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Li Auto Inc. (NASDAQ:LI) is one of the leaders in China’s new electric vehicle (“EV”) market. Their stock has suffered a loss of more than 45% over the past 3 months due to certain well-known conditions, including the Covid-zero policy and supply chain constraints. However, we think LI stock is on its way to a rapid rebound and strong growth by next year due to the factors we will outline in a moment.
Especially with Xi Jinping’s policies mandating that 40% of EV sales be electric by 2030 and all-electric by 2040, a rapid transition to renewable energy and electric vehicles is almost a guarantee. And as things stand, many of the old car competitors seem to be asleep at the wheel.
Li Auto’s fleet currently includes several EVs, characterized primarily by their long-range capabilities. Their range-extended electric vehicles, or REVs, are a combination of a large battery pack combined with a small internal combustion engine (“ICE”) to solve range anxiety.
The company’s first product, the Li ONE, went into production in late 2019 and has already surpassed 200,000 units, demonstrating their tremendous speed in time-to-market and production capabilities. Li Auto’s new lineup consists of the Li L9, which began delivery in September, and their Li L8, which just started selling this month. There is also an L7 in the pipeline, which is expected to go into production in the first quarter of 2023. However, we are most excited about Li Auto’s future all-battery electric car, which is expected to hit the market next year.
Deliveries, on the other hand, have fallen in recent quarters for several reasons. One is a shortage of certain parts, such as batteries, and prolonged downtime due to China’s COVID-zero policy. Li Auto has also just begun delivery of its Li L9 vehicles, which accounted for most of its September sales. This is also reflected in its share price, which has fallen 58.94% over the past year.
Note that the company did not specify what type of vehicles were sold in October, and only gave us a 10,052 delivery number for the month. One positive catalyst that could be seen in this, however, is the fact that the Li L9 is a premium sedan, and thus has higher gross margins.
Current margins are 21.50%, and forecasters think they will come in at 21.88% next quarter, although we think this could certainly be higher and thus exceed expectations next quarter. The L9 is expected to have a production capacity of 15,000 units per month.
Author’s Visuals (Li Auto IR Data)
The Li L8 also seems to have a lot of wiggle room, as in their latest delivery update they said that the L8 “had a strong start with a continued increase in orders.” In their Q2 earnings call, they also said that:
“when the L8 is available, I think that will be a good time to compare product competitiveness with newly released competitors and we are confident that we will dominate all these products with our L8.”
It was also mentioned during the Q2 earnings call in August that after just 1 month they had received 30,000 orders for the L9, and that in the days following up to the conference call there was still strong demand for the product. Therefore, we think that as long as production allows, Li Auto should be able to sell all the cars produced and is probably not constrained by any demand-side problem.
We think the most interesting thing about the EV revolution is the lack of competition from automakers of the past, such as VW (OTCPK:VWAGY) and GM (GM). Even in China. Looking at the chart below, we can see how battery packs historically cost per kWh. In 2010, the price was $1220 per kWh, and it has dropped to $132 per kWh. In China, the price has already dropped to $111 per kWh.
Author’s Visuals (Bloomberg Data)
The fascinating thing is that when the price per kWh drops below $100, EVs are below sticker price parity relative to regular ICE vehicles, and it becomes extremely illogical to buy another ICE vehicle. Currently, ICE vehicles are already cheaper from the standpoint of the total cost of ownership (fuel cost, maintenance, etc.). But once the sticker price drops below that of an EV, we can expect a “tipping point,” and that should drive the demand for EVs even higher.
According to Wright’s Law, for every cumulative doubling of production, the price of batteries should fall by a certain percentage. Historically, that percentage has been about 28% for batteries. Since the ICE market is saturated and growing at an extremely slow pace, they cannot enjoy the cost reductions for every cumulative doubling of production. But EV sales made up only 10% of total car sales last year, and have a few more cumulative doublings to go before the market is saturated.
