We Are Avoiding Li Auto Right Now

Summary

  • Increasing revenue and increasing deliveries compared to the year-ago quarter.
  • Despite the drop in share price, the firm remains overvalued based on the traditional price multiples.
  • Risks related to the macroeconomic environment, competition and regulatory landscape create uncertainties in the near term.

Li Auto, one of the leaders in China’s new electric vehicle market, has been one of the overhyped electric vehicle stocks in 2020 and 2021. Since then, the stock price has come down substantially from its highs of ~$43/share. In 2022 alone, the stock price has declined more than 25%, significantly more than the overall market.

Data by YCharts

Although Li Auto has exhibited significant growth and continuously improving financial results in the previous quarters, we are yet to see positive earnings. In our view, in the current market environment it is better to avoid high growth stocks with negative earnings, due to the high risk associated with uncertainties around rising input costs, supply chain disruptions, chip shortages and the development of the COVID-19 outbreak in China.

On the other hand, we believe as the world is trying to increase the share of electric vehicles, the strong secular tailwinds could create opportunities for Li Auto, not only in China, but on a global scale.

Financials

Li Auto has reported their financial results in early May for the quarter ending on the 31st of March 2022. They have reported impressive sales and delivery figures compared to the year ago quarter. Sales in Q1 have reached $1.47 billion, which represents a more than 160% increase year-over-year. Not only the sales have increased, but also there was a vehicle margin expansion, reaching 22.4%, compared to 16.9% in Q1 2021. Despite the growth in sales and the improving margins, Li has reported a loss from operations more than $65 million in the first quarter, comparable with the figures from 2021. On the other hand, net loss in Q1 2022 was only $1.7 million compared to the $57 million in the year ago quarter. The operating cash flow growth of the firm was also remarkable, increasing by 98% year-over-year, reaching $289 million. Free cash flow, however, declined by about 15%.

Quarterly revenues (Seekingalpha)

Li Auto has also started to increase its R&D spending, which we believe is a good sign in a highly competitive market.

R&D expenses (Seekingalpha)

In our view, Li Auto’s financial performance is promising. They have been able to deliver and sell significantly higher amount of vehicles this quarter than a year ago, despite the macroeconomic headwinds. LI also has a strong cash position with more than $8 billion in cash and short term investments, with debt being slightly below $1.5 billion. The firm also has a current and quick ratio above 3. We believe that Li Auto is well-situated from a liquidity point of view and has the financial flexibility to successfully manage potential short term headwinds.

Li Auto’s business outlook for the second quarter is also relatively positive. Although they expect to delivery only 21,000 to 24,000 vehicles, these figures are still 19% – 37% higher than in Q2 2021. In light of the current macroeconomic and political situation, this softer guidance is understandable and justified, in our opinion.

Valuation

Although the stock has fallen significantly from its highs, we believe the LI remains overvalued. As the company has net losses, price-to-earnings ratio is not applicable. However, other traditional price multiples, like EV/sales, price-to-sales and price-to-cash flow, all indicate that the firm is trading at a significant premium compared to the sector median.

The EV/sales of LI is 2.14x, twice the sector median of 1.07x, the P/S ratio is slightly more than 3x, more than three times above the sector median of 0.91x. On the basis of P/CF the firm also appears to be overvalued significantly overvalued.

In our view, it is not justified for the stock to trade at such a high premium compared to the sector medians. Although Li Auto is one of the market leaders in the Chinese EV market, we believe that the slowing growth in the near term raises concerns, as the uncertainties around inflation, chip shortages, supply chain disruptions and COVID-19 related headwinds remain high.

Further, important to note that Li Auto has been consistently increasing its number of shares outstanding over the previous years.

Number of shares outstanding (Seekingalpha)

This is not unusual in case of young companies to get access to capital through issuance of shares; however, we prefer to own businesses that do not dilute their shareholders.

All in all, we believe Li Auto is not an appealing investment at the moment from a valuation point of view.

Risks

Also important to mention some of the key risks mentioned in LI’s annual report.

1) Uncertainties related to doing business in China

Economic, political, social conditions, or government policies in China could have significant effects on Li Auto’s business. The rapidly changing regulatory landscape can be off-putting for potential investors. The uncertainties related to VIEs, and the issues related to being listed on U.S. stock exchanges may also be concerning for some. The potential phasing out of government subsidies could also create potential headwinds.

2) Competition

The Chinese EV market has seen the emergence of a lot of new entrants, including NIO (NIO) and XPeng (XPEV), just to mention a few. Additionally, bigger players like Tesla (TSLA) are also competing for market share on the Chinese market. Although, Li Auto has shown impressive growth so far, we have to be aware of the rapidly developing technology and EV market that could negatively affect LI’s performance, if they fail to keep up with the competition. Also, we do not see any moat or competitive advantage of the firm.

3) Revenues dependent on a single vehicle model

Li ONE is the single vehicle that Li Auto is selling at the moment. Later this year, the Li 9 SUV is expected to debut, however the macroeconomic headwinds may cause slight delays. In general we prefer firms, which have a wide variety of products, to serve a large customer base. This also includes car manufacturers, who do not particularly specialize in EVs.

To sum up, we believe that besides the macroeconomic headwinds, there are other risks to consider, including fierce competition, regulatory changes and the reliance on a single vehicle model. Due to these risks, we do not feel comfortable with starting a position now.

A more comprehensive list can be found in the risk factors section of the annual report.

Key takeaways

Impressive revenue growth and margin expansion compared to the year-ago quarter.

Despite the drop in stock price, the firm remains overvalued according to several traditional price multiples.

Risks related to the macroeconomic environment, the regulatory uncertainty and the fierce competition in the Chinese EV market create significant uncertainty in the near term.

Author: Bela Lakos, Seeking Alpha

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