CENN - China-Based EV Supply Chain Renders Cenntro Electric As High Risk

Summary

• Cenntro will fail to qualify for Inflation Reduction Act era EV tax credits with its main manufacturing facility based in China.
• The company's revenue is growing but losses are mounting.
• Global commercial EV sales growth should be strong in the decade ahead as decarbonization momentum ramps up.

Not investing in a company because it has a China-based supply chain might not seem prudent at face value but Cenntro Electric ( CENN ) faces headwinds in its mission to capitalize on the growth of the US commercial EV market. The company's business model is built around its large manufacturing facility in China shipping semi-completed vehicles to its US plants for assembly and delivery. Whilst this operational setup exposes Cenntro to a level of supply chain risk, import tariffs, and zero Covid related disruption, it has fundamentally meant the company's vehicles will not be eligible for the tax credits being made available by the Inflation Reduction Act.

Mimicking the offshore China-based manufacturing model of the recently bankrupt Electric Last Mile poses a structural risk to Cenntro. This renders investments in its common shares too risky against a vast array of other safer choices. Cenntro does have a better liquidity position and its larger market cap allows it the option for stock sales. However, should this position ever deteriorate materially, then the company would very quickly find itself facing the same headwinds that brought down Electric Last Mile. In this, a pertinent risk-off trade combines with anemic sales even against a fast-expanding total addressable market and the loss of once rapacious animal spirits to collapse the company's future.

US Sales Likely To Suffer With No Inflation Reduction Act Support

In May of this year, Cenntro spent $19.5 million to acquire a new manufacturing facility in Huzhou City, China. The new facility is 474,000 square foot and will allow the company to manufacture its new Metro series, a street-legal light electric commercial vehicle designed for urban areas. The facility began trial production in the third quarter of 2022. Whilst this move provides a cheap cost base for global sales, it is at odds with the Inflation Reduction Act. The IRA will become one of the most material climate-focused bills passed by Congress as it allocates $370 billion over 10 years to decarbonization initiatives. There will be an electric vehicle tax credit for commercial EV sales providing a boost for the fledging yet fast-growing US EV sector.

However, the bill includes a prohibitive requirement that qualifying cars must be assembled in North America. It also states that critical minerals in the battery must come from the US or a country with whom the US has a free trade agreement. This would immediately make the company's light and medium-duty electric commercial vehicles ineligible for the tax credit and broader incentives being made to boost demand for EVs. Whilst the IRA has been criticised for being a misnomer, it's a strong long-term bet by the US government on a radically decarbonized transportation and energy system.

Cenntro last released earnings for the first half of its fiscal 2022. This saw revenue come in at $5 million , up 105% year-over-year on the back of 337 vehicles sold. This included 132 units of its newly launched Logistar 200, a multi-purpose light electric commercial vehicle. Net loss during the period rose to reach $23.05 million, a material increase over a loss of $4.5 million in the year-ago period. But cash and equivalents remained strong at $183 million and formed 67.5% of the company's current market cap. This exposes the company's bull case and core salvo for bulls. The valuation seems decent against its large cash pile and revenue growth. Further, bulls could also state that the cost savings from a China-based manufacturing plant could more than offset the tax credit it would otherwise have received from the US government. This would mean its products are still competitive against similar US-built commercial EVs. The company's Logistar 400 , a class 4 truck designed for urban delivery and freight, was recently introduced to the North American market and management should be able to provide an update on sales momentum in their upcoming earnings report.

A Secular Shift In Transportation Is Underway

Cenntro is stepping up investments across is core business operations including R&D to support its effort to grab the opportunities posed by the decarbonization of transport in the decade ahead. And whilst management guided that they will remain cautious on this due to the uncertain macroeconomic environment, recent operational developments from the acquisition of a new manufacturing facility to the launch of new products show that the company is building a strong level of momentum which it hopes to compound going into 2023.

The secular shift towards lower-emission transportation from EVs is now entrenched in the post-pandemic economic zeitgeist of most developed nations racing to combat anthropogenic climate change. This shift is still in a very early stage, but the pace of growth ahead is material. We are all now living through the most significant generational change in transportation as EV adoption moves to occupy a more prominent position for Cenntro's ESG driven customers. Shares are however not a buy as the broader stock market will continue to pose headwinds going into 2023.

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