Renault (OTCPK:RNSDF) and Ford (F) target a cost of $80/kWh by 2030, while BloombergNEF forecasts the price at $62/kWh. Statista estimates the price at $58/kWh, but we think it is closer to $45/kWh. Our research leans closer to that of RethinkX, which has accurately predicted cost declines for solar, batteries, and wind, compared to others, who have been far too conservative in their estimates in the past.
Author’s Visuals (Bloomberg Data)
So the inflection point is coming and is almost here. And yet not too long ago GM and FEV thought it would be a great idea to develop a new 3.0L diesel engine, which usually costs US$1BN+ and has a payback period of at least 10 years. GM currently has “aspirations” to go full-EV by 2035, although back in 2017 it promised to have 20 new EVs by 2023. Currently, it has 4.
In the United States, for example, GM had a 53.7% market share in 1963 and Ford had 26%. GM’s market share is now estimated at 13.3%. Ford’s market share is estimated at 13.2%, with both parties declining in market share. While Tesla is gaining huge market share, Chinese EV manufacturers are scaling up rapidly, while the incumbent automotive industry seems to be getting complacent.
Looking at the current Chinese landscape, the top-selling EVs have largely been Tesla (TSLA), BYD Company (OTCPK:BYDDY), and Guangzhou Automobile (OTCPK:GNZUF) (2238:HK). Domestic manufacturers in China accounted for nearly 80% of EV sales in the first half of this year, and we believe that these domestic manufacturers will retain most of their market share and eat into the current demand of older cars still producing ICE vehicles. Not to mention the debt these automakers are carrying.
As you can see from the chart above, the debt load of some automakers is astounding. Many of them have debt in excess of $100 billion and an Altman-Z score that indicates a high degree of distress and a high risk of future bankruptcy. And this is especially frightening as the Fed raises interest rates.
In the chart above, you can see that many of these new automotive companies with large market shares in China have little to no debt. And most are already profitable or close to profitability. Old cars want to compete in these markets, but seem to forget that they are severely disadvantaged by their debt.
Plus, as we mentioned, we believe that the transition to EVs will be exponential as EVs reach an equivalent sticker price. That means the perceived “advantage” the old cars have with their cash flows could quickly turn from an asset into a liability as ICE falls out of favor.
One of the reasons we believe Li Auto is one of the winners in the Chinese EV market is its margins compared to its competitors. Especially the gross margin, which currently stands at 22.44%. The only direct competitor with better gross margins is Tesla, which currently has a gross margin of 26.6%.
Li Auto is also already producing free cash flow and is trading at a fairly reasonable multiple of 13.3x cash flow. Although Tesla and BYD currently control a large segment of the car market, we think there is still a lot of room for Li Auto to grow and gain market share.
Their balance sheet is also very strongly positioned. They currently have US$7.53BN in liquid assets, despite their market capitalization of US$19BN. They have sufficient funds to continue their future operations, prosperous growth, and a strong buffer.
Looking at competitors, only XPeng (XPEV) appears to have a lower price relative to tangible book value. However, it is important to note that XPeng is currently experiencing a decline in revenue growth combined with a loss of over US$300M per quarter in terms of operating loss.
Strong sales growth, large gross margins, and already generated cash flow combined with new product launches and a softening of Covid-Zero policies could give the company a serious and unexpected boost. Currently, Li Auto’s consensus EPS forecasts growth of more than 4x, from 0.13 to 0.73 by the end of 2024. That means the manufacturer would trade at 25.25x forward EPS.
That would be cheaper than Tesla, which is currently trading at 29.21x expected earnings per share for 2024. We believe the consensus estimates of growing sales to US$19.12 billion by the fiscal year 2024 are achievable, given Li Auto’s historical growth and fast time-to-market.
