GWLLF - Geely Auto Needs Better Market Share And Margin Numbers To Change The Tone

2023-10-05 17:55:27 ET

Summary

• Geely Auto's shares have been caught up in the downturn in Chinese auto stocks, but have held up better than most BEV-centric rivals.
• Geely is struggling to gain market share in the most attractive parts of the Chinese auto market, particularly in the high-end BEV segment.
• Margins have declined due to higher input costs and the growing contribution of lower-margin BEVs and PHEVs in the sales mix.
• Even with meaningful lower margin assumptions, Geely shares look undervalued but the market likely won't care until market share and margins improve.

The last year and a half has been a challenging one for Geely Auto (GELYF) (GELYY) ((0175.HK)) investors. As the market has digested a combination of increasing pressures in the Chinese electric vehicle market and weaker than expected profitability, the shares have sold off meaningfully – falling about 25% since my last update . While some other EV-driven stocks have done even worse ( NIO (NIO) down almost 60%, XPeng (XPEV) down 38%) and Great Wall (GWLLF) has done similarly on similar challenges, BYD (BYDDY) and Li Auto (LI) have managed stronger performance over that time.

I’m finding it harder to maintain a bullish stance on this company. There has always been an elevated level of difficulty here to the complicated ownership and reporting structure (Geely Auto is a publicly-traded subsidiary of privately-held Zheijiang Geely, and there are multiple interlocking JVs and financial arrangements). On top of that, margins have been considerably weaker than expected, market share hasn’t really improved, and the company’s efforts to establish itself as a real player in the higher end of the market haven’t gained the expected traction.

Even with lower estimates, the shares still look undervalued, but the reality is that the Street needs a reason to like this name more, and being outdone in BEV sales and continuing to post lackluster margins doesn’t help.

Share Data Isn’t Suggesting A Lot Of Momentum Where It Counts Most

There are a lot of ways to parse the monthly statistics for the Chinese auto market, but I think the most important take away is that Geely just isn’t gaining the hoped-for share in the most attractive parts of the market.

August sales of battery electric vehicles (or BEVs) in China rose 21%, but Geely’s share slid below 6% (to 5.8%) and the company’s overall Chinese auto market share (including traditional internal combustion engines (or ICE), hybrids (PHEVs), and BEVs) hasn’t really moved meaningfully higher since its pre-pandemic level (around 6%), and that’s despite the expansion of Lynk & Co and the introduction of models under the ZEEKR and Livan brands.

While full data points are not yet available for September, the early numbers I’ve seen don’t look particularly encouraging either. Overall unit growth of 31% will probably be above-market, but BEV sales rose only 9%. The PHEV sales growth of 132% is a positive, but that market is still regarded as more of a bridge than anything else, and so companies strong in that space don’t tend to get a lot of credit for it.

That 9% BEV growth from Geely doesn’t look so impressive next to the 44% growth at NIO, the 72% growth at Aion , the 81% growth at XPeng or the 200%+ growth at Li, and I believe it further underlines the challenges that Geely is having moving its brand and business up-market. Geely’s overall average selling price is around RMB 100K now, with Lynk & Co and ZEEKR models well above that (with ZEEKR above RMB 300K in some cases).

A lot of these rivals have similar or higher ASPs, though, and Geely just isn’t keeping up in terms of unit share. Stronger performance in more economy-class segments isn’t worthless, but a big part of the bull thesis for Geely was that the company would successfully migrate from a low-to-mid-range automaker to a competitive player in the lucrative and faster-growing high end of the market, and that just doesn’t seem to be happening as quickly as previously expected.

At the same time, the expansion of the company’s overseas business has likewise been somewhat slower than expected. Exports grew 28% in September, but a lot of this growth has been in lower-value legacy models and efforts to grow Lynk & Co and ZEEKR in attractive EU markets have taken longer to deliver results.

