When is a value stock not a value stock? How about when you can't understand who's really in charge of the freakin' company!
On the surface, China Yuchai (NYSE:CYD) looks like it should be a slam-dunk stock for those wanting a little China in their portfolio. After all, the underlying business of diesel engines is profitable, growing, cheap, and well-positioned to take advantage of the growth in the Chinese heavy-truck market.
So why, then, does the stock trade for only six times earnings? Why do institutions have virtually no interest in it at all? Why are more than 10% of the company's outstanding shares shorted? Shouldn't this be the next Cummins (NYSE:CMI) or Daimler Chrysler's (NYSE:DCX) Detroit Diesel?
Dig deeper and you begin to see why the stock trades at the level it does. Oh, and get ready for some confusion.
When you buy shares in China Yuchai, you're not exactly buying shares in a Chinese diesel engine maker. What you're buying is shares of a Bermuda company that owns upwards of three-quarters of the stock of a Chinese diesel maker, Yuchai. China Yuchai itself is more than 20% owned by Hong Leong Asia (HLA), and HLA has a "golden share" that allows it to do pretty much whatever it pleases, including controlling the board of directors.
That remaining 25% or so of Yuchai is the sticky part. It's owned by an entity called the State Holding Company, which is basically the Yulin city government -- Yulin is where Yuchai is located. What's more, Yulin, through Coomber Investments, owns almost 25% of China Yuchai.
Got all that?
Wait, there's more.
Even though China Yuchai owns a huge chunk of Yuchai, it's more or less in the position of a nonoperating partner. That is, it doesn't (and, frankly, can't) make any day-to-day decisions about the company or its financial structure, including dividends or capital expenditures.
Recently, this has been a problem. The Chinese management of Yuchai and the management of China Yuchai have not been seeing eye-to-eye on matters. Not only have dividends been withheld from China Yuchai but also Yuchai has attempted to pull stunts such as not permitting board meetings to be held, not implementing board decisions, and even attempting to give a sweetheart loan to another Coomber-controlled company.
When China Yuchai began to complain about these goings-on, the State Holding Company tried to bring the whole thing crashing down by having China Yuchai's ownership stake declared illegal. This is a time-tested practice in China -- if the foreign partner gets a little too big for his britches and doesn't let the locals do what they please, the government tries to pressure him with threats of invalidating the whole shebang.
To its credit, China Yuchai tried to resolve the mess in a July 2003 agreement (called "the July 2003 agreement") whereby both groups essentially pledged to play nice and cooperate. Well, it's been 18 months, and the agreement has yet to be implemented. What's more, the CEO of Yuchai, who is essentially a State Holding Company ally, threatened in December 2004 that the agreement may not be implemented at all. And then in February, Coombers again asserted that China Yuchai was in violation of various Chinese laws and was interfering in Yuchai's operations.
To make matters even more interesting, it appears as though Coombers has been contemplating an increase in its holdings of China Yuchai -- perhaps in an effort to throw off the ownership structure in such a way that HLA would loose its "golden share" and therefore lose control of China Yuchai. But then, you expected that, right?
If anybody has followed this far and doesn't yet have a headache, they're a stronger person than I.
While I really love the inherent idea of China Yuchai -- a growing Chinese maker of diesel engines that trades at a single-digit price-to-earnings ratio -- the reality would give me nightmares if I tried to own this thing. True, the squabbling hasn't really hurt the operations of the underlying company yet, but there's just too much turmoil here for my comfort.
That said, I really hope the ownership situation and the seemingly incessant squabbling gets resolved somehow, because this is the type of stock I'd love to own someday.
Want undervalued stocks you can understand? Take a free trial of Motley Fool Inside Value , where Philip Durell and team lay out two ideas a month.
Fool contributor Stephen Simpson has no ownership interest in any stocks mentioned, and after researching this piece he needs to lie down for a bit.
