The automotive inspection industry has recently garnered considerable attention in China, particularly with the introduction of new standards that will elevate the expectations placed upon annual vehicle inspectionsRecent discussions have emerged surrounding the implementation of On-Board Diagnostics (OBD) systems in these inspectionsOBD, effectively an integrated onboard computer, is designed to help technicians swiftly and accurately identify any faults within a vehicleThis new technique signifies a push for improved vehicle quality and compliance, potentially transforming what was once a routine inspection into a challenging process for the nation's 492 million car owners.

The rising scrutiny of the automotive sector reflects the increasing importance of vehicle safety and maintenance within ChinaAs such, the automotive inspection market is poised for continuous expansion, indicating significant growth opportunities not only for inspection services but also for the supporting companies involved in the automotive ecosystem.

Within the capital markets, several prominent automotive inspection companies such as Chengdu Huawai, Xiechuang Data, and Huihan Shares have demonstrated notable performance recentlyMoreover, a key player in the industry, Boca Testing, is set to unveil its public offering on December 9, 2023. Set against a competitive backdrop, Boca Testing has managed to maintain a comparatively lower price-to-book ratio, while its return on equity stands at an impressive 15%, well above the average for its industry peersThis raises a pivotal question: will Boca Testing be able to uphold its high return on equity and favorable valuation after going public?

Focusing on the company’s revenue streams, a critical aspect of an automotive services firm like Boca Testing lies in its ability to secure major clientsThe company's current client roster boasts significant names in the industry, including BYD, Xpeng, and CRRC CorporationsBYD, in particular, has been of utmost importance, with transactional volumes rising dramatically in recent years.

One of the advantages of working with a giant like BYD is the sheer volume of work available

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In 2023 alone, BYD launched approximately eight new vehicle models, leading to expectations that total sales could reach an astonishing 4 million vehicles across both new and existing modelsFor suppliers like Boca Testing, securing even a fraction of that pipeline can be a game changer for sustaining operations.

By 2022, BYD trailed closely behind as Boca's second-largest client, with transactions in 2023 swelled by an eye-popping 221% compared to the previous year, positioning BYD as Boca's largest clientHowever, this close relationship also comes with its drawbacks.

Firstly, the pressure on profit margins is significantAs a key player within the domestic automotive ecosystem, companies like BYD maintain considerable leverage over their suppliers, often prompting a reduction in prices with a single phone callBYD’s notoriety for price competition is a testament to this reality; just last week, they priced their Qin model as low as 59,800 CNY, which directly influences the profit margins for Boca Testing.

In 2023, Boca Testing generated roughly 276 million CNY from their automotive inspection systems, with BYD alone contributing about 122 million CNY, accounting for nearly half of the company's revenueHowever, despite this increase in sales, Boca's gross margin took a hit, declining significantly from 42.04% to 36.14%, a trend likely exacerbated by the issues connected to their reliance on BYD.

Secondly, Boca Testing is grappling with a substantial amount of accounts receivableThe power dynamics within the industry yield effects that extend beyond price reductions, manifesting as delayed paymentsIn the first half of the year, Boca found itself with nearly 100 million CNY in accounts receivable, starkly contrasting with its net profit of only 41 million CNYThis infers a troubling ratio, where receivables amounted to 2.05 times the net profits, creating significant cash flow challenges for the firm.

To address these issues, Boca's IPO financing aims to raise 200 million CNY specifically for supplementing working capital

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In total, Boca plans to raise approximately 750 million CNY, including investment in two production projectsHowever, this raised an eyebrow as the company's net assets stood at only 483 million CNY by the third quarter of the year—a troubling reality where raised funds could potentially exceed available assetsHowever, it is important to note that alongside net assets, a significant portion of Boca’s assets comprises inventory, bringing the company’s total assets to approximately 1.347 billion CNY.

From 2019 until the first three quarters of 2024, Boca Testing's inventory level surged from 331 million CNY to 476 million CNY, drawing close to the levels of net assetsThis situation begs the question of whether such high levels of inventory might hinder Boca Testing's operationsAnalysis of the company's unique operational model can offer some context here.

Notably, the company engages in long project acceptance cyclesThe period from contract signature to design confirmation takes anywhere from one to six months, while product shipping tends to vary between two and nine monthsFollowing shipment, the installation phase can run for an additional one to six monthsFinally, after the installations, systems remain in trial phases for up to nine months before receiving final acceptance from clientsAs a result, project timelines for Boca Testing can extend anywhere from several months to over two years, which contributes to the accumulation of inventory significantly as products awaiting delivery are recorded as stock.

Additionally, Boca Testing's downstream clients, such as BYD and CRRC, exhibit high expectations for product quality, prolonging the acceptance timeframeHence, high inventory volumes reflect the business model, rather than a struggle with product salesCurrently, nearly 60% of Boca's inventory is less than one year old, suggesting stable operational health—at least in terms of inventory management.

It’s evident that while substantial reliance on extensive clients compresses profit margins and sees accelerated account receivable and inventory growth, the aphorism "no pain, no gain" eerily rings true

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What Boca Testing is experiencing could very well be considered a necessary phase of transformation; as long as they hold onto their core growth areas, Boca Testing's growth trajectory seems quite promising.

The most crucial avenue of growth for Boca Testing lies within the burgeoning electric vehicle (EV) marketSince 2021, the production and sales of new energy vehicles accelerated dramatically, with last year's sales soaring to 9.495 million units—an approximate twentyfold increase from 2016. Despite this rapid growth, EV sales captured only 35% of total sales in the first half of this year.

The entire EV space exhibits characteristics suggestive of “rapid growth yet a fledgling scale.” The sector is undergoing a phase of swift market expansion, subsequently aiding related industries, including automotive inspection services like Boca TestingIn the third quarter of this year, automotive inspection revenue reached 210 million CNY, constituting around 65.34% of the company’s total revenue—a clear indication that Boca Testing is positively benefiting from the rise of the EV market.

On the other hand, traditional business areas—such as servo hydraulic testing equipment—also provide significant stability for Boca TestingTheir servo hydraulic testing systems cater primarily to academic institutions like Tsinghua University, Central South University, and Tianjin University, with these clients exhibiting high long-term engagement and reliable payment cycles.

So, despite the systemic challenges posed by partnerships with major industry players, Boca Testing is well-positioned to capitalize on both emerging and established market opportunitiesThis duality of expanding customer bases and traditional operations fosters a sense of confidence in Boca’s ability to pursue a second growth curve.

In conclusion, the wisdom in the adage, “To consider advantages, one must also contemplate potential pitfalls; to pursue success, one must also recognize possible defeats,” rings especially true for Boca Testing

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