BYD has encountered a few rough patches lately with cuts to its sales target for 2010 and second quarter profits that were significantly below consensus estimates.  These developments have resulted in a sharp drop in BYD’s share price with the ADRs falling close to 52 week lows.  Adding to the negative news, Bloomberg reports that China’s Ministry of Land and Resources has accused BYD of illegally building seven factories on 112 acres of farmland that was zoned for agricultural use. The government will make a decision regarding the punishment for the company prior to the end of September.

According to Bloomberg, China is struggling with striking an appropriate balance between further growth in the manufacturing sector and preserving enough arable farmland to achieve the government’s goal of self sufficiency in grain production:

China, which consumes one-fourth of the world’s grain, needs at least 297 million acres of arable land to grow enough food to feed its people, the land ministry said.

Economic and social development from 1997 to 2007 reduced farmland by 83 billion square meters to about 1.22 trillion square meters. That is about 1.4 percent above the minimum requirement for arable land, according to the ministry.

“We are facing a grim situation on enforcing laws regarding land-resources protection,” Li Jianqin, head of the ministry’s law enforcement and supervision division, said July 15. “The ministry will severely punish violators of land- safeguarding laws and regulations, and we should dare to tackle tough cases.”

BYD built its factories even though 92 percent of the land they occupied in Shaanxi province was still zoned for agriculture, the ministry said. The province grows corn, wheat and rice, according to the China Statistical Yearbook 2009. It produced 4.84 million tons of corn and 3.92 million tons of wheat in 2008.

The potential penalties are unclear at this time but the worst case scenario would be a government order for BYD to tear down factories that have been built on agriculturally zoned land.  This would further impact BYD’s struggle to build enough manufacturing capacity to fulfill the company’s ambitious growth plans over the next several years.

Berkshire Hathaway owns 10 percent of BYD through its MidAmerican Energy Holdings subsidiary.  The company was brought to the attention of Berkshire Hathaway Vice Chairman Charlie Munger several years ago through discussions with Li Lu, a hedge fund manager who handles a significant portion of Mr. Munger’s personal investments.  Recently, Mr. Munger identified Li Lu as a future investment manager for Berkshire Hathaway and speculation regarding the timing has only increased with the recent retirement announcement of Lou Simpson, GEICO’s investment chief.

Disclosure:  The author of this article owns shares of Berkshire Hathaway.

BYD Faces Trouble Over China Land-Use Violation
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