Bitauto (BITA) is benefiting from strong growth trends in China's auto market. These trends are expected to continue in the future, with China's auto sales set to double from 2011 through 2020. The company also aims to increase revenue in the used car market, as management sees increasing demand for used car valuation products. That has led to a partnership with the U.S. based Kelly Blue Book, which will provide vehicle valuation products via web and mobile to consumers, automakers, auto dealers and other automotive-related companies. As a result of the secular growth trends in China's auto market and the growth in online advertising, Bitauto is delivering robust earnings and revenue growth. My initial price target is $45, representing 32% upside from Friday's closing price.
Strong growth of China's Auto Market
China has been the fastest growing economy in the world, with annual growth averaging 10% over the last 30 years. China's automotive sector grew at an annual rate of 24% between 2005 and 2011. According to McKinsey Perspective on China's auto market in 2020, China's auto market will grow at an annual growth rate of 8% from 2011 to 2020 to 22.2 million vehicles. These trends will be supported by continuing growth of China's economy, as well as improving quality of roads, expansion of road systems, higher incomes and the fact that the auto market is still underpenetrated.
China's passenger-vehicle sales rose 24% to 1.61 million units in October, the highest increase since January, helped by a recovery in economic growth and a rebound in demand for Japanese brands. Analysts estimated 1.5 million units. In the first 10 months of the year, 14.5 million automobile were sold.
Bitauto stands to benefit from these growth trends, as well as the fast growth of internet usage in China, which is expanding significantly in recent years. This growth has made the internet an important marketing and advertising channel for China's automotive industry. The growth of the internet advertising market will surpass the growth of the auto market in China, and Bitauto is still in its early stages of its development.
Bitauto's management estimates (according to company's third party research results) that the auto industry will spend about $1.5 billion on internet advertising this year. Given Bitauto's full-year revenue guidance, the company's market penetration is between 15% and 20%. The entire auto industry market spend in China is about $10 billion; this would imply that about 15% of spending is online. Given the strong growth trends of online advertising, there is ample room to grow, and it will get larger in terms of percentage of total marketing spending by the auto industry.
Outstanding earnings and revenue growth
Bitauto has grown earnings and revenue considerably in the last couple of years. Revenue has grown 46% and 58% in 2011 and 2012 respectively, and is expected to increase 37% in 2013. Adjusted net income has grown 50% and 40% in the same period, and is expected to increase 65% in 2013. The company reported earnings and revenue growth of 112% and 37% respectively in Q3 2013. Profit margins have expanded significantly lately. Gross margin in the latest quarter was 74.7% compared with 73.2% in Q3 2012. Operating margin expanded 750 basis points to 20.2%, while non-GAAP net margin increased 730 basis points to 20.5% in the third quarter over the same period last year.
Source: Bitauto's financial reports
Improved margins are the result of business scalability and an increase of operational efficiency. The company continues to execute its three core growth strategies:
1. Enhance the range of services and products available on the EP platform.
2. Continue to work on raising Bitauto.com's brand recognition.
3. Continue to invest in taoche.com
Review of business segments
Bitauto has four business segments: Bitauto.com advertising, EP platform business, taoche.com business and its digital marketing solutions business.
The Bitauto advertising segment's revenue has grown 47% in the first nine months of 2013, and operating profit has increased 64%. This segment's gross and operating margin have improved 250 and 280 basis points respectively to 85.8% and 27.5% in the first nine months of 2013 when compared to the same period last year.
EP platform revenue increased 43.5% in 9M 2013 over the same period last year, while operating profit increased 84%. The segment's operating margin improved 415 basis points to 18.7% over the same period, and was 22% in Q3.
The Bitauto advertising business and the EP platform business are the ones that are delivering strong revenue and operating profit growth, while the taoche.com and digital marketing solutions businesses are a drag on the company's bottom line, and have been delivering mostly negative revenue growth and operating losses in the previous quarters. Taoche.com's revenue in the first nine months of 2013 was just $2.3 million, down from $2.8 million in 9M 2012. That is about to change for the taoche.com business segment, with the new Kelley Blue Book partnership, which I believe will bring substantial results in late 2014 and beyond. Until then, taoche.com business will remain unprofitable, and will negatively affect the company's profit margins.
On the other hand, the digital marketing solutions business has larger participation in total revenue, and its revenue growth has been volatile in recent quarters. In the first nine months, digital marketing solutions' revenue increased 5% to $23.1 million with an operating loss of $1.2 million. Management noted in an interview with IBD that the company wants to sell the digital ad business to a global ad agency looking for a strategic foothold in China, and that "global players have aggressively approached the company on this asset". I believe that this would be an excellent move for the company, as this business is eating up cash, and will enable the company to strengthen its cash position and reinvest the funds in the healthy part of the business - the two very profitable and growing segments, as well as further investing and developing of the taoche.com business, given the large opportunity in the used car market. The sale of the business would also have a positive impact on profitability, with a significant increase of gross and operating margin.
