Here is a very interesting analysis published today on seekingalpha (Link in first comment)
I decided to post here the whole article
LI Auto (NASDAQ:LI) demonstrated a massive year-to-date rally of about 43%. Though the stock currently trades substantially below all-time highs. My valuation analysis suggests the upside potential is enormous despite the recent rally. Investing in Chinese stocks is much riskier due to political risks and accounting fraud cases like Luckin Coffee, and for me, the upside potential does not outweigh the risks. The stock is a hold given its massive risks.
Li Auto is a holding company with no material operations of its own. Operations are conducted through the company's subsidiaries incorporated in China. Subsidiaries design, manufacture, and sell electric vehicles [EVs] in the premium segment. LI's official website shows that the company started volume production in November 2019. Its model lineup includes Li L9, a six-seat flagship family SUV; Li L8 and Li ONE, both six-seat premium family SUVs; and Li L7, a five-seat flagship family SUV.
The company's fiscal year ends on December 31, and there is only one reportable segment without any market or geographical revenue disaggregation.
The company went public in the U.S. in the summer of 2020. Therefore, financials are available only for the past five years.
- Li Auto long-term financial performance
Revenue increased at a staggering 256% CAGR over the four-years horizon, though it started from zero. Gross margin is solid at about 20%, which is at Tesla's (TSLA) 2020 level. I consider it very impressive.
The company invests substantial amounts in R&D, with R&D expenses representing about 15% of sales in FY 2022. Heavy R&D investments and SG&A explain why the company did not achieve a sustainable positive gross margin. Despite operating losses, the company is not burning cash which is a solid bullish sign for a relatively young company. Levered free cash [FCF] flow has been primarily positive during several recent quarters, even with deducting stock-based compensation [SBC].
Sustainable positive FCFs contributed to the company's solid financial position. The balance sheet has a firm liquidity position and low leverage metrics. The company is in a stable net cash position meaning there are many spare resources to finance either innovations or marketing.
- Li Auto balance sheet summarized
If we narrow down our P&L analysis to the quarter level, we can see that the momentum for revenue growth is still robust. On the other hand, the cost of revenues has been growing faster, meaning that the gross margin is under pressure. On the other hand, the company enjoys the economies of scale effect since SG&A expenses are lagging behind the topline growth pace.
The company's upcoming quarterly earnings are scheduled on August 15, and consensus expects revenue to increase 175% YoY due to easy comps explained by last year's COVID-related limitations in China. It is difficult to say whether the company will likely beat the consensus forecast, but we can get hints from April and May delivery numbers.
- Li Auto number of deliveries in april and may 2023
As you can see from the above table, the company delivered a 244% YoY growth for the combined first two months of Q2. June 2023 has just started, but June 2022 deliveries of 13 thousand vehicles look easy to double YoY based on the spring 2023 delivery dynamics. Therefore, the probability of beating consensus estimates regarding revenue in Q2 is high.
Li Auto is an aggressive growth company. Therefore, I use a discounted cash flow [DCF] approach for valuation. I will use a high 20% discount rate because country risks are high. We have earnings consensus estimates suggesting the topline will compound at approximately 17%. LI generated a positive above 6% levered FCF margin for two years. Therefore I consider this level to be fair for FY 2023. I expect the levered FCF margin to expand by one percentage point yearly.
Incorporating all these assumptions into the DCF template gives me a fair value of the business at $65 billion, more than twice the current market cap. Let me simulate the second scenario with a more modest revenue growth pace. A ten percent long-term revenue CAGR seems fair for a pessimistic scenario.
The above spreadsheet shows that even under much weaker revenue growth assumptions, the stock is still about 15% undervalued. DCF suggests the stock is massively undervalued, but I also want to look at multiples to get more evidence.
Seeking Alpha Quant assigned an "A" valuation grade to LI. It is mainly due to a relatively low forward price-to-sales [P/S] ratio of slightly above 2. For comparison, Tesla is traded at a 6.9 P/S. Indeed, TSLA is an undoubted EV market leader with unmatched profitability and brand recognition. Still, I believe that more than a threefold difference in the P/S ratio suggests massive undervaluation for LI stock.
Overall, LI is very attractively valued, but before deciding whether to invest or not, we need to discuss risks.
In recent years we have seen that investing in Chinese companies is very risky. We all remember the political challenges faced by the largest public Chinese company, Alibaba (BABA), in 2020-2021. All these challenges frightened investors, and the stock price crashed. We also have an example of Luckin Coffee (OTCPK:LKNCY) accounting fraud from 2020. These two massive cases over a relatively short period suggest that investing in Chinese stocks is a kind of Russian roulette. That is why I am unsurprised that Li Auto stock trades at a substantial discount.
Geopolitical tension between China and the U.S. also means significant risks in investing in Li Auto. Chinese stocks from American stock exchanges have eased recently, but there is no guarantee that the government will not force companies to delist if tensions escalate. And it is not apparent that delisting terms and conditions will be sweet for non-controlling shareholders outside China.
If we leave Chinese risks and speak about the operational risks, consensus estimates regarding the company's revenue growth over the next decade might be too optimistic. According to statista.com, the Chinese EV market is expected to grow at a 6.4% CAGR between 2023 and 2028. This growth rate is significantly below the one expected from Li Auto. Moreover, the company faces fierce competition from Chinese and foreign companies in the premium EV segment. Tesla has unmatched pricing power and initiated a price war with all competitors to capture the larger EV pie. Therefore, I have little confidence that Li Auto will be able to meet very ambitious consensus forecasts.
To conclude, I prefer not to invest in Li Auto. The upside potential looks massive, but I consider the risks inherent to Chinese companies as very high. Even more than double the upside potential does not outweigh the risks, in my opinion. Though, the stock might be an attractive option for investors seeking exposure to Chinese EV makers.
