XPEV - XPeng: Deteriorating Margin Trend Is A Concern (Rating Downgrade)

2023-08-21 11:37:26 ET

Summary

• XPeng reported a decline in vehicle margins and a significant loss for Q2, leading me to downgrade shares of the EV maker to hold.
• XPeng saw its second consecutive quarter of negative vehicle margins.
• Slowing demand and a price war in China have negatively impacted XPeng's operating metrics and margin situation.
• XPeng is still the highest-valued EV company in the industry group.

Although I recently commented on the game-changing relationship between German car brand Volkswagen (VWAGY) and XPeng ( XPEV ) and rated the Chinese electric vehicle company as a buy, I am down-grading XPeng back to hold after the firm's Q2 earnings sheet submission last week. One thing that I have worried about in the past was the vehicle margin situation at the Chinese electric vehicle start-up and it turns out those concerns were justified: XPeng reported a massive decline in its vehicle margin in the second-quarter which resulted in a huge loss for Q2'23 as well. The trend is very concerning to me now that XPeng has reported the second consecutive quarter of negative vehicle margins and I am down-grading XPeng back to hold because of it!

Revenue and EPS miss, record losses, concerning margin trends

XPeng reported revenues of 5.06B Chinese Yuan ($0.7B) which slightly missed expectations for the second-quarter. XPeng also reported a larger loss than expected, which caused the EV company to miss the consensus EPS estimate by $0.08 per-share.

Slowing demand in China and an escalating price war, initiated by Tesla ( TSLA ) earlier this year, have led to a material deterioration of operating metrics for XPeng as well as other Chinese electric vehicle companies. The pressure that XPeng is exposed to is expressed in the firm's vehicle margins which show investors how profitably an EV company can produce its products that it brings to market.

In the second-quarter, a noticeable deterioration occurred in terms of margins, largely due to growing choice in the EV market, slowing consumer demand and resulting pricing pressure for electric vehicle manufacturers. XPeng's vehicle margin declined to negative 8.6% in the second-quarter, showing a decline of 6.1 PP quarter over quarter and a 17.1 PP decline year over year. It was also the second consecutive quarter in which XPeng reported negative vehicle margins. The last time the electric vehicle company reported double-digit vehicle margins was in the third quarter of FY 2022 (11.6%).

Since then the trend has seriously deteriorated and it has resulted in XPeng reporting record losses for the second quarter as well. XPeng's gross margins also turned negative for the first time in Q2'23, indicating that stiff competition and pricing pressure have made vehicle production unprofitable in the second-quarter. Not surprisingly, XPeng's Q2'23 earnings sheet showed its largest loss ever: the company lost 2.8B Chinese Yuan ($387M) on 5.1B Chinese Yuan ($698M) on revenues.

(Source: Author)

A positive takeaway: XPeng's delivery guidance for Q3'23

XPeng delivered a solid delivery forecast for the third-quarter, indicating that the new G6 product launch may help the company reinvigorate its delivery growth, in terms of which XPeng has fallen behind its rivals lately : the EV maker expects a Q3'23 total delivery volume of 39-41 thousand. In the third-quarter of FY 2022, XPeng delivered 29,570 electric vehicles, so XPeng's guidance implies Y/Y delivery growth potential of 32-39%. In part, the strong outlook relates to XPeng's recent launch of the G6 coupe sport utility vehicle which is built on its new SEPA 2.0 modular EV architecture. With a price tag of less than $30 thousand, the G6 SUV is a direct competitor of Tesla's popular Model Y.

XPeng's valuation is high relative to other EV rivals

XPeng's valuation is high relative to some of its EV rivals that are executing better (seeing stronger delivery growth) and reported better vehicle margins for Q2'23. NIO ( NIO ) has not yet reported results for the second-quarter, but Li Auto ( LI ) did and the firm crushed it both in terms of delivery growth as well as vehicle margins. Li Auto generated a Q2'23 vehicle margin of 21% , showing both a Q/Q improvement of 1.2 PP as well as profitable mass production on a per-vehicle basis.

Still, XPeng is the highest-valued EV company in its peer group with a P/S ratio of 1.7X while, interestingly, the best-executing EV maker Li Auto, is selling for the lowest P/S ratio of 1.35X in the industry group. Therefore, my recommendation is for investors looking for a promising investment in a rapidly-growing, foreign EV company, to go with Li Auto over both XPeng and Li Auto.

Risks with XPeng

The risks are obvious: the margin trend indicates that XPeng is now in a position in which it is losing money on each electric vehicle sold, on both a vehicle margin as well as gross margin basis. And XPeng has fallen behind the competition lately regarding delivery growth, with Li Auto performing especially well. XPeng, however, has an opportunity to reinvigorate its delivery growth and turn its margin trend around if the launch of the G6 coupe sport utility vehicle goes well. The G6 apparently sees strong demand from customers and has surprise potential.

Final thoughts

While I like XPeng and the deal the Chinese EV maker struck with German car company Volkswagen recently, the margin trend in the second-quarter changes things a bit, and not for the better. I can deal with temporarily slowing delivery growth as production snags occasionally hit all EV makers, but the deterioration of the margin trend is a bigger issue, especially if the trend is so pronounced that XPeng is now losing money on each vehicle sale. I would be prepared to change my rating back from hold to buy in case XPeng demonstrates in the coming quarters that it can reverse its vehicle and gross margin trend. In the meantime, it may be best to take a wait-and-see approach!

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