Expanding mobile offerings
Management remains focused on expanding the range of mobile offerings. As a result, product development expenses increased 76.1% in Q3 2013 from Q3 2012. Bitauto invested in creating the industry's leading mobile offerings, which management regards as critical in accelerating the trend toward mobile. Bitauto's mobile applications are gaining popularity among consumers. In the first nine months of 2013, over 11 million new users activated Bitauto's Android and iOS app. The key focus of the company's mobile strategy is to deliver more cost effective sale leads to auto dealers, and almost 25% of sales leads were generated by consumers completing Bitauto's online vehicle purchase application via mobile.
Kelly Blue Book partnership to enhance the used car segment
On November 7, Bitauto announced that it has entered into an agreement to establish a joint venture with Kelley Blue Book, the leading provider of new and used car information in the United States, and the China Automobile Dealers Association ("CADA"), a national representing automobile dealers in China. The joint venture will provide China-wide vehicle valuation products via web and mobile to consumers, automakers, auto dealers, along with insurance, finance and other automotive-related companies that seek vehicle valuations. This is the result of Bitauto's efforts to bring vehicle valuations to China's used car market, and management stated that they see strong demand for such products. These products are expected to serve as a central hub for development of China's new and used car industries.
The ownership structure of the joint venture will be: 40% Bitauto, 40% Kelley Blue Book and 20% CADA. Bitauto's taoche.com is already the number one online used car marketplace in China. The consumers will now have the option to find out the value of the vehicle that they currently own and/or want to buy, before they pursue any sort of transaction. The vehicle valuation products are experiencing increased demand in China's used car market, which is underserved and is entering a period of rapid development. The joint venture will enable the company to become the leading provider of vehicle valuation products in China, and the used car business segment will be strongly enhanced and enjoy strong growth in the future.
Valuation and price target
Bitauto is currently trading at 38 TTM P/E and a forward P/E of 24. Given the strong earnings growth rates, and the fact that the company can maintain revenue growth of at least 30% in the next couple of years, Bitauto is trading at a significant discount to growth. As the company continues to scale its business, profit margins will expand further, and earnings will grow at a faster rate than revenue. The base case scenario is: forward P/E of 30, which means that there is at least 25% upside from current levels. However, the company is delivering ahead of analyst estimates, and I believe that the estimates are conservative, and that Bitauto's 2014 EPS will be between $1.45 and $1.55, as opposed to current consensus estimates of $1.29. At the mid-point of my projection, and based on a forward P/E of 30, my initial price target is $45, representing 32% upside from the current price. Shares could easily double in the next two-three years on continued multiple expansion.
Price extended - wait for a pullback before buying
Bitauto's stock price is currently extended, and vulnerable to a pullback. The stock has risen more than 300% year-to-date, and may consolidate gains over the next couple of weeks or months. This would create a solid buying opportunity and I would be a buyer in the $22 to $25 range.
(click to enlarge)
Source: stockcharts.com
Risks and challenges
Bitauto faces certain risks and challenges that must be acknowledged:
- China's economic growth has slowed down in the last couple of years, and it might slow down further, which could affect Bitauto's revenue and profitability. However, there are signs of improvement recently, as can be seen in increased auto sales in October and as industrial output growth accelerated and inflation stayed below a government target last month. Production rose 10.3% from a year earlier, while inflation was 3.2%. China's economy might also benefit from the "boldest reform in decades", with the expected relaxing of its one-child policy and further freeing up markets.
- Bitauto is in early stages of development and monetization of its mobile platform. Future revenue and earnings might be negatively impacted by a lower than expected level of mobile monetization.
- Bitauto faces increased competition in each of its business segments. The automobile advertising services faces competitors such as pcauto.com and autohome.com.cn, as well as the automotive channels of major portals and traditional forms of media, and also from social networking websites and internet video websites. The taoche.com business faces similar competitors, except that the competition is more focused on the size of used automobile inventory and market penetration among used car dealers. The digital marketing solutions business faces competition from well established international advertising agencies, such as Dentsu and WPP, as well as local agencies that specialize in providing online marketing services.
- Over the last couple of years Chinese stocks have faced scrutiny over their accounting practices. The latest example is NQ Mobile (NQ), which dropped more than 50% after a bearish Muddy Waters report which questioned the company's financial statements. Bitauto's share price could be pressured if there was a similar attack on the company, whether it was founded or not.
Conclusion
Bitauto presents a way to participate in the strong growth of China's auto market, as well as the growth of online advertising. There are several catalysts that could push the shares higher:
- Continued growth of China's economy, auto market and the growth in online advertising.
- Strong revenue growth, coupled with earnings growth and margin expansion.
- The company is in early stages of mobile monetization, which presents a strong growth opportunity for the next couple of years.
- Kelley Blue Book partnership will further strengthen the company's product offerings in the used car market.
- Despite a significant rise of the share price, Bitauto continues to trade at a discount to growth, and my initial price target is $45, representing 32% upside from Friday's closing price. If the company decides to sell its digital marketing solutions business, the cash position will increase and operating margins and overall growth might accelerate if the company decides to reinvest the funds into its healthy parts of the business, as well as the used car segment, which I expect to be a larger revenue contributor by late 2014 and beyond. Shares could go up even more if the company can continue to grow ahead of analyst expectations. However, the stock is currently vulnerable to a pullback, and could provide a better entry price in the next couple of weeks or months.
Additional sources: Bitauto SEC filings
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. (More...)
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