BYD: Attractive Fundamentals As A Dominating Automotive Company

seekingalpha08-19

BYD is a Chinese automaker with a very strong competitive advantage.Growth will continue to be an important return driver and will be supported mainly by lower-priced NEV segment but also the emerging...

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Robert WayThesis BYD (OTCPK:BYDDY) (OTCPK:BYDDF) is an automobile company with a competitive moat. Its superior technology, dominance of the lower-cost automobile segment in China, and benefits from its large scale make it a resilient and profitable company in the highly competitive industry. Its P/E ratio of 20 is not cheap out of context but reflects its historical and expected future growth from the EV adoption trend and BYD's diverse product lines with various levels of premium. I believe earnings will continue to grow at a similar but lower pace that still supports its current valuation, and potentially higher if we consider the fundamental strengths that BYD has over its peers. Overall, I think this is a \"buy\" opportunity considering quality, growth, and to a certain extent, value. Context Before we assess the opportunities of BYD, let us begin its context and the decades of operating experience leading up to its success that we see today. BYD was founded in 1995 as a battery manufacturer in China. The battery business continued since. In 2003, BYD entered the automobile industry with ambitions to combine its technology with car manufacturing. Throughout its history, it focused on a diverse set of vehicle types. The launch of its \"7+4\" back in 2015 is a testament to that. In the next fiscal year, sales had reached $1.5 billion. More recently, in 2023, sales had reached $85 billion, and market share within the NEV segment reached 31.9%. This reflects a very high growth in its NEV demand, as it ceased the manufacturing of internal combustion engines in the year before that. Throughout, the company has undergone significant changes. It now has a far clearer brand image, much better vehicle qualities, and a clear technological advantage. Personally, I am impressed by this trajectory and think it reflects a very capable management.  Stock Performance Seeking AlphaHere is an overview of BYD's stock performance along with some of the competitors within the NEV space and also against the overall Chinese consumer discretionary sector represented by the Global X MSCI China Consumer Disc ETF (CHIQ). Relatively, the performance of BYD is strong given its fundamentals and competitiveness, as we will discuss. The brand is largely defined by its price appeal, with vehicles generally selling in the 100k - 200k CNY price range, which is significantly lower than some of the other domestic NEVs. Competition and BYD's Advantage The global automobile industry is highly competitive where margins are generally weak. For BYD, it faces competition from domestic brands such as XPeng (XPEV), NIO (NIO), Li Auto (LI), etc. There is also competition from imported brands such as Tesla (TSLA), BMW (OTCPK:BMWYY), Mercedes-Benz (OTCPK:MBGAF), etc., which generally command higher premiums reflecting on quality. The Chinese auto industry is also facing a price war at the current moment given the number of competitors in the industry along with new entrants such as the mobile company such as Xiaomi. In this environment and in general, a 5% net income margin is considered to be quite good and is a figure generally exhibited by more established brands that lead in volumes sold and efficiency. Volume is particularly important to benefit from economies of scale and to fund crucial components such as selling costs or R&D. Consider BYD, a company with over 600 billion CNY in revenue vs. Li Auto for instance, a company with over 120 billion CNY in revenue, the percentage of earned revenue spent on R&D as well as the scale of spending are very different. In 2023, BYD had spent around 40 billion CNY on R&D vs. the 11 billion from Li Auto. The impact will be material in the long run, particularly on product quality that we can already witness as of this moment. While on the topic of competition, NEV market segmentation strategy is particularly important. There is BYD, which has a price range of around 100k - 200k CNY. With a price range generally higher than 250k CNY, there are brands such as Tesla, XPeng, Li Auto, Nio, or perceptively more premium European brands. More premium NEVs face much greater risks with respect to price wars, competition, income sensitivity, and also consumer preferences in my opinion. The dynamics for BYD are quite different with its 32% NEV market share as well as the nature of its current strategies. Here is some information on NEV sales projection amid the electrification trend as well as the current market share compositions that support its dominance and resilience, which is also evident from its relative stock outperformance.  Despite BYD's low price range of its vehicles, it managed to be quite profitable with a gross margin of 20%, in line with competitors that have positive net income. Not only that, but it can also leverage its technological strengths, which are apparent with its battery technology. Note that not all vehicle manufacturers have BEV capabilities, including Li Auto, which only manufactures PHEV. Growth has also been robust for the company, although the magnitudes are expected to decline as the NEV industry consolidates, with unit NEV sales growth converging towards 10%. It is likely that BYD will grow faster given its strategic initiatives and expanding product lines with some products at a way higher price range. The product lines include Denza, Fangchengbao, and Yangwang (highest price range), all of which achieved robust success since the recent launch. I think that they will be important drivers of growth in the future, not only from their direct channel growth, but also from the synergistic benefits that they carry. Premium brands under BYD will serve as testaments to the quality technological abilities of the overall brand and increase the appeal across product lines. This is a clear advantage that other brands don't exhibit nearly as much. Valuation and Growth Overall, I think valuation is attractive reflecting on the fundamental factors of including its growth outlook. Multiples have been declining, that has to do with both the weak sentiment in China that drags the equities market and also the gradual consolidation of the automotive industry. The arguably low-level and stable valuation (another of my articles focusing on the broader Chinese market) presents an attractive opportunity to buy BYD to capture returns from a lower cheapness and a large potential for earnings to grow.  Multiples and Financial Metrics Seeking AlphaAs of now, it has a P/E ratio of 19.5 and a PEG ratio of 0.37 with 27% year-on-year revenue growth. I've made a comparison page against a few of the stocks. In relative, BYD's stock trades cheaply not only considering a few of the multiples, but also considering a few of the fundamental factors that had led me to believe that BYD should be priced relatively higher. The fundamental factors will continue to fuel domestic demand growth and also, to a much smaller extent, export potentials in the longer-term considering jurisdictions including the EU and a few emerging markets.  Risks Geopolitical risks: BYD's main exporting regions are the EU, Southeast Asia, and Latin America. Exports account for a relatively small portion of sales. Tariffs are also dependent on the extent of subsidies, which are decreasing. Overall, the risks on this front are limited.  Competitive risks: BYD is currently undergoing several initiatives. Its lower-end products have proven to be successful for years. Although its higher-end products are gaining traction, the trajectory is uncertain given the abundant set of substitutes.  Macroeconomic risks: China is still being challenged economically, which has a negative impact on auto sales. Moving forward, consumer sentiment is dependent on policies that are uncertain and the impact they have. Housing, for instance, has a wide-reaching effect and the prices have yet to stabilize.  Auto industry Policy risks: In the context of the NEV market, subsidies play an important role. In 2023, subsidies amounted to around 15% of net income. Subsidized amounts per vehicle have been declining, which is both a positive and negative sign.  Conclusion There are several reasons why BYD is an attractive buy. Its competitive advantage stems from its superior technology, cost efficiency, and strong management. For the last point, I think it is evident in history as BYD started out as a battery manufacturer and slowly found its way to becoming a leading NEV seller. Evolutions of its technology, car design, and marketing strategy have demonstrated success. The majority of revenue is generated from lower-priced vehicles of 100k - 200k CNY. BYD thrives in this segment, where competition from price and availability of substitutes are limited despite the large consumer base. The large quantities of demand fuel its relatively favorable unit economics by funding fixed costs such as R&D, which is a crucial edge in this industry and allows BYD to fund endeavors such as expanding product lines to more premium products. All these positive factors will compound and so will the synergies across BYD's product lines, making this is strongly differentiable company. As for valuation, BYD is fairly attractive with limited downside with earnings being the main driver of performance. Growth will come from low-priced vehicles as well as the expansion of premium products. There are a few risks to consider. However, I think their magnitudes are limited. Exports represent around 8% of sales, and it has almost no exposure to high-risk countries such as the US. Sentiment and economic performance will be an important short-term driver directly influencing auto sales and valuations. These are fairly stable at the moment with limited downside.   Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. 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