EBITDA margins should also improve from -1.8% this year to 4.9% in fiscal 2024. Again, we believe this is achievable as battery pack prices continue to decline, gross margins improve, and OpEx. spending decreases as the company’s product line becomes more saturated. If Li Auto can reach the US$19.12BN revenue target by 2024, and have EBITDA margins of 4.9%, we think they should at least trade at similar levels to other automakers out there today.
We also believe that growth is an important factor in the stock price of modern automakers, and will therefore use a PEG ratio rather than an EV/EBITDA or P/E multiple to evaluate the company. After 2024, we believe Li Auto’s earnings per share and revenue growth will be much closer to or lower than Tesla and BYD, i.e., 50% year-on-year. The current PEG ratio for the auto market is 0.96.
Currently, Li Auto is trading at a 2024 Forward PEG ratio of 0.51, which represents an 88.24% discount to the average 0.96 PEG ratio. Thus, at a 2024 PEG ratio of 0.96, Li Auto should cost $35.04 per share.
Finally, we also think 2 additional factors could contribute to another sharp rise in sharp rice: their development in autonomous technology, and a rebound in the Chinese economy.
China’s economy has been suffering recently, with the Hang Seng falling as much as 47% between February 2021 and now. In the past 30 years, however, the Hang Seng has always recovered fairly quickly. During the GFC in 2008, for example, the Hang Seng fell 48.27%, but in 2009, it rose again by 52.02%. After falling 53.71% from 2000 to 2003, the Hang Seng continued its rebound and had 5 years of average gains of 25.22%. So maybe the worst is already behind us.
In terms of autonomy, China is expected to likely be one of the first countries to adopt autonomous driving. Since August, for example, China has introduced regulations that make it legal to drive autonomous vehicles without a human driver within areas designated by city authorities. With China’s autonomous vehicle market expected to grow at 58.9% CAGR between 2021 and 2030, any positive developments from Li Auto can be considered a huge bonus.
In terms of risk, we think the biggest factor is competition, mainly from Tesla and BYD. Both competitors still have quite an advantage, being early in the EV race and holding most of the EV market share in China. The chart below shows that Li Auto is still a small fish compared to both of its competitors.
On the other hand, Li Auto’s sales growth still seems to be higher than BYD and Tesla, currently 140/25% year-on-year, compared to Tesla at 59.80% and BYD at 72.10%. Li Auto as a company can certainly still enjoy higher sales growth because it is still in the early stages of aggressively scaling up production.
Only until recently, when production slowed because of China’s Covid-Zero policy, combined with supply chain constraints, did growth seem to be held back. We believe that once these issues are resolved, Li Auto will return to record levels of sales growth, as it has in the past.
Another key risk we are considering is possibly the risk Li Auto faces by perhaps diversifying too much and producing too many models in too short a time frame. For example, in the latest earnings call, management explained that the number of orders for the original Li One seemed to be slowing down as more customers seemed to be paying attention to the recently released L9.
The final risk that we are watching closely is the state of the Chinese economy itself, as in times of economic distress, car sales usually fall sharply. We think current policies such as covid-zero and supply chain restrictions are temporary measures that will eventually return to baseline.
With Xi Jinping promising to sell only EVs by 2040, Chinese EV manufacturers went full steam ahead. Not only are EVs likely to replace ICE vehicles soon, but looking at the curve of cost reduction, they are likely to reach the same sticker price soon and demand will skyrocket while supply is still limited.
In our view, Tesla and BYD are the current leaders in the EV market in China, and the rest of the market is populated by new EV manufacturers, and Li Auto is among the best prospects as a competitor. Li Auto offers high revenue growth, has sufficient funding to run its operations, has sufficient demand, and appears cheaply valued at a PEG ratio of 0.51x by 2024, despite being in a high-growth sector.
And in the long run, we think Li Auto is also a winner, as legacy automakers are slow to ramp up production and let Chinese manufacturers capture much of their market share while having little to no debt.
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Disclosure: I/we have a beneficial long position in the shares of TSLA either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.