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Bitauto Holdings: An Excellent Play on the Chinese Automobile Industry

- By Ishan Majumdar

Since U.S.-China trade tensions commenced and the Chinese economy looked to slow, a number of U.S.-listed Chinese small caps have interested growth investors for trading at ridiculously low valuations despite having strong business fundamentals.

Bitauto Holdings Ltd. (BITA), a digital services player catering to the Chinese automobile industry, is an example of such a stock. The company is trading at less than half of its book value due to China's falling car sales. Bitauto has reasonably strong business fundamentals and a large addressable market and appears to be a compelling investment at current levels.

Bitauto's business and the management objective

Bitauto is one of the leading internet content and service providers in China's auto sector. The company mainly delivers applications and packages to auto dealers and other companies to use in their online marketplaces, with added facility for e-commerce transactions. It also enables auto financing and loans via its subsidiary, Yixin, and generates additional income through its website via auto advertisements, reviews and so on.

The management's objective has been clear: to maximize revenue by cashing in on the growth of the auto sector in the world's most populous economy. As a result, the company's revenue has grown at an annualized rate of nearly 50% over the past five years. In fact, despite the auto slowdown, it managed to report revenue of $464.74 million for the fourth quarter of 2018, reflecting 9.19% growth from the same period in 2018. This is a remarkable achievement for a company operating in a tough business environment, facing inflationary pressures, regulatory pressures, and a slowing Chinese economy with weak auto sales.

Growth initiatives causing the current cash burn

Investors often tend to perceive Bitauto's losses as a sign of fundamental weakness, but that is not true. The only reason the company's revenues have been able to grow at a phenomenal rate is that management has invested in it, particularly through working capital, which caused the losses. Management employs more than 1,200 employees to create multiple revenue streams. And this number will only grow, as they plan to create new mobile apps to enable fast transactions for auto loans via Yixin. This implies a big upcoming hiring cost.

Another point affecting the income statement is that financing services for automobiles have resulted in increased provisioning, apart from the higher level of receivables on the balance sheet. Management is also gradually expanding and investing in the marketing solutions business. All these factors are responsible for the growth as well as the high cash burn every quarter.

A phenomenal growth story

Bitauto has grown revenue to $1.54 billlion in 2018 from $422.10 million in 2014, which is a fantastic growth story. The company has a robust gross margin of nearly 60% and while it may be loss-making on paper, this was the price management paid for fueling the revenue growth. In fact, its negative net margin has gradually improved over the years, and it is only a matter of time before the company turns profitable at the net income level.

The Altman Z-Score of the company is low at about 0.31, but it should not scare investors. It implies that the company would certainly need more financing to survive, but management is well aware of this fact and is effectively using the invested funds to fuel growth.

The stock has collapsed from the 52-week high of above $30 to levels that are ridiculously low given the price-sales multiple of 0.66 and the price-book ratio of 0.35. The downturn in China's economy and weak auto sales were the primary drivers. The stock could jump if the U.S. and China sign a trade deal in the near future but even in its absence, the company appears to be a decent long-term investment bet.

Disclosure: No positions

This article first appeared on GuruFocus.