To The Moon

At first blush, carmakers Guangzhou Xiaopeng Automotive Technology Co Ltd - better known as "XPeng" ( $XPeng Inc.(XPEV)$) - and NIO Inc ($NIO Inc.(NIO.SI)$) don't come off as being particularly noteworthy in China's crowded automotive market. Neither company is currently profitable nor have any of their models featured in the Top 10 list by brand for any of the months in this year. Despite that, two very interesting developments occurred over the past two months:

1. Towards the end of June, CYVN Holdings - a specialist wealth fund of the Abu Dhabi government - poured $1.09 billion into NIO to secure a 7% stake and a director's spot on the board. 

2. Almost exactly a month later, Volkswagen ($Volkswagen AG(VWAGY)$, VWAPY) announced the purchase of a 5% stake in XPeng, along with the decision to develop two mid-sized VW-branded EVs in a strategic partnership. 

Both investors are well-advised, not prone to frivolity, diligent and patient in their strategies. The core principles are likely driven by macro changes in the Chinese auto market. 

Shifting Macro Trends

After a rather slow start in January of the year, China's monthly automobile sales have generally been beating levels seen in the past two years in terms of sheer volume. 

In the first half (H1) of this year, i.e. from January through June, around 28% of all automobiles sold in China have been "New Energy Vehicles" (NEVs). 

A little over 1 in every 5 vehicles sold have been Battery Electric Vehicles (BEVs). This trend also persists in production stats, with a miniscule gap between production and sales. This suggests that sales forecasting has been a very efficient process among the majority of China's automakers. 

Now, the Year-on-Year (Y-o-Y) trends mask an interesting extrapolation. The lowest positive growth metric is seen in the "Sedan/Hatchback" category. The only negative trend is seen in the "Minivan" category. It bears noting that this is distinct from the MPV or "Multi-Purpose Vehicle" category. While an MPV is commonly referred to as simply a "van" or "minivan" in the U.S. (like, say, a Honda Odyssey), it does not mean the same in China, India or anywhere else in Asia. "Minivans" tend to be compact budget vehicles while MPVs tend to be considered as "large" luxury vehicles just like SUVs (or "Sport Utility Vehicles") tend to be. Furthermore, most NEV models tend to fall into the "sedan/hatchback" category.

A number of past articles had referenced the looming affordability crisis in the Western Hemisphere. A recent article discussing trends seen in Mercedes Benz, Volkswagen and Ferrari also highlighted that sales of "less affordable" cars have been buoying these carmakers' sales figures, with the "pure-play luxury brand" Ferrari triumphing over the other two. Considering the metrics of the two "budget" categories versus the two "luxury" categories, it could be extrapolated that "budget" vehicle purchases are beginning to falter while luxury vehicle sales continue to be strong. There is an indicator that there is an affordability crisis beginning to take hold in China. 

What supports this assertion is the fact that the Chinese government, which was supposed to end incentives for EV purchases in 2022, has announced a four-year tax break package in June that is worth a massive 520 billion yuan ($72 billion) for new energy vehicles (NEVs), with tax credits of up to 30,000 yuan ($4,170) per vehicle from the present day through 2025 and half that amount in 2026 and 2027. 

A breakdown of sales by origin country of brand reveals a few more interesting facets that even consolidate this extrapolation:

Japan's brands (outside of the likes of, say, Lexus) have long been a byword in affordable and reliable vehicles worldwide. Over the course of H1, sales of Japanese brands have been hit hard - with Nissan and Honda showing a 25.7% and 23.8% YoY decline respectively. Toyota has a relatively lower decline at 4.9%. Nearly all of this has been picked up by a surging faith reposed in Chinese brands. While American and Korean brands show a relatively strong performance, their total contribution to sales is relatively negligible (around 11%). German brands - the next level of reliable vehicles and with a long history in China - have shown a rather muted YoY increase. Sales figures for all carmakers in China for the month of July aren't available yet but top-selling VW and General Motors (GM) models in China have shown double-digit percentage declines in YoY terms.

