Chinese auto starter maker on a roll

Wonder Auto Technology, Inc.

Wonder Auto Technology, Inc. (OTCBB: WATG)
Liaoning, China
Web Site: http://www.wonderautotech.com/
Rating: Buy
Initial Coverage: $7.30 - March 19, 2007
Price Target: $11.00
52-week low / high: $1.02 / $7.70
Shares Outstanding: 23.96 million
Market Capitalization:  $174.9 million

Why We Like Wonder Auto Technology:

    * 12.4% share of the starter and alternator markets in China, the second largest automobile market in the world
    * Low-cost, high-technology manufacturer
    * Entering Korean and EU markets

Wonder Auto Technology is the second-largest manufacturer of starters and alternators in China.  Wonder’s share of the Chinese automotive market was 12.4% in 2005.  Wonder has already begun to migrate to other key markets including Korea and the European Union.  Wonder became a U.S. publicly traded company in June 2006, through a reverse merger transaction.

The company operates a 450,000 sq. ft., state-of-the-art manufacturing facility in Jinzhou City plus two R&D centers located in Jinzhou, Liaoning and Beijing. Wonder owns 14 starter- and alternator-related patents in China and can produce as many as 135 different alternators (SKUs) and 70 types of starters.

In late 2006 and early 2007, Wonder posted some impressive new business wins.  Its newest customers include Beijing Benz-Daimler Chrysler Automation and Nanjing MG Rover Motor Company. Both of these contracts are for higher output engines and thus will broaden the company’s product manufacturing experience.

In addition, Wonder has also recently entered the Korean market and EU markets with contracts from Doosan Infracore and SW-Tech Corporation in Korea.  In the U.K., the company has received orders for sample production runs from the LDV Group Limited, the second-largest commercial vehicle manufacturer in the U.K.

These solid deals add to an already impressive roster of more than 40 world-class manufacturing customers, including eight of the top 20 auto manufacturers in China. Wonder’s clients include Beijing Hyundai Motor Company, Dongfeng Yueda Kia Motor Company, Shenyang Mitsubishi Aviation Engine Company and Haerbin Dongan Engine Company.

Wonder also has a strategic manufacturing alliance with Korea Hivron automobile electric company, focused on the research and development of advanced automobile electric technologies, products and processes.

The firm is completing work on a new line of starters and alternators, which will go into production by June 2007. And, in the third quarter of 2006, Wonder acquired a 50% interest in Dong Woo, a key supplier.  The company began consolidating the results of Dong Woo's operations and its financial position as of December 1, 2006.

Wonder’s goal is to be the number one alternator and starter manufacturer in China by 2008.  The company positions itself as a low-cost manufacturer, but also one that adds value through a consultative selling approach: working closely with customers in the development of new starters and alternators.

Wonder is currently working on 20 new starter/alternator development programs for existing customers. These new models are slated for delivery between six and 24 months down the line.  Thus, the new product pipeline is healthy.

The firm is looking well beyond China, however.  It is planning an aggressive export sales initiative.  Wonder plans to derive as much as 30% from export sales over the next five years.  The company believes, quite rationally, that its low-cost, high-quality approach coupled with world-class manufacturing experience will serve it well internationally.

The company believes future growth will come from a burgeoning aftermarket in China.  Though most aftermarket sales are currently handled through the existing dealer channel, it’s likely that, as the Chinese market matures, a superstore market will develop similar to that in the United States.  In the meantime, Wonder is well ensconced in the existing dealer network through its OEM relationships.

Though the company does very little business in the United States, it is engaging in ongoing discussions with certain entities about participating in the U.S. aftermarket.  Those talks are extremely preliminary at this time, largely because of the very large commitment of capital that would be involved in maintaining inventories and distribution centers to serve the needs of large aftermarket franchises in the United States.

The company also plans to stay alert to potential acquisitions that serve its strategic plans, such as in the development of additional manufacturing capacity or cost reduction.  With its additional stock offering in 2006, enviable balance sheet position and availability of credit, Wonder has taken steps to be able to react quickly to acquisition opportunities.

