Summary

• Li Auto, a Beijing-based company founded in 2015 by Xiang Li, focuses on REEV SUVs, offering extended range and leading sales in China.

• Xiang Li's unique approach contrasts with NIO's, opting for SUV models after the LSEV plan failed due to regulatory issues.

• Li Auto's financials show strong revenue growth, solid margins, and liquidity, positioning it well for future expansion and benefiting from China's stimulus.

• Despite risks like the Chinese market and VIE structure, Li Auto's valuation through discounted cash flows and multiples suggests it could be a good investment.

Li Auto electric car store. Chinese electric vehicle manufacturer

At the beginning of the year, I was part of a conference with a focus on the automotive industry. During this conference, a lot of industry experts gave their opinion about the transition to EV, the auto industry in general and the economics behind it. One name that was touted multiple times was Li Auto (NASDAQ:LI). At the time, I was unfamiliar with the company as it did not sell any cars in Europe - this being my initial focus area. After doing a deep dive into the company, I think that Li Auto could be a good investment at a reasonable valuation.

Company

History

Li Auto is an automotive company hailing from Beijing, China. The company was founded by Xiang Li (founder of Autohome (ATHM), PCPOP) in 2015, after denying becoming a co-founder of NIO. The reason he denied the opportunity with NIO was that he had opposing views with regards to running the company. NIO is following the Tesla (TSLA) plan, meaning that it starts with more expensive EV's and eventually get to mainstream models, whereas LI preferred using two different models: LSEVs and SUV. The LSEV was supposed to be a small urban mobility solution. However, due to the fact that the Chinese government wasn't very interested in legalizing the LSEV, the plan for the LSEV failed.

As a result of the failed LSEV, Xiang Li decided to focus on SUV models. His vision was to have 5 meter long cars that can seat six to seven people. The first model was announced in 2019, and deliveries commenced in early 2020. It is important to note here that LI's models are not full BEVs, but rather REEVs (range extended electric vehicles). The advantage of a REEV is that its range is significantly higher, as the petrol motor takes over once the battery is empty. Interestingly, LI is one of the only companies that is successfully using the REEV technology. In fact, the company is doing so well that it is one of the best-selling vehicles in China and was the first new Chinese car-making company to reach 1 million vehicles delivered as per the company's announcement on Weibo.

What has happened over the past few quarters

Before investing, I always like to get the gist about what happened over the past few quarters. For example, I found that Li Auto had to lower its target for vehicles sold from 800k (at the end of Q4 2023) to 500k (MRQ). This was the result of lower than expected sales in its Li Mega BEV (due to a more competitive BEV market), among other things. Furthermore, I found that the company's market share in Q3 2024 was 17.3% vs 15.4% in Q3 2023 (in the NEV over 200k CNY market). The company has also emphasized that it will focus on the over 200k CNY market, as they think the market below 200k is crowded. Finally, in its most recent quarter the company mentioned that it is planning to have 500 retail stores at the end of 2024 and 4000 charging stations by the end of 2025. Finally, the company recently announced expansion into AI, however, not much is known about this yet.

Finances

After getting some familiarity with the company, it is important to look at the company's finances. Personally, I look at a few key components from the three statements which include, among others, revenue growth, margins, and liquidity.

The first thing I looked at for LI was its revenue growth. Companies in the EV space come from a low revenue base and thus a high revenue growth rate is very common and will have a significant impact on the company's value. If we compare LI to its closest NEV (new energy vehicle) Chinese peers (NIO and XPeng (XPEV)) and the largest EV company by market cap (Tesla), Li has had the highest revenue growth rate for the past two years. This is interesting as it has a higher base than its Chinese peers. As such, I would argue that, at least comparing to those two, it is doing a significantly better job.

Revenue growth Li vs peers (Tikr.com)

A high revenue growth number is important, but if your margins are low, it does not necessarily add value. In the graph, it can be seen that both NIO and XPeng have negative operating margins. This means that every extra dollar earned does not lead to higher cash flows. Tesla is the strongest in the peer group with a margin of 8.4% at the end of 2023, while Li is catching up with a margin of 4.4% at the end of 2023. This means that the high revenue growth also leads to higher cash flows.

Operating margins Li and peers (Tikr.com)

In terms of liquidity, Li Auto is the strongest within its peer group. The company has had the highest quick ratio in all of the past 3 years. This is important because it means that the company is easily able to service its current obligations.

Liquidity (Tikr.com)

The final thing that I look at is the company's debt level. In this case, I opted to use the debt to equity ratio, as Nio and XPEV have a negative EBITDA. I think it is important for companies in rapidly growing sectors to have a relatively low debt ratio, as this gives them flexibility to increase debt later on to grow faster. In the peer group, Li Auto currently has the second-lowest debt to equity ratio (22.4%), only trailing Tesla (15.1%).

Debt to equity ratio (Tikr.com)

All in all, Li Auto is among the top companies in its peer group. The company has higher revenue growth and higher liquidity than its peer group, and is in second place for margins and debt ratios. As such, from a financial point of view, the company is very strong.

Valuation

Before you put your hard-earned money into an investment, it is important to understand the value of the business. This gives you an indication of what a company should be traded for based on the cash it is expected to generate. Personally, I like to use multiple methods, two of which are based on discounted cash flows (DCF and APV) and one that is based on trading multiples.

