XPEV - Li Auto: High Expectations Lots Of Potential

Summary

• Li Auto is expected to grow quickly in the upcoming quarters.
• In my opinion, analysts are too optimistic about its growth, as reflected in its valuation.
• However, Li Auto has already shown signs of dominance, which is why I put the rating on Hold.

Thesis

Although Li Auto ( LI ) shows great promise in a growing Chinese market, it's still a new company and has yet to dominate the constantly changing EV market. After outcompeting other Chinese EV makers, analysts hold high expectations for this fiscal year. However, with its high PE ratio, I would recommend holding the Li Auto stock and instead waiting to see how Li fares against its competition.

Overview

Li Auto is a Chinese electric vehicle manufacturer based in Beijing. The company started volume production in November 2019 and aims to become a leading player in the growing Chinese EV Market.

Li Auto announced its unaudited financial results for the third quarter of 2022. Vehicle deliveries increased by 5.6% year-over-year, reaching 26,524 vehicles. Total revenues were US$1.31 billion, an increase of 20.2% from the third quarter of 2021. While gross profit was $166.2 million, a decrease of 34.8% from the third quarter of 2021.

As for the month of January, they have reported delivering 15,141 vehicles in January 2023, up 23% YoY, but down 29% from December. The stock, however, rose 6.1% the day the report came out, as the decrease was expected. Overall, I would call it a successful month considering the poor EV market.

A Race Toward the Top

The EV market is rapidly expanding, there's no doubt about that. However, the market is more competitive than ever before. Nio ( NIO ) and XPeng ( XPEV ) are some notable competitors in the Chinese EV market.

On the bright side, it appears Li Auto is at the forefront of the race. In the same period, Li went up 51% YoY , NIO also went up 51%, while XPeng actually was down about 25% YoY. It is important to keep in mind 2022 has been a difficult year for automakers, especially in China, as Covid restrictions slowed down supply-chain and production.

There's no doubt that if one were to choose one EV company to bet on in the Chinese market, it would be Li Auto. They lead in YoY delivery growth, and also the total number of deliveries, around 10% more than XPeng and NIO. Its gross margins are also significantly higher, at around 21.5%, compared to 13% and 11% at NIO and XPeng respectively.

The company targets the SUV class with its Li L models, the company has 296 retail stores as of February 2023. Overall, the company has experienced great growth and is expected to continue growing at a fast pace due to the expanding market.

Good Business Model

Now let's take a look at how Li Auto sustained a great business model to outgrow its competitors. In the third quarter of 2022, the company spent RMB1.80 billion on research and development, a 103.1% increase from the same period the previous year and a 17.8% increase from the second quarter of 2022. They have continued to allocate the large sums of their money to growing the business and is looking for developing new models. They also used the money to grow their research and development staff.

As for improving their profit margin, chief financial officer Tie Li stays optimistic, confident that demand will continue growing at a fast pace to rapidly ramp-up supply.

Looking ahead, we are optimistic that with rapid production ramp-up, rigorous execution, and responsible cost management, we will realize greater economies of scale and further drive down costs, putting us back on track to hit our profitability inflection point.

As for ESG, the Company received an "AA" rating from MSCI ESG Research for the second consecutive year. This is one of the highest ratings among EV companies, and they've already made a positive social and governance structure at an early stage. This shows an environment suitable for sustainable growth. Overall, the company is well structured, and I do not think they're overly ambitious by allocating large parts of their funding into development teams.

Valuation

Though the numbers are looking promising, their valuation throws me off. As one should with all EV companies, expect very high volatility. As of February, the stock is valued at about $25 a share. Although the pricing is cheap compared to the past, its price/earnings of over 2,500 is still quite the valuation. Its earnings a year ago were in the negatives, which proves just how far Li Auto has come in little time.

It is quite impossible to predict Li Auto's worth, as it all depends on its growth rate. Just be prepared that the slightest change in its earnings and delivery report will make the stock shoot up and down.

Its analysts expect the company's revenue to grow 105% this fiscal year, and to turn a normalized net loss of -RMB416 million to a positive normalized net income of +RMB3,022 million (S&P Capital IQ).

Personally, I see it unlikely Li Auto will match the growth its investors expect, but they have already proven themselves, and I would be unsurprised if they continue to do the same. If the Chinese market opens up and restrictions is lifted, Chinese EV companies can see unparalleled growth.

What will change my view

A simple number to look for is the monthly delivery number. It is important the compare its change MoM to its competitors like NIO and XPeng. For now, Li Auto has shown faster growth than the other two, but if they begin dominating the market and significantly outperforming its competitors, that's a sure sign of investing in a future monopoly.

Another factor is the overall Chinese market. It is likely Li will outperform expectations in the scenario that China opens up faster than expected, and vice versa. The news that China will phase out cash subsidies should not alarm investors as Li Auto is currently a premium EV SUV brand, with nothing to subsidize.

And, as always, the balance sheet- but don't look too hard. Li Auto is a growing company, for example, its cost of sales increased 36% in the 3rd quarter, but that is explained by inventory provisions. Instead, look for how the company is set up for growth- dividends or any lack of commitment to growth may be a red flag that damages its competitive edge in the long run.

Conclusion

Li Auto has proven itself to be a fast-growing company and has the potential to dominate the market. While I do not wish to bet against their success, I simply do not think Li auto will grow at the anticipated rate, and that its stock will not see a return for a long time. Until they've expanded to the world stage or monopolized the Chinese EV market, their rating is still a hold.

For further details see: