Don't Buy This Buffett Pick

Odds are that if you heard about a Warren Buffett pick trading near its 52-week low that had "amazed" Bill Gates, you'd be pretty interested in picking up shares for yourself. You might even rush out to do so once you got wind of the rumor that Buffett was looking to increase the size of his investment in the company. Tack onto that the fact that it's a fast-growing company in China, and this could be a stock you'd hold and profit from for the next decade or more.

Does this wonder stock exist? Yes, it's Chinese automaker BYD, but BYD bulls are misguided. Investors looking for undervalued stocks or for exposure to China should be looking elsewhere.

The case for BYD
Before I get to bashing BYD, it's important to note that Buffett has already made a lot of money on this investment. The 10% stake Buffett bought in the company in 2008 for $230 million after being impressed by company management and its aim to become the world's top seller of electric cars is now worth almost $1.2 billion. That's a good return no matter how you slice it, and it was generated by BYD's fast growth over the past year -- sales and operating income were both up more than 40% -- as well as by the benefits of the spotlight Buffett's investment shone on the company. With China now the world's largest auto market and industry groups estimating 30% growth there this year and beyond, BYD's prospects for maintaining its momentum look on the surface to be fairly good.

BYD, however, has some warts that are beginning to clarify themselves to investors.

The case against BYD
First, the company announced in early October that the Chinese government had repossessed seven of its factories because they were being constructed on illegally rezoned land. Not only does this development inhibit BYD's capacity for near-term growth, but it also shows that the company may not curry as much favor with the Chinese government as might be expected with such a high-profile operator.

Second, the company delivered very disappointing recent earnings, with profits dropping 99% year over year in the most recent quarter. The reasons cited were falling sales in China and delayed shipments of electric cars to the United States. The former reason is of particular concern because China needs to be a near-term growth driver for the company with the widespread adoption of electric cars still seemingly so far off. But BYD is nothing special in China, with its basic offerings competing on price with a bevy of domestic and foreign rivals, including Dongfeng, Geely, GM (NYSE: GM  ) , Ford (NYSE: F  ) , and more. Most concerning for BYD investors is that shipments by competitors GM and Dongfeng increased even as BYD's were declining.

Third, it doesn't look like the headwinds that depressed demand for BYD cars during the third quarter are abating. The Chinese government recently decided to end tax breaks for purchases of small cars, and because of worsening traffic jam problems in Chinese cities, will actually be limiting new car purchases next year (and potentially for the foreseeable future). This is bad news for BYD. With increasing competition and depressed demand, it should prove difficult for BYD to meet the growth expectations that are priced into its stock.

More on those expectations
What are those growth expectations? At first glance, BYD's valuation at 1.8 times sales and 14.1 times EBITDA doesn't look all that appalling within the broader context of China. Recent Chinese offerings such as Youku.com (NYSE: YOKU  ) and Dangdang (NYSE: DANG  ) are trading for much higher multiples despite having much lesser businesses.

But place BYD within the context of the automotive sector -- in China or elsewhere -- and it starts to look much less attractive.

Company

EV/Sales Multiple

EV/EBITDA Multiple

Toyota (NYSE: TM  )

1.0 times

9.2 times

Honda (NYSE: HMC  )

1.0 times

7.5 times

Ford

1.2 times

11.0 times

GM

0.3 times

3.6 times

BMW

1.5 times

15.0 times

Dongfeng

0.7 times

5.3 times

BYD

1.8 times

14.1 times

Brilliance China

3.1 times

16.9 times

Geely

1.4 times

13.6 times

Great Wall Motor Co.

1.2 times

9.4 times

Tesla Motors (Nasdaq: TSLA  )

23.7 times

N/A

Source: Capital IQ, a division of Standard & Poor's.

Sure, BYD trades at a discount to electric car industry peer Tesla, but it trades at a wide premium to other global automakers and a slight premium to its Chinese peers. This might make sense if one concluded that BYD was going to be China's leading automaker or if its battery technology would help it conquer the electric car market, but I suspect neither one of those scenarios to emerge. China, again, is a hypercompetitive auto market already, and the CEOs of Ford, GM, and other major manufacturers have said that China stands to be their No. 1 growth market going forward. Given that GM, via a joint venture, is already China's No. 1 automaker with better than 13% market share, it will be difficult to dislodge.

As for the electric car bet, it strikes me as speculative at best. Not only will it take years for consumers to make the transition (if they ever do), but BYD is not the only company trying to perfect this technology. Again, it's competing with established giants as well as with innovative upstarts such as Tesla.

The global view
All told, if you're looking for exposure to the Chinese auto market, instead of thinking about BYD, think about lower-priced options such as Dongfeng or a multinational such as GM. And if you're looking for exposure to the electric car market, hold off entirely until we get a better handle on how the technology will be deployed.

Get the team's top global stock picks by joining Motley Fool Global Gains. Tim's "Global View" column appears every Thursday on Fool.com.

