BYDDY - BYD: Fundamental Setup Could Work Based On China's Healing Macro Story

2024-01-06 04:55:16 ET

Summary

• BYD is a top performer in China's EV market, with strong delivery numbers and growing global brand recognition.
• The stock has struggled within a lower trading range, indicating challenges and opportunities ahead.
• BYD's fundamental outlook is positive, with solid profits and plans for global expansion, but it faces risks from US and European restrictions on China's EV industry.

China EVs are a highly contested investment theme with extremely choppiness, which I believe ultimately ends in upside

BYD (BYDDF) (HK-1211) is one of the top relative outperformers in China's landscape in calendar year 2023, where the majority of technology names capitulated 10-20% losses in another year where the Hang Seng has been mired in frustrating stagnation.

Strong delivery numbers, growing global brand recognition, and a secular adoption towards EV powered BYD to a single digit gain in last year's highly contested China market shakeout.

The last 45 days, however, have seen the stock struggle inside a new lower trading range between 196-218 in the HK-1211 counterpart that foreshadows challenges (and opportunities) ahead. This is equivalent to BYD between 25 and 28 per share.

We'll discuss their latest business outlook at a high level and talk about whether a breakout can be achieved.

The Catalysts for BYD and Fundamental Outlook

BYD produced more than 3 million new EV cars in 2023 as it discontinued selling pure gas/diesel cars in spring 2022. Out of these 3 million cars, BYD saw overseas sales do more than 240K new EV cars and is now building a production center in Europe's Hungary to scale its global production. BYD currently has 5 models in Europe and 3 more in the pipeline to be released over the coming 12 months. Europe is a major international business expansion opportunity for BYD in the long term.

Their latest quarter was solid with n et profits up 82% year over year while also seeing their vehicle margins rise by 3%. Its newly released models - Tang Sedan, Song L, and Seagull DM - should help BYD to continue its current growth trajectory of impressive production volumes in China. There is upside potential to the average selling price range of 100K-300K CNY per vehicle if the company's luxury premium brands Denza N7 and Denza N8 get more traction and a larger sales mix among China's affluent EV shoppers.

Looking forward, the Street believes that revenue contribution from the automobile business will rise to more than 75-80% by next year 2025. Because BYD has its own in-house battery business, it allows the company to accelerate its own R&D for its new EVs with additional customization if necessary. The latest market share data of EV Battery Makers is below from Jan-June 2023.

The company is actively working on advancing its own battery tech and charging solutions to expand range potential on its fleet of cars. The greater its ability to expand range potential on driving, the more attractive its product line becomes. NIO recently received substantial investor attention when it unveiled a new EV battery with 1000KM range.

Rising battery raw costs are most likely one of the most fundamental challenges that BYD and other automakers will face, as this directly puts their margin per vehicle under pressure.

To better understand what drives the pricing components of an EV battery pack, this quote from Visual Capitalist does a good job at describing it:

The price of an EV battery pack can be shaped by various factors such as raw material costs, production expenses, packaging complexities, and supply chain stability . One of the main factors is chemical composition. Graphite is the standard material used for the anodes in most lithium-ion batteries

The current EV landscape is highly competitive in China as Li Auto, XPeng, and NIO along with other players join the race for market leadership in this expanding total addressable market. The industry has very high capital investment costs and the aggregate demand for EVs can be quite sensitive to China's economic landscape, so we do think that it is very important for China's consumer sentiment to stabilize before the EV names see more sustained upside. Over time though, as long as the stock price matches the fundamental story, you can see below that BYD's market share is climbing year over year in a very competitive operating environment.

The Sell Side expects to see BYD grow revenue at a pace of 20-25% for the next several years while its operating margin grows to the high single digits by 2025. With a steadily increasing operating margin, the Street believes that BYD can increase its net profit margin to the CNY 48-50 billion region in 2025. This growth will most likely come at the expense of legacy automakers in China.

Risks & Thoughts on Entry

There is a whale shareholder in BYD which should be followed and that is Berkshire Hathaway ( BRK.B ). They have been slowly distributing the stock after returning a multi-fold return from its decades of investment. Charlie Munger and the investment team at Berkshire Hathaway ( BRK.B ) was able to turn their BYD $270 million investment into $8 billion.

Stock prices move due to supply and demand - it's as simple as that. We will need to see large institutional buyers replace the supply that Berkshire ( BRK.B ) has created in the open market. That said, I believe this risk is manageable as BYD's fundamentals will attract more investor capital over time.

Actually, the biggest risk to BYD based on my observation of their price structure in relation to ongoing events is that the U.S. is adamant about posing roadblocks to China EV imports for American consumers. We can see this clearly in the latest $7500 tax credit ruling which most EVs in China will not qualify for. Essentially, this ruling will nearly ensure that China's EVs never make any serious auto market share progress domestically in the U.S.

Additionally, Europe has for now also taken a hawkish stance against China's EV industry as it wishes to protect its domestic auto industry from a flood of new competition (at lower prices). Tariffs from EU's Bloc or outright restrictions is a major headwind for global expansion opportunities for BYD and other China EV players.

BYD's share price valuation accounts for this as shown below, its EV/EBITDA valuation multiple is at multi-year troughs even though the company's fundamentals are among the best in class in China's difficult landscape.

The key to greater durable upside in BYD is for U.S. & China relations to see structural improvement. The problem is, it appears that U.S. & China relations have entered a long-term decline in competitive relations as protectionism heats up. Given that the Hang Seng is the primary home for BYD's shares with its primary listing HK-1211, for the foreseeable future, BYD's returns will be heavily correlated with the overall performance of the H-Shares market. Right now, the H-Shares market is a big target for foreign short-sellers as "Short China" is still the #2 most popular crowded trade among institutional investors, according to the Bank of America Fund Manager survey.

In the near-term, China EV will trade in tandem together - with Li, XPeng, NIO, and BYD all trading as a basket. If there are adverse or positive developments for the other EV automakers, BYD will be similarly affected. It is not enough to follow BYD's individual fundamental performance to judge its share price. The whole collective EV theme must be considered.

I like BYD long-term but market participants who follow the stock closely perhaps have concluded that for now, the stock is a trading vehicle for upside potential when the Hang Seng experiences short squeezes.

Until U.S. and European headwinds subside, we can expect large rallies to get reversed. At the same time, we can expect big selloffs to get bought due to its promising fundamental setup in China's healing macro story in 2024.

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