Well-positioned to mitigate margin erosion in 2023E; new growth curve driven by globalisation
On Wednesday, we hosted an NDR conference call on BYD (1211 HK/HK$178.00, BUY). The management addresses a wide range of questions from investors with focus on margin impacts from NEV subsidy phase-out and overseas expansion plan which is expected to drive a new growth curve for BYD. In this report, we summarise major takeaways from the conference call, coupled with our latest views.
Better-positioned to Counter Margin Erosion from NEV Subsidy Phase-out in 2023
The street is reaching a consensus that China will completely cease NEV subsidies in 2023, given that the penetration rate of NEV sales has reached 30% in recent months, far ahead of government’s target. We see the investors’ concern about BYD’s margin impact from NEV subsidy phase-out reasonable, as the majority of BYD’s models on sale currently are covered by subsidies (excl. a rather small proportion of Tang and Han sold at above RMB300,000).assuming BEV subsidy of RMB11,340 and the PHEV subsidy of RMB4,800 per vehicle, we estimate NEV subsidies for BYD’s models at RMB14.8bn aggregately this year (c.5% of 2022E auto segment revenue), which is significantly higher than other own-brand OEMs.
At the NDR, management expressed confidence that the company is well-prepared to stabilise margin from both ASP and cost side. On the ASP side, the company plans to offset the subsidy phase-out indirectly through introducing facelifts of current models by upgrading or adding new configurations. The company hopes to see sales mix improvement led by better consumer awareness, instead of a straight-forward mark-up of MSRP for current products. On the cost side, management mentioned a steady cost-reduction between 3-5ppts per year, which mostly benefit from NEV’s steeper cost curve versus ICE as well as the company’s dominant sales scale among NEV makers. In addition, despite highly self-sufficient in manufacturing core EV parts, BYD has accelerated partnerships with a range of tier-1/tier-2 suppliers, which will also contribute to cost optimisation.
In our view, thanks to its reputable brand premium and cost advantage from greater economies of scale, BYD is undoubtedly better-positioned than most other OEM to cope with industry-wide headwind of subsidy phase-out next year. Even so, we estimate core earnings per unit for auto business for 2023 may pull back by at least RMB2,000-3,000 from c.RMB10,000 in 3Q22, considering the comprehensive impacts from intensified competition and NEV subsidy quit along with its rapid capacity release. In addition, another swing factor for margin outlook next year is the raw materials for battery as the price of lithium carbonate has rebounded to a record high recently.
Globalisation Strategy and Ambitious Target
Starting with the successful delivery of Tang EV in Norway at end of last year, BYD has gathered momentum to move forwards in overseas market. In 1H22, it entered Australia market with Yuan Plus (under the name of ATTO-3 locally), and central America market with Han EV, QIN Plus DM-i and Song Plus DM-i models. Given its absolutely dominant position in China NEV market (27% of market share in 9M22), the company has now regarded globalisation as the major driver to achieve its second expansion curve.
Exports set to further accelerate in 2023E According CAAM’s statistics, export volume of BYD reached 9,529 units in October and accounted for 4.5% of total sales volume with an ascending momentum YTD . In terms of model breakdown, Yuan Plus is the major export model accounting for 74% of total export volume in 9M22, reflecting the wide acceptance of this well-positioned sports SUV model in Australian market.
According to management, BYD aims to boost its export volume to 300,000 units (c.10% of its total sales volume target of 3m units), which is a huge jump from this year’s export at 50,000-60,000 units under our estimates. In terms of region, majority of export volume next year will be contributed by European market, followed by Australia, Japan and South East Asia (Malaysia and Singapore etc.).
European market as a priority at present For overseas region, management indicated that BYD regards Europe as its current priority given the huge auto consumption market size, greater preferences on NEV purchase, and moderate competition of European market. To build up a high-end brand image in Europe, BYD has prepared five mid-to-high end models for export in European market, differentiating itself from other Asian automakers such as Toyota and Hyundai which position themselves with affordable and economical features in Europe.
On 28 September, BYD presented pre-sale prices of three flagship BEV models (incl. Han EV, Tang EV, Yuan Plus EV) for European market via a virtual event, and will commence deliveries in a range of countries (incl. German, Norway and Sweden, etc.) by end of this year, signaling an officially rivalry with traditional Europe brands such as Volkswagen and BBA.
In order to gain a solid foothold in overseas market, management mentioned that BYD will implement three following tactics: i) development of localised products for individual overseas markets; ii) strategic cooperation with local dealers in terms of distribution channel; and iii) cultivation of premium brand image in overseas market with co-marketing campaigns.
In terms of profitability of export, management indicated that export could enjoy higher gross margin given the higher MSRP than similar models sold domestically.