Tim Hanson is the advisor of Motley Fool Global Gains. He does not own shares of any company mentioned. BYD is a Motley Fool Rule Breakers recommendation. GM is an Inside Value pick. Ford and BMW are Stock Advisor selections. The Fool's disclosure policy will drive you wild.


Read/Post Comments (17) | Recommend This Article (59)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On December 30, 2010, at 6:04 PM, langco1 wrote:

    many of buffetts picks even he is quietly trying to dump.the two biggest being moody's and kraft...

  • Report this Comment On December 31, 2010, at 8:48 AM, WhiteHatBobby wrote:

    And to thnk about it, Ford is selling Geely cars in the United States. Four 2011 Fords -- the Taurus, Flex, Edge, and New Explorer -- are built off one Geely sedan, so Geely, not BYD, is the automaker that will probably dominate in China. Geely has a huge dealer network worldwide through its ownership of Volvo Cars, and Ford is using Geely to source their cars.

  • Report this Comment On December 31, 2010, at 10:32 AM, dcsilver wrote:

    What's the symbol?

  • Report this Comment On December 31, 2010, at 11:54 AM, TMFDiogenes wrote:

    BYDDY.PK

  • Report this Comment On December 31, 2010, at 1:32 PM, picchis wrote:

    That's incorrect. The symbol is actually BYDDF.PK

  • Report this Comment On December 31, 2010, at 1:34 PM, Merton123 wrote:

    I wonder who are the manufacturers of motor scooters and smart cars in the USA? As Oil continues its steady rise upwards the demand for fuel efficient vehicles should also rise. I agree with Tim Hansen that 100% electrical vehicles are still a way out as we wait for battery technology to improve

  • Report this Comment On December 31, 2010, at 4:40 PM, ifool100 wrote:

    I think that once the broader US market gets a taste of electric there will be no turning back. Torque, speed and low noise of EV makes internal combustion with all it's gas and gears feel like a 20th century clunker. The real question is whether or not consumer sentiment can outweighing big oil, in persuading our politicians to allow this to occur.

  • Report this Comment On December 31, 2010, at 7:43 PM, SeeknDestry wrote:

    Why can't we get this symbol on MF already?

  • Report this Comment On January 01, 2011, at 3:03 AM, UltraLongFI wrote:

    I think BYD is a BUY. It is growth play as opposed to value play. That explains the multiple. However,this means that it is naturally more risky than established big auto companies. But like they say: risk and reward go hand in hand:

    http://seekingalpha.com/article/242707-byd-clearly-a-growth-...

  • Report this Comment On January 01, 2011, at 1:49 PM, Charlie1368 wrote:

    Just to clear the record, while BYD is at a 52-week low, Buffet still bought it at less than half the current price.

  • Report this Comment On January 02, 2011, at 1:02 PM, gt1135 wrote:

    @picchis: Actually both BYDDY and BYDDF are for the same company. I believe one has different voting rights than the other, or something like that. I've owned BYDDY for about 6 months.

  • Report this Comment On January 02, 2011, at 9:08 PM, cathat12 wrote:

    Living in Beijing, all of my coworkers have said BYD make bad quality cars, even compared to other Chinese car manufacturers. Also, the new car laws are going to restrict car sales to one third of previous year car sales, so it is almost certain that the auto industry in China will be tanking.

  • Report this Comment On January 03, 2011, at 8:25 PM, iksnamyzs wrote:

    Alas,No fumes, Alas, Fresh air. Electric is coming-the world is going green. There are problems to be solved and still to overcome by BYD but the gas fumes are history. Bad CO2. Talk to Mr. Gates. And this company has a cost advantage. So I believe its Way too early to throw in the towel on this one.

  • Report this Comment On January 05, 2011, at 12:00 PM, jl3793 wrote:

    Let's build another coal burning plant to make electricity for these green cars. And how's the new (as in 50 year old) technology for your new batteries coming along. Is that another fifty year wait for a marginal improvement. Thanks, but I'll just wait for the flying cars as per Popular Science magazine Sept 1964.

  • Report this Comment On January 05, 2011, at 2:08 PM, JPDemers wrote:

    With trafffic jammed and car sales restricted, Chinese who want personal transportation are flocking to scooters and motorcycles.

    Electric scooters have good range, low operating expenses, and a much lower price than electric cars. I think that's where the growth is going to be most spectacular. ABAT is one of the more promising plays on the electric vehicle market in China.

  • Report this Comment On January 05, 2011, at 9:12 PM, xedubig wrote:

    This is a very poorly researched article. How much knowledge of the Chinese automotive market do we need to assume the author has?

    The largest automotive maker in China is Volkswagen (16.6% in 2010), which is not even mentioned here. Ooops.

  • Report this Comment On January 07, 2011, at 4:26 PM, klnana wrote:

    This comment is specifically directed to Rule Breaker Fools.. who were just a few short months ago directed to buy BYDDY pink... so, I purchased 30 shares @$69.77.. 9/23.. by Dec.. the stock split.. supposedly 5 to 1.. but my shares are now noted at 120 hovering around a value of $11.. we are being advised not to buy.. for those of us who already own.. why are we not being advised to sell?

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