DB - XPeng: Credibility Needs To Be Earned Through Deliveries

2023-04-17 13:43:28 ET

Summary

• XPeng's latest platform has thrilled investors, promising to reduce costs and enhance the company's competitive edge.
• However, management must start delivering to prove its worth and justify aggressive growth estimates.
• The brutal market share battle ignited by Tesla's price reductions and BYD's remarkable sales momentum has dealt a heavy blow to XPeng.
• Without a substantial valuation dislocation, XPEV falls far short of being a compelling speculative opportunity.

Chinese EV investors returned in time to bolster XPeng Inc. ( XPEV ) stock as the company is scheduled to launch its highly pivotal G6 compact SUV at the Shanghai Auto Show.

XPeng also released its Smart Electric Platform Architecture, or SEPA 2.0, intended to " reduce the cost of development and manufacturing."

As such, it has lifted investors' sentiments that the company is on track to regain its mojo with lower production costs. It needs to scale rapidly to meet Wall Street's estimates of positive free cash flow or FCF margins by FY25.

However, the price war spurred by Tesla ( TSLA ) as it continued to reduce prices to gain market share has caused consternation in investors of EV upstarts.

Therefore, all eyes will be on how XPeng's G6 launch and ramp cadence will follow, as it's touted to compete against Tesla's Model Y.

Deutsche Bank ( DB ) weighed in recently, articulating why G6 " is crucial for XPeng to be relevant in the market again." However, the negative sentiments by a usually positive DB team is palpable, likely seeing XPeng squeezed from all corners by the EV leaders BYD Company ( BYDDF ) and Tesla.

Management expects G6 to contribute markedly to its deliveries recovery, where "monthly deliveries could reach 15,000 units at some point in the third quarter."

Hence, much is at stake for investors to assess whether XPeng's operational revamp with SEPA 2.0 could lift the company's ability to compete effectively with Tesla and BYD.

Notably, XPeng's SEPA 2.0 platform is interchangeable and "will support a range of vehicle types." As such, it should help improve the company's operating efficiencies as it ramps production through "technology upgrades by 2025."

Also, the platform is estimated to improve the turnaround in its R&D cycle. The company expects to shorten the cycle time by 20%, leveraging the interchangeability in its platform to drive down costs further.

However, the critical question is whether introducing the platform could lead to a step function change in the company's ability to compete with Tesla and BYD.

We think it's still too early to tell. XPeng's unprofitability and lack of economic moat indicate the need for a significant valuation discount even to justify taking up a speculative position.

While XPeng investors have often lauded the company's advances in autonomous driving, it has not proven to generate significant deliveries momentum over the past year.

Moreover, Morningstar reminded investors that its technological lead "may not be retained." As an auto manufacturer, XPeng needs to scale and sell. While its annualized capacity could reach 400K, the company needs to ramp quickly as the Street has likely penciled in high expectations in their estimates.

Morningstar expects XPeng's annualized delivery slate to reach 350K by 2025, up from FY22's 120.76K. As such, XPeng must achieve a deliveries CAGR of nearly 42.6% to meet the Street's projections.

Is it reasonable? We believe the EV price war has worsened the outlook for the upstarts, compounded by the risks of potential overproduction in 2023. Hence, the operating environment is highly dynamic and could remain treacherous as Tesla threatens to take share in a slower growth market environment by cutting prices .

Furthermore, there's no apparent valuation dislocation at the current levels, as seen in Seeking Alpha's Quant rating (C+). Coupled with its unprofitable business model (D-), it's challenging to argue for a bullish thesis at the current levels without a significant margin of safety.

Takeaway

XPeng has promise as one of China's leading EV upstarts. However, it desperately needs to ramp production to justify the estimates implied in the Street's forecasts, or its ability to turn FCF profitable by 2025 could be delayed further.

The balance between growth and profitability remains a highly challenging act, which isn't currently supported by a dislocated valuation. As such, without a significant undervaluation driver, the risk/reward profile of XPEV isn't attractive enough at the current levels for investors to even consider a speculative setup.

Rating: Hold (Reiterated). See additional disclosure below for important notes accompanying the thesis presented.

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