We recently welcomed China Automotive Systems (CAAS) to The Value Line Investment Survey. The company, founded in 2003 and headquartered in Hubei Province, People’s Republic of China, is China’s second-largest manufacturer of power steering systems and related auto components. As such, it stands to benefit greatly from the rapid economic expansion and stunning car boom now under way in that fast-developing nation of more than 1.3 billion people.

The supplier has already racked up a pretty impressive financial track record in its short history, highlighted by an average annual share-earnings advance of nearly 28% since 2003. And its stock, which trades on the NASDAQ, has handily bested the benchmark Standard & Poor’s 500 Index over the past five years. (The issue has appreciated more than 200% during this tumultuous period.)

Looking ahead, based on strong sector and company-specific fundamentals, we strongly believe that China Automotive Systems’ best days are still to come. The auto parts stock may not continue to outperform the broader market indices in the three to five years hence, however, given its somewhat lofty valuation at present. Indeed, much of the company’s growth potential out to 2013-2015 already seems to be reflected in the current quotation.

Home Cooking

China Automotive Systems, now generating annual sales in the $300 million range, focuses predominantly on the domestic original equipment manufacturer (OEM) market, with the bulk of its sales coming from China’s largest automakers, including BYD Auto Co., Chery Automobile Co., Beiqi Foton Motor Co., Zhejiang Geely Holding Co., Brilliance China Automotive Holdings Limited, China FAW Group, and Dongfeng Auto Group. (These top seven customers accounted for 70% of the top-line mix in 2009.) This positions the supplier well, we think, to capitalize on China’s developing love affair with the car.

Notably, auto ownership in China remains quite low, in the mid-single digits on a percentage basis, notwithstanding favorable government policies aimed at stimulating this sector. This figure ought to trend markedly higher over the next several years, however, as numerous factors support a further, widespread car-buying spree, similar to the one that took place in the U.S. following World War II. Among these factors are rising personal incomes (more Chinese can now afford a middle-class lifestyle); an increasingly vast road network (980,000 kilometers of highway and 4,719 kilometers of expressway were developed in 2009); and a population shift away from rural farms and towards urban and suburban centers, where jobs are more plentiful and individual mobility is of great importance.

The Chinese government, meanwhile, is apt to continue pushing aggressive stimulus measures, as part of a wider effort to spur private consumption and transform China’s traditional agricultural economy. These initiatives, including tax breaks for some first-time buyers and subsidies for upgrading to more fuel-efficient vehicles, will probably support the country’s car sales boom throughout the decade, and keep China Automotive Systems’ financial results headed in the right direction.

All told, industry experts now anticipate that automobile ownership in China, already the world’s biggest car market, will surpass a hefty 200 million units by 2020, up from around 75 million today. Moreover, yearly demand for passenger cars in China will likely reach more than 25 million units by decade’s end, compared with the roughly 15 million units expected for all of 2010.

Growth Beyond China

While securing a strong position at home, the company is hoping to further jumpstart its top and bottom lines by inking new deals with international OEMs, particularly the large U.S.-based automakers. To this end, the firm recently scored a major coup when it signed an agreement with Chrysler North America to supply parts for the Jeep Wrangler platform. The contract represents a big endorsement of China Automotive Systems’ mainstay power steering gears, given the strict safety regulations regarding these important devices in both the U.S. and Europe. And the watershed deal should eventually lead to more contracts with Western automakers (e.g., General Motors and Ford (F)) that are looking to build enduring relationships in the Chinese auto market. This would be a significant development, since it would add some needed geographic diversity to the company’s business and help smooth out its results over time.

Financial Stability

China Automotive Systems, while still in the early stages of its development as a multinational parts maker, maintains solid cash flow and a clean balance sheet, with very little debt and about $65 million in cash. This should give the company plenty of flexibility to expand its manufacturing capacity and develop new, noncore products. Accretive acquisitions and joint ventures are realistic possibilities, too, especially as the supplier looks to penetrate the North American market.

In sum, China Automotive Systems is a well-managed, financially sound parts outfit that ought to profit handsomely from China’s car sales boom and efforts to gain ground in the Western world. We think that long-term investors would do well to accumulate these shares on any meaningful price pullback.

At the time of this article’s writing, the author did not have positions in any of the companies mentioned.