Chinese EV stocks: Navigating the post-bubble landscape

Warnings about the creation of yet another bubble in the Chinese electric vehicle (EV) space were aplenty between 2019-2020. Against the backdrop of a low interest rate environment over the past few years, growth stocks like those in the EV space saw meteoric rises in valuations, evidenced in the high enterprise value-to-revenue (EV/Revenue) multiples. Since then, the likes of BYD Co. Ltd (SEHK: 1211) and NIO Inc. (NYSE: NIO) have seen their EV/Revenue fall from high teens in 2021 to mid-single digits more recently. Declining EV/Revenue multiples suggest that valuations for Chinese EV stocks have come down, possibly presenting opportunitiesfor bullish investors to enter. In this piece, we put forth the idea that the frothiness of certain Chinese EV stocks has subsided, and some of them may just be worth a second look.

We begin by scaffolding the automobile and EV arena: 2022 was a momentous year as the number of EV units sold surged past the 10-million mark, representing more than 14% of new cars sold and a tenfold jump from the share in 2017. China leads the charge by accounting for over half of all EVs on the world’s roads, totalling 13.8 million. Even in the existing climate of heightened rates that will likely continue to increase, growth appears to retain its allure among market participants, outperforming other investment styles in the most recent quarter.

Growth is exactly what Chinese EV brands promise to deliver, and if the outperformance of growth stocks is any indicator of what is to come, the market may soon reward the fast-growing Chinese companies by driving their share prices higher. Despite smashing the national target of achieving 20% sales share of new EVs far in advance of the 2025 goal, China looks to accelerate its timeline of taking over the global EV space. The country aims to push sales shares to 50% in key air pollution control regions by 2030, which if the existing trajectory holds, will once again be attained ahead of time. Led by homegrown brand BYD, other Chinese competitors have been faring exceptionally well by ranking within the top 10 models sold in China this year. These include models manufactured by SAIC Motor Corporation Limited (SHSE: 600104) and Guangzhou Automobile Group (SEHK: 2238). A closer examination reveals that of the top 10 models sold, Tesla Inc. (NASDAQ: TSLA) is the only non-domestic name. Other native brands are also strong contenders to vie for market share in 2023, of which include Chongqing Changan Automobile Company Limited (SZSE: 200625) and Li Auto Inc. (NASDAQ: LI).

China’s EV policies

A large part of China’s leadership in the EV space is attributable to its policies centred around achieving carbon neutrality by 2060. China’s slew of policies to support the deployment of EVs can be broken down into demand and supply-focused policies. Perhaps the most significant is to disburse financial incentives. This demand-focused policy encompasses tax exemptions, construction of support infrastructure, and extending subsidies to consumers. China’s EV subsidies trace back to as early as 2009 when EVs were more expensive than internal combustion engine (ICE) vehicles. From that point forward, the government gradually shifted towards optimising its fiscal EV spending by scaling down subsidies. In spite of this, the Chinese government spending in EVs still outstrips that of other regions such as Europe and United States. Supply-side strategies target automakers by requiring them to sell a minimum share of zero-emissions vehicles (ZEVs) and establishing emission standards. As China trims the amount of subsidies it dispenses, we would expect more pro-EV policies to lean towards increasing the proportion of EVs available within the larger automobile market.

Besides the above, there are other factors that propel Chinese EVs in front of international automobile manufacturers. Some examples include control over refinery capacity of key raw materials  necessary in battery manufacturing (which accounts for 30% of the price of a mass-market EV) and adopting a state interventionist approach towards implementing large-scale industrial policies via a central decision-making body. Together with early implementation and hefty monetary spending, these unique idiosyncrasies contributed to the progressively apparent victories scored over international EV makers.

Apart from the type of EV, i.e., battery electric vehicle (BEV) versus plug-in hybrid electric vehicle (PHEV), China also emerged ahead of global EV peers in terms of mode of transportation. China’s sales share of two-wheelers such as mopeds and motorcycles beats every other region, and only falls behind India in the three-wheeler department. However, sales share of heavy-duty vehicles is where the country truly shines, as it continues to dominate the production and sale of electric trucks and buses. This illustrates that gaining access to the Chinese market should be at the forefront of every EV manufacturer’s strategy. Indeed, many worldwide brands have penetrated into the Chinese market. Yet, they still lag behind China-made brands.

