CATL: When will the trillion era return as the growth rate slows down?

On the evening of October 19, 2023, CATL announced its financial results for the third quarter of 2023. Dolphin Research has analyzed the performance of the third quarter and focused on the marginal changes.

Revenue and profit lower than expected: In the third quarter, CATL's revenue was 105.4 billion yuan, a year-on-year increase of 8%; net profit attributable to shareholders was 10.4 billion yuan, a year-on-year increase of 9%. Both revenue and profit performance were lower than market expectations, and the year-on-year growth rate slowed down.
Continued destocking? Maintaining gross profit strategy: In the third quarter, inventory remained at 48.9 billion yuan, the same as the second quarter. However, the inventory turnover days decreased from 76.5 days in the second quarter to 74 days in the third quarter. The gross profit margin for this quarter was 22.4%, an increase of 0.4% compared to the previous quarter. CATL still maintains its strategy of sacrificing market share to protect gross profit, instead of actively lowering prices like downstream leader Tesla to eliminate competitors.
Continued decline in lithium prices, products affected by inflation: The price of lithium carbonate continued to decline from a high point of 30 yuan/ton in the second quarter to about 17 yuan/ton currently. Industry demand is still declining, and the unit price of lithium batteries is still affected by inflation.
Inventory impairment not exaggerated: Asset impairment in the third quarter was 900 million yuan, accounting for only 1% of revenue, which is basically in line with the second quarter and within expectations.
Improved cost control, increased core operating profit margin: The three expense ratios decreased compared to the previous quarter, with the expense ratio decreasing from 11.6% to 10.4% in this quarter. The control of expenses is reasonable, and the core profit margin increased by 1.2% compared to the previous quarter to 10.2%.
Increase in order backlog: Compared to the previous quarter, contract liabilities increased by 4.4 billion yuan in this quarter, indicating an increase in order backlog, which is expected to be driven by the increase in pre-orders due to the release of the SuperCharge battery in August.

Dolphin Research's overall view:

Since the last earnings report, Dolphin Research has mentioned that the second-quarter revenue exceeded expectations, and the profit met expectations. The destocking efforts of CATL may have come to an end, which is favorable for a short-term recovery of CATL's stock price. However, the industry fundamentals have not fundamentally improved, and the demand side is still weak. After a short-term recovery, CATL's stock price has experienced a pullback.

In the third quarter, the industry fundamentals still face the following challenges:

The withdrawal of new energy vehicle subsidies and the slowdown in the growth rate of new energy vehicle penetration. The increase in the proportion of hybrid vehicle deliveries has led to a situation where the growth rate of new energy vehicle sales exceeds the growth rate of power battery shipments, resulting in a structural slowdown in overall demand for domestic power batteries.
The industry has previously invested aggressively in production capacity, while lithium prices continue to decline. The industry is still in a state of overall deflation.
Although CATL has maintained its gross profit margin by actively destocking and reducing capacity utilization instead of expanding market share, the logic of market share has had a certain impact on its growth potential.

As the industry tends to rely on secondary suppliers to maintain the stability of the supply chain, and CATL faces the squeeze of BYD's rapid growth in new energy vehicles and its strategy of protecting gross profit rather than market share, CATL's expansion of market share has been hindered.

In the third quarter, CATL's domestic market share continued to decline, from 42.6% in the second quarter to 41.8% in the third quarter. However, it was not the first-tier competitor BYD that took away CATL's market share, but some second-tier battery manufacturers such as Zhongchuangxinhang, Zhengli New Energy, Fengchao Energy, and Ruipu Energy. This is also the result of the industry's overall tendency to choose secondary suppliers to maintain supply chain stability, as well as CATL‘s strategy of actively reducing inventory and lowering capacity utilization to maintain gross profit margin.

However, in the situation of slowing demand for power batteries and continuous price decline, CATL has not narrowed the profit advantage compared to other battery manufacturers, but even increased it, thanks to the product premium brought by technological innovation, scale procurement and production, and yield control.

In terms of gross profit per Wh, CATL can basically maintain around 0.2 yuan, which is about 0.12 yuan higher than the industry average of 0.07-0.08 yuan. In terms of net profit per Wh, CATL generally maintains around 0.1 yuan, while excellent second-tier battery manufacturers such as Zhongchuangxinhang can only reach 0.02-0.03 yuan, and other manufacturers have already fallen into a loss.

The unit investment intensity of lithium batteries is relatively high, and the expansion of production capacity requires continuous capital expenditure. Under the current background of low valuation and tight financing conditions in the lithium battery sector, self-generating ability will become an important influencing factor in the medium-term pattern. CATL has a continuous net cash flow from operating activities higher than capital expenditure, and had 16.4 billion yuan of cash at the end of the third quarter of 2023, so future capacity expansion is not a problem. However, on average, second-tier battery manufacturers have significantly smaller operating cash flows than capital expenditures, and the speed of capacity expansion has slowed down this year.

This means that the industry has entered a cyclical adjustment phase. If lithium battery demand continues to grow slowly in the next two years and the losses of second-tier battery manufacturers continue to widen, their available funds may not support further expansion under the conditions of tightening financing and weakening operating cash flow. On the other hand, CATL still has sufficient funds for capital investment. In the medium-term pattern, CATL's market share is likely to enter a phase of initial decline followed by continuous improvement. In the final competition pattern, Dolphin Research predicts that the battery industry will present an oligopoly competition situation similar to the mobile phone industry, and CATL will ultimately win with its leading battery technology and production capacity advantages.Currently, CATL has stabilized its battery shipments and revenue growth through energy storage and overseas expansion. However, the barriers to energy storage are weaker than those of power batteries, and the stability of overseas markets is not as good as that of the domestic market, resulting in a discount in overall valuation. In the short term, lithium batteries are still expected to deflate, and CATL can only rely on performance delivery to stabilize its stock price, unable to achieve valuation expansion with limited upward elasticity.

From a valuation perspective, CATL's current TTM PE is only 19 times, still relatively cheap. Market concerns about the continued slowdown in shipments next year, Dolphin Research expects CATL to continue to achieve growth in shipments next year by focusing on the mid-range market with its Super Charge battery. Currently, CATL's order backlog has increased.

The following is the main content:

1. Overall Performance: Revenue below expectations, still focusing on destocking to maintain gross profit

1) Revenue below expectations: In the third quarter of 2023, the single-quarter revenue was 105.4 billion yuan, a year-on-year increase of 8%. The sell-side expectation seen by Dolphin Research was 105.4 billion yuan, and the revenue performance was lower than market expectations, with a slowdown in growth.

Behind the revenue slowdown, on the one hand, it is due to the slowdown in battery shipments. The shipment volume in this quarter was only 100 GWh, lower than the market and Dolphin Research's expectation of 110 GWh, with a MoM increase of only 5%. Among them, power battery shipments were about 80 GWh, and energy storage battery shipments were 20 GWh. On the other hand, the company made rebate arrangements for automakers, which had a negative impact on the revenue side.

2) Continued destocking? Still focusing on maintaining gross profit

Since the beginning of the year, CATL has actively reduced inventory levels by lowering capacity utilization rates. However, the capacity utilization rate in the third quarter rebounded slightly from 62% in the first half of the year to 70%. At the end of the third quarter, CATL's inventory was 48.9 billion yuan, unchanged from the second quarter, but it was reduced to 64% of the peak level. The inventory turnover days