are undervalued and sell the ones that are overvalued, and the answer you get depends on the method, forecast and strategic mindset of the analyst. Geely is without doubt a healthy company so the buy, held, sell decision lies within how you value the growth opportunities, how Geely can facilitate R&D and implement acquisitions and thereby benefit from synergies. 6. 0 Recommendation
Geely have the recent years had an expansion strategy, and as a consequence a high level of investment. This has resulted in a higher leverage and that earnings significantly are exceeding cash flows. However this is also a natural picture of a company in an expansion phase. It is found that Geely has satisfactory interest rate coverage even though leverage is increasing. Furthermore, accounts receivables is found worse than industry average, but good bank agreements make it easy for Geely to meet liquidity issues. Inventory turnover is also good, as the focus on SCM systems have proven its worth.
This is moreover expressed in the increased asset turnover which partly is the driver behind the increasing ROCE. However it is important to note that the adjusted profit margin is declining. The overall performance shows increased revenue/earnings, but it is very difficult to determine the earnings quality since most of the rise is due to consolidation and acquisitions. The positive free cash flow and satisfactory reinvestment ratio shows that Geely are taking care of investors. SWOT analysis identifies possible business catalyst as R&D and the new acquisition of Volvo that could create synergy effect.
It is our opinion that these business drivers are rather uncertain but is very likely to succeed and combined with Geelys current healthy financial situation; we are taking a positive approach towards Geely and recommends to buy the stock.
- Geely Automile Holdings Annual report 2005-2009 Investment Reports: DBS (8. June2010)
- Hong Kong/ China Company Focus; Geely Automobiles Holding; DBS Vickers Securities; Analyst: Miu, Rachel Credit Suisse (12. July 2010)
- Asian Daily – Geely Auto; Credit Suisse Analysis; Analyst: HungBin Toh CIMB (28. Sep. 010) Geely Automiles Holding LTD; CIMB Reasearch; Analyst: Cheam, The Shen JP Morgan (26. Sep. 2010 )
- Geely Automiles Holding LTD – Initiating Coverage, JP Morgan Asia Pacific Equity Research; Analyst: by Li, Frank Deutche Bank (26. Aug. 2010)
- Geely Automiles Holding LTD; Deutche Securities Asia LTD; Analyst: Ha, Vincent Yuanta (26. Aug. 2010)
- Geely Automiles Holding LTD; Yuata Research; Analyst: Wong, Johnny Websites: Reuters (http://www. reuters. com/finance/stocks/analyst? symbol=0175. HK) Appendix A: Restated income statement Appendix B: Restated Balance Sheet
- Appendix C: Overview of Analysts opinion Source: Reuters (http://www. reuters. com/finance/stocks/analyst? symbol=0175. HK) -------------------------------------------- [ 2 ].
- Industry average figure reference: http:// www. stats. gov. cn [ 3 ].
- Property, plant and equipment are depreciated on a straight-line basis at the following rates per [ 4 ].
- Goldman Sachs, China: Automobiles, May 19, 2010 [ 5 ].
- Business Monitor International, BMI China Auto’s Report 2010, November 2009 [ 6 ].
- Global Times, China's Expanding Auto Production Triggers Overcapacity Concerns, July 19 2010
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