Discounted cash flows and APV

For LI, I decided to forecast the revenue based on growth in volume per store and an increase in vehicle price based on inflation. I would have loved to forecast it based on volume and mix but, I was unable to locate the right data. The expected growth in cars sold for 2024 and 2025 were based on the company's expectations. The same goes for the store count. After those years, volume growth is expected to range between 15% and 2%. This led to the following results:

Revenue expectations in MCNY. Note that the . is used as a thousand separator (Author)

The costs were forecasted based on the division between vehicle sales, R&D and other sales and services and takes into account the expected store growth. This leads to the following income statement:

Income statement forecast (Author)

The WACC was determined based on the risk-free rate, the company's cost of debt, as well as a risk premium. I use an average approach based on the capital structure of peers (TSLA, NIO, XPEV, BMW (OTCPK:BMWKY), VW (OTCPK:VWAGY) and Mercedes (OTCPK:MBGAF)), the company itself, the beta of the company, and the beta of peers, and this led to a WACC of 6.86%.

Overview of WACC estimate for Li Auto

WACC estimate for LI (note the difference between comma and full stop) (Author)

With growth in perpetuity of 3%, approximately equal to the average GDP growth rate and an exchange rate equal to 7.30 CNY per USD, this led to a valuation using the DCF method of $66.49.

DCF valuation of Li Auto

DCF valuation (note difference between comma and full stop) (Author)

In the APV model, which takes the tax shields and distress probabilities (which I put at 10% for LI) into account, this leads to the following price target:

APV model for LI Auto

APV model estimate (note difference between comma and full stop) (Author)

Multiples

For the multiples, I prefer to use the median of the peer group. For Li Auto I decided to use a mixture of pure EV companies and some established names like the ones mentioned before. As a result of the lower multiples of the established names, this leads to the following results:

Multiples valuation for LI Auto

Multiples valuation (Author)

Taking the median of the price targets using the multiples method leads to a price target of $19.29.

If we take the average of the DCF method, the APV method, and the combined multiples median, we arrive at a price target of $39.99, or approximately 63.9% above the price at the moment of writing.

Drivers

Having a price target is great, but there needs to be catalysts or drivers that will bring the stock price closer to its intrinisic value. For Li Auto, I currently see two main drivers. I do exclude the aforementioned move into AI, as it is still in its infancy.

Expansion Abroad

One of the main drivers I see for Li Auto is its planned expansion abroad. In the Q3 earnings call, the company mentioned that it is following a slightly different strategy than its peers as its initial focus is on the Middle East and Africa. Peers like Nio and XPEV focus on Europe and the US, which have implemented taxes to improve the competitiveness of the local incumbents in the car industry, among other things. From that point of view, it makes sense to initially focus on MEA (in particular Saudi Arabia and the UAE, which were worth around $27 billion combined in 2023 and are expected to be worth $100 billion by 2032). However, the European and US markets have higher disposable incomes than the MEA market, which makes it easier to afford the "luxury cars" of Li and its closest peers. Nevertheless, the expansion into more countries is positive as it increases the company's TAM. It also wouldn't surprise me if the company will expand to South America, as Wang Jing (who oversees international expansion) used to be responsible for sales and services of Huawei in Chile.

China Stimulus

An additional stimulus for Li is the stimulus coming from the Chinese government to boost growth in the country. The CCP has given multiple stimulus packages to people exchanging their old cars for EV or more fuel-efficient vehicles. These stimulus packages are expected to continue in the future and will boost the overall sales in China mainland. The stimulus can lead to people opting for slightly more expensive brands (including Li Auto) and to families being able to upgrade (which is the main target group of Li). As such, if the stimulus continues and/or gets increased, I expect it to further boost sales for Li Auto.

Risks

As with any investment, there are risks. For Li, there are multiple types of risks including execution risk, business risk etc. However, I currently view the main risks to be associated with an investment in China.

Currency risk

The first risk for Li Auto is the fact that the company collects its revenues in CNY, while the stock is denominated in USD. This could mean that the stock price goes down, even when the company is performing better or in line with expectations. For example, if someone bought the stock in 2022 when the CNY per USD was approximately 6.3, the exchange rate would have had a large impact as the current exchange rate is almost 7.3 CNY per USD.

Chart

Data by YCharts

Chinese economy

Another important factor to take into account that is related to the currency is the overall economy. The aforementioned stimulus packages from the government are given because the Chinese economy hasn't been growing as much as it used to. Additionally, the country is even experiencing some mild deflation over the past few quarters. The expectation for this year is that the country's GDP growth is moving towards the higher end of 4%, while in 2025 GDP growth expectations are around 4.2%. This lower growth rate is a clear negative, and thus it is necessary for Li to expand abroad to continue growing.

VIE Structure

The final risk that I see is the VIE structure. The VIE structure has been discussed multiple times before in different articles. What it comes down to is that foreigners aren't allowed to own a piece of a Chinese business, and, as such, they set up an entity that signs a contract with the Chinese business that gives it the right to the benefits of the business (think cash flows etc.). This is a loophole and if the CCP wanted to they could put this to a halt. I currently do not expect this to happen, but I would rather own a piece of the business outright.

Conclusion

Li Auto is an interesting company that is active in the Chinese NEV market. The company is currently one of the few profitable companies in this space, but uses a slightly different transmission than its peers (BEV vs. REEV). The finances are looking good, with Li consistently ranking in the top 2 (out of 4) in its peer group.

The company is currently also valued approximately 64% below my intrinsic value calculation. I expect this undervaluation to narrow driven by its expansion abroad and the continued stimulus in China. There are risks to this thesis which include currency risks, the Chinese economy and the VIE structure. However, for me, the positives currently outweigh the negative and as such I have a speculative position in the company.

Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.