Paying A Higher Cost To Build The Business

Certainly not a Geely-specific problem, investors have started paying a great deal more attention to the margins of Chinese auto companies over the past year, and particularly those more leveraged to the BEV market. While higher overall input costs haven’t helped matters (a phenomenon seen across virtually all markets/sectors), BEVs in particular have generated lower incremental margins.

As Geely’s BEV/PHEV business has expanded, gross margins have declined from the high teens (17%-plus) to the 14%’s, with management specifically calling out the growing contribution of BEVs and PHEVs in the mix as a factor in the weaker margins. Some of this can be attributed to scale, but key components like batteries and electric motors have had a bigger impact on profitability than investors previously expected.

At the same time, Geely continues to reinvest in the development of the business. SG&A spending at over 13% of sales is well ahead of the likes of Ford (F), General Motors (GM), and Renault (RNSDF) and Geely likewise continues to invest considerable sums into R&D, including a recent JV with Renault to work on hybrid and efficient ICE powertrains. I can appreciate why Geely wants to continue investing in areas like battery technology, autonomous driving, and so forth, but investors can certainly debate whether these high levels of ongoing operating expenses are earning their keep in terms of driving market share and revenue leverage.

I will note, though, that the company is still relatively early in its strategic shift to standardized shared architectures (like SEA) and this should reduce development costs over time, as well as improve unit margins as manufacturing and sourcing become standardized.

The Outlook

It’s worth noting again that there are more complexities with Geely Auto than with your typical U.S. stock. Zheijiang Geely runs its operations for its own benefit, and that does not necessarily mean that’s what’s best for Geely Auto shareholders. Lynk & Co and ZEEKR, for instance, are both structured as JVs (Lynk with Volvo, owned by Zheijiang Geely, and ZEEKR directly with Zheijiang Geely), and that creates some “noise” in the reported financials compared to what investors may be used to with American or Western European companies. Likewise, there are factors like R&D capitalization, subsidies from the Chinese government, and “licensing” payments to the parent company that complicate the analysis.

I admit that I’ve been disappointed with the progress (or lack thereof) in market share at Geely, and particularly with its newer higher-end offerings. Likewise, margins have not developed quite as I’d hoped, with FY’22 EBITDA margin about 150bp lower than I’d expected.

I don’t think Geely is “broken” on any meaningful fundamental level, but the company needs to show that it can take that long-awaited next step and become sustainably more competitive at the higher ends of the Chinese market (as well as in export markets). Last year’s sales did exceed my expectations and my estimates are higher for FY’23 and FY’24, and I’m still looking for long-term revenue growth in the low double-digits (about 10%). Key to this will be delivering on the up-market and export growth initiatives.

On the margin side, I’ve revised my margin expectations significantly lower; I no longer think a mid-teens EBITDA margin is viable in FY’25, and my free cash flow margin estimates move from the mid-to-high single-digits in 2030+ to the mid-single-digits. Companies like Great Wall have seen similar pressures, and I’m not ruling out the possibility of greater leverage as volumes grow further, but I want more evidence in hand before getting more bullish here.

Even with those significant revisions to margins, I end up with estimated fair values significantly higher than today’s price (30%-65%) on the basis of discounted cash flow and margin/return-driven EV/revenue and EV/EBITDA. Margin-driven EV/revenue gives me the lowest apparent potential return now (around 30%), and that’s based on an EBITDA margin in the 7%-8% range.

The Bottom Line

So, what about the stock? I do think the shares are undervalued, but I’ve been wrong about the market share growth that I expected from Geely, as well as what it would cost (in margin terms) to build the new EV/PHEV business. I think the stock market is going to demand improved monthly share performance in China’s BEV market and visibility on double-digit EBITDA margins (or at least a path back to them) before getting substantially more bullish, and I think the growing worries about China’s economy are not trivial. I do see the prospect for meaningful returns from today’s price, but I see too many outstanding questions about the business to be confident in recommending the name.

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