But management also emphasized higher SG&A expenses related to exports during the early stage of globalisation.
Aggressive Capacity Expansion for Vehicle and Battery
Vehicle capacity and sales target Considering BYD’s strong order backlog of 700,000-800,000 units for delivery, the company has made every effort to expand capacity. According to management, the capacity plan of reaching nearly 300,000 units per month by end of this year is on track, which means next year’s annual capacity could reach at least 3.5m units and further expand towards 4m units.
In terms of sales performance, management mentioned there is no doubt that full- year sales volume could beat 1.8m units, while whether it could achieve aggressive target of 2m units this year may lie in the mitigation of COVID-19 and supply chain issue. For 2023, management guided external sales target of 3m units, which seems a bit prudent compared with internal target of 4m units set by Chairman Mr. Wang.
Faster-than-expected expansion for battery capacity With respect to power battery capacity, we think its expansion pace seems more radical than originally expected. At the NDR, management mentioned BYD’s annualised battery capacity would reach 300GWh by end-2022, which would further expand to 400GWh by end-2023. We reckon that the current capacity for power battery far exceeds its actual output (90-100GWh for 2022 under our estimation).
Management explained that faster expansion on battery capacity mainly comes from two considerations: i) explosive growth of its own NEV demand for power battery; and (ii) advanced preparations of abundant capacity for external battery supply and energy storage business.
For external clients of power battery, BYD now supplies battery to strategic customers including own-brand FAW, Toyota with which BYD established JV and US OEM. Along with capacity expansion, management expected that power battery for external supply will also increase in future. In addition, if raw material prices of battery could slide some time, the development of energy storage business will be accelerated. Management guided that battery output of 50-60GWh next year will come from external supply and energy storage, and output of 150-160GWh from self-use, assuming: (i) sales target of 3m units; (ii) roughly equal sales proportion of EV and PHEV, and (iii) battery capacity of 60-80KWh and 30-40KWh for BEV models and long-range DM-i models, respectively.
New Model Pipeline
Given the stronger-than-expected demand for BYD’s existing models and persistent supply bottlenecks, the launch of new models seems slower than expected, some of which have been postponed to 2023, according to management.
For Ocean network, four brand-new models are expected to be unveiled for the next 12 months. Considering the postponement of Guangzhou Auto Show, Frigate 07 DM-i, which is originally planned to unveil at GZ Auto show, will be delayed for launch by end of 2022. Two BEV models Seagull and Sea Lion, targeting at low-end A00 segment and B-class SUV segment, respectively, will come to market at appropriate time next year. In addition, Destroyer 07 DM-i, which is regarded as the sister of Han DM-i, will be launched in 2H23.
In terms of Dynasty network, facelifted version of Han and Tang will be launched in 1H23, with major upgraded features in vehicle intelligence. For Denza brand, a mid-size SUV which seems like a replacement for Denza X, is planned to roll out in 1Q23, followed by two other new models to be unveiled next year.
New premium brand Yang Wang to be launched in 1Q23 To improve product mix upward and monetise high net worth consumers, BYD plans a new premium EV brand Yang Wang with price range of RMB800,000 to 1.5m. According to management, the first model under Yang Wang will be released in 1Q23 and positioned as a deluxe off-road SUV to benchmark with Mercedes-Benz G-Class. The model will be featured with multiple disruptive innovation configurations including centralised E/E architecture, high-level autonomous driving, as well as amphibious driving. The management has expected to effectively improve product mix upwards with the debut of Yang Wang, and expressed confidence in Yang Wang’s potential to harvest market share from comparable gasoline vehicles with best-in-class electric and smart configurations, and fashionable brand awareness.
Valuation
Despite much better fundamentals than most peers, BYD’s share prices have pulled back over 40% since July along with overall sector. In addition to market concerns over the industry-wide headwinds such as NEV sales slowdown coupled with intensified competition and subsidy phase-out, we reckon another important non- fundamental factor lies in the concerns over the shareholding reduction of Buffett whose institution Berkshire Hathaway has held 225m shares of BYD (7.7% of total outstanding shares) for 14 years. Since 24 Aug 2022, Berkshire Hathaway has reduced stakes in BYD for three times and sold only 6.34m shares in total.
Management expressed that the interaction with this famous long-term shareholder has been quite smooth and the company is considering plans to deal with Buffett’s shareholding reduction but without any information to disclose so far.
Now its H shares are trading at 30.1x 2022E P/E and 24.3x 2023E P/E, respectively, below its historical average level of 45x P/E and undemanding in our view. We maintain BUY with TP of HK$270, based on 35x 2023E P/E. We reckon the positive catalyst may arise from export volume and external supply of battery business.