Climbing the Value Chain Won’t Be Cheap for the World’s Most Profitable Car Maker

October 29, 2013 Leave a comment

Crack in the Great Wall of Profits

Climbing the Value Chain Won’t Be Cheap for the World’s Most Profitable Car Maker

ABHEEK BHATTACHARYA

Oct. 28, 2013 5:46 a.m. ET

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The world’s most profitable car maker may not wear its crown forever. Great Wall Motor, GWLLY -4.22% one of China’s largest SUV makers, sports higher operating margins than even ultraluxury players such as Ferrari. It has achieved this partly because utility vehicles, which fetch higher profits, make up a bigger proportion of its sales than of the average car maker’s. Great Wall has kept costs to a minimum. Research and development spending came to just 2.2% of sales in 2012, the lowest among major Chinese car makers, according to Goldman Sachs. Its global peers typically spend 4% to 5% of their sales on R&D.Great Wall said late Thursday its operating margin fell to 17.6% in the quarter ended September, from 19.1% the quarter before, even as sales grew smartly. Partly to blame: higher R&D costs, as well as expense of moving production to a new plant. Company executives say R&D spending will stay at 2% to 2.5% of sales until 2016, notes Macquarie.

Staying frugal on R&D could be easier said than done as the firm moves up the value chain. The Chinese car maker, which has so far sold low-end SUVs, plans later this year to introduce a bigger, high-end model called the H-8. A five billion yuan ($822 million) R&D center opens in 2014, and the company plans to hire about 4,000 engineers, says Bernstein Research’s Max Warburton.

Great Wall’s Hong Kong shares have rallied 93% this year, even as the Hang Seng Index has stayed flat. China’s car industry has been a bright spot in an otherwise lagging mainland economy. Investors have also been attracted to the SUV maker’s margins.

The rally has pumped up Great Wall’s market capitalization to about $21 billion, higher than all Chinese auto makers save SAIC Motor, the local partner of General Motors. It’s higher than the capitalization of Italy’s Fiat, Japan’s Mazda Motor or India’s Tata Motors, though the current fiscal year’s estimated sales for each of those three are at least three times Great Wall’s, according to FactSet. Investors are putting a lot of faith in Great Wall’s dandy margins not to crumble.

Great Wall has kept costs down with low-end products. But it may have to pay a price to get to the next stage of development.

Filed under Macro Trends

Unknown's avatarAbout bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (www.heroinnovator.com), the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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