Closing in on the leaders

For many years, U.S., European, Korean, and Japanese players have done well in the automobile space, but their historical leadership seems be in the process of getting usurped by Chinese makes. More recently, companies like The General Motors Company (NYSE: GM) have given up both sales and market share. In a bid to recover lost ground, some of them such as Tesla turned towards price wars to the extent of sacrificing profitability which have regrettably backfired. Of course, automakers with higher margins have greater optionality due to having more room to cut prices. One example of this is European manufacturer The Volvo Group (STO: VOLV-B). Depending on the composition of EVs sold, it may also make sense to spur sales figures through discounts, and in the process avoid penalties associated with missing ZEV sales quotas.

The issue that some Western corporations face is their reliance on the Chinese market. Volkswagen AG (FWB: VOW), the second largest automobile seller in the world by volume, is touted to be heavily dependent on China for its revenue and net profit. Beyond bolstering its financial metrics, China is a major partner in many of Volkswagen’s joint ventures. Being so closely entwined with domestic consumers, enterprises, and regulators in China exposes these companies to geopolitical risk.

Just a week after Russia’s invasion of Ukraine, European automakers pulled out of the invader. This decision was an easy one to make given that Russia constitutes a small percentage of their end markets. The same cannot be said for China which forms a sizeable portion of their businesses. Unfortunately for these European automakers, officials back at home labelled China as an ‘authoritarian regime’. German politicians have called for Volkswagen to prune their Chinese exposure while its investors demanded closer scrutiny of its plants in China. Despite the pressures exerted by various stakeholders, Volkswagen remained steadfast. The group not only opted to carry on operations in its Chinese facilities, but it also poured fresh funds in April 2023 to deepen their relationships within the local business sphere. The above examples should serve to elucidate just how dependent these Western automakers are on China, a noteworthy risk that is likely to go neither unnoticed nor unpunished by investors.

Western contestants are not the only ones who face challenges. Japanese titans are also in danger of being overtaken by its sprawling neighbour. Notable names like Nissan Motor Corporation (TYO: 7201) have struggled. The group’s Nissan Sylphy – China’s three-time top selling model – was overtaken by BYD’s Song plug-in hybrid SUV this year. Elsewhere, the chief executive of the reigning top global vehicle exporter Toyota Motor Corporation (TYO: 7203) sounded the alarm of Japanese automotive manufacturers being dethroned by their Chinese counterparts amidst geopolitical and technological headwinds. It is evident that home brands have edged ahead of foreign ones within the largest, rapidly expanding, and vital Chinese market.

The fifth perspective

What does all of this mean for investors? The current state of play sees Chinese EV brands to be more richly valued with many of them being hardly profitable on an EBITDA basis. Before ruling the shares of these companies out entirely, it may be helpful to pause and recall that the market is forward looking. For instance, some of these EV makers show signs of breaking even based on analyst estimates. The market consensus also puts their median forward EV/Revenue multiple at 0.8 times, which is lower than the 0.9 times amongst international players. Pairing these quantitative factors with encouraging signs of Chinese EV dominance, investors may be able to discover some worthwhile companies to due diligence inside the Chinese EV realm.

Of course, that is not to say that investors should buy into these companies this very instant. Those interested can take a page or two out of the venture capitalists’ (VCs) playbook, since Chinese EVs attract significant VC investments and exhibit similar characteristics of fuelling fast growth while bleeding cash – a phenomenon that looks to exacerbate lately due to ongoing price wars.

To start, investors can take a deeper dive to shore up one’s understanding of these companies as doing so may better position investors to make more opportunistic moves in the future. After all, it is almost without doubt that EVs represent the future of humanity’s transportation and the Chinese is certainly a force to be reckoned with. Due to riskier financial profiles of Chinese EVs, risk management is absolutely critical. This starts with understanding one’s own risk appetite which will dictate your investment horizon. Next, diversify risk by allocating capital across not just different EV players but also ICE manufacturers and other participants in the supply chain. These include metals mining, materials processing, and battery cell component manufacturing.

A convenient way to do so is to buy into exchange traded funds (ETFs) focused on China EVs. Another way to manage risk is to spread out the timing at which one buys into such securities through dollar-cost averaging. The industry and macroeconomy is in a constant state of flux which likely introduces volatility into share prices of automotive companies. Therefore, regularly investing a predetermined quantum can reduce the average cost per share. The bottom line is that even if one remains convicted that there have been, or still is a bubble surrounding Chinese EVs, omitting them from your watchlist can cause you to leave money on the table once market valuations align with their alluring prospects.

Tan Ke Xuan

Ke Xuan holds a Bachelor of Business Management from SMU. He identifies as a value investor who prefers to combine both macro and micro analyses when learning about businesses. He believes there are opportunities to be uncovered in every stage of the economic cycle.

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