As mentioned, Wonder positions itself as the low-cost supplier.  Its main Jinzhou City facility is extremely efficient, incorporating the latest DNC (Direct or Digital Numerical Control) technology, which enables fast changeovers between production runs.  Where other manufacturers measure their SKU changeover in shifts, Wonder’s changeovers are measured in minutes, literally as few as 39 minutes.  In addition, the production lines are highly automated, allowing for an alternator to be completed every 21.8 seconds when the line is at speed.

In terms of quality, the company has received 13 customer awards for excellence.  The company also works closely with an extensive local supplier network, which further enables a control over the quality of its manufacturers and in terms of just-in-time inventory management.
 

Financial Results

Wonder’s financial results have been truly impressive.  Revenue increased by 50% to $72.2 million for the year ended December 31, 2006, from $48.1 million in 2005.  Net income increased by 29% to $8.2 million, or $0.40 per diluted share, from $6.4 million, or $0.37 per diluted, share in 2005.

In the fourth quarter of 2006, revenue was up 84.4% to $19.1 million, from $10.4 million during same period in 2005.   Net income increased 85.8% to $2.5 million, or $0.10 per diluted share, up from $1.3 million, or $0.08 per diluted share, a year earlier.

As of December 31, 2006, Wonder had $13.0 million in cash, cash equivalents and restricted cash.  Total debt, including short-term bank loans and bills payable, stood at $37.2 million.  Net cash provided by operating activities was $1.4 million in 2006, versus $11.4 million in 2005, the difference of which can largely be attributed to an increase in inventory.

The company is projecting approximately $100 million in sales in 2007, an increase of nearly 39% from 2006.  Wonder projects a 55% increase in net profit for 2007, to $12.8 million, or earnings of $0.62 per fully diluted share.
 

Outlook and Prospects

The Chinese automobile market has experienced considerable growth in recent years.  In 2003, 2004 and 2005 automobile sales increased by 35%, 15% and 12.6% respectively.  In 2006, China produced more than 7 million automobiles, and is projected to reach 10 million units by 2010.  (In fact, on March 2, 2007, the government reported that car ownership in China was up 33.5 percent, reflecting the country’s continued meteoric annual GDP growth rate of 10.7% in 2006.)

The company believes that the overall parts market will triple in China alone through 2010 --  A faster growth rate than the overall market, which is sensible since older cars need more replacement parts.

Wonder also projects organic growth as a result of: 1) its continued and increasing OEM relationships with international footprints, 2) the Chinese automotive market growth and 3) prospective forays into international markets.

Spurring Wonder’s growth opportunities are efforts by the major manufacturers to source parts in China.  GM, VW and Ford all have major initiatives underway to develop local sources of supply in China.  For example, last year Ford Motor Company announced that it will source about $2.5 billion of parts, opening a purchasing office for this purpose.

This is partially due to pressure from the central government to increase local content, but it also follows a well-established model used by foreign competitors elsewhere.  Though there is no official policy in place, the market is reacting like there will ultimately be a local content policy in China.  China’s unofficial goal is to become the world's largest auto market by 2015, thus manufacturers are treating China as a long-term opportunity.

One point of weakness for Wonder Auto is its reliance on a few large customers for the bulk of its sales volume.  For example, sales to Beijing Hyundai Motor Company increased by 96% to 19% of gross 2006 revenues.  And, sales to Shenyang Aerospace Mitsubishi Motors increased by 132% during 2006, accounting for 18% of the company’s 2006 overall revenues.  Thus, only two companies accounted for almost 40% of the company’s total sales. The company’s plan to increase exports to 30% should counter this over-reliance on a few large customers.

The consensus analyst estimate calls for earnings of $0.54 per share on revenues of $100.2 million in 2007, and earnings of $0.70 on revenues of $125.5 million in 2008.  Based on these estimates, Wonder shares currently trade at 14X the 2007 estimate and a very low 11X the forward year estimates.  For a firm expected to grow its revenues by nearly 40% in 2007 and a further 25% in 2008, these trading multiples are surprisingly low.  We are initiating coverage on Wonder Auto Technology with a Buy rating and price target of $11.00 which represents a still low 20X the 2007 earnings estimate.  From the current price of $7.30, this represents price appreciation potential of 51%.

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