Thus, the fact pattern that emerges is that it is entirely likely that the average Chinese customer is facing issues with affording their vehicle purchases. However, when purchases are being made, they're increasingly turning to Chinese brands. Furthermore, luxury vehicles, ostensibly made by "recession-proof" customer segments, continue to find strong demand. 

It also bears noting that neither NIO's models nor those offered by XPeng are considered to be particularly cheap in China. 

Stock Performance and Metrics

When considering the stock performance of the two companies' stocks versus the broad-market S&P 500 (SPX in index form and SPY in ETF form), neither instrument has been particularly remarkable in a 1-year window. In fact, holding the broad market was the significantly better proposition.  

Both stocks are marked with remarkably high volatility, likely driven in part because of their low profitability not inducing high retail investor confidence and on account of their main market being China, a region which has witnessed large swings in investor preference. 

Trends in key items in their financial statements have many interesting points of similarity. Comparing XPeng's full-year results versus the past quarter (Q1) is a decidedly mixed bag. 

2021 was a watershed year for XPeng. While 2022 marked a year of steady revenue growth, lowered cost of sales and lower net losses than the previous year, Q1's line items relative to those in 2022 indicate that will both revenue, operating expenses and cost of sales might be running a little under par with net losses being around par if present trends continue. 

A number of these observations hold true for NIO as well when considering its most recent reported quarter (Q1) vs the past few full years:

2021 was a watershed year as well, with lower net losses in the subsequent year. If Q1's trends were to continue, however, NIO's losses seem included to run above par relative to last year. 

All matters considered, there are no high deviations and nothing substantial to indicate massive underperformance is brewing right off the bat. 

The two stocks' Price-to-Earnings (PE) Ratios, however, have shown very interesting results:

Of the two stocks, NIO has shown a 145% improvement in its (negative) PE Ratio while XPeng has shown an 81% improvement.

This is a rather interesting development which lends itself to some more extrapolations. The past year has seen a significant decline in retail investor participation. With that vanished the relative high convictions that led to massive gap in PE Ratios in both stocks seen in previous periods. This lends itself the idea that current drivers of stock trajectory are primarily institutional player volumes with a distinct long-term outlook, possibly in NIO more so than XPeng. 

In Conclusion

A recent note from Bank of America indicated that sales of Tesla's ( $Tesla Motors(TSLA)$) products in China have dropped by 31% month-over-month in July, while its main competitor BYD Auto ($BYD Co., Ltd.(BYDDF)$), grew 4% month-over-month. The note also concluded that this was likely not driven by local economic factors. Given the statistics presented here, it's evident that Chinese EV carmakers catering to the mid- to high-income segments have come into their own and are able to attract higher buy-ins than ever before. Given the size of the market, BYD wouldn't be the only beneficiary. The likes of NIO and XPeng would likely see stronger demand in the coming months and years. This long-term outlook is what inspired strategic investors to buy into this stock, regardless of their lack of profitability. Even this has a remedy in time and sustained performance. 

Overall, there is no expectation that either stock would make a massive comeback such that it outperforms the broad market on a Year-to-Date (YTD) any time soon. However, for investors with the wherewithal to allocate capital and wait over a period of years, either or both stocks are worthy of consideration. For those without said wherewithal but the need to stay in the market, they might consider a more-diversified instrument.

Meanwhile, given that that an institutional hand is steering the trajectory, it is very possible to deploy Exchange-Traded Products (ETPs) to make short-term gains from both stocks’ short-term trajectories:

1. $NIO3 gives a 3X exposure to the upside of NIO’s stock while $SNIO does the same on the downside.

2. $XPE3 gives a 3X exposure to the upside of XPeng’s stock while $XP3S does the same on the downside.

For broader articles that dives into business and culture in Asia, visit asianomics.substack.com. The latest article discusses the persistent overblown valuations of Korea’s EV Battery Sector along with a simple model for postulating the price range for a popular Korean battery stock. This article is en route to being published/mentioned in a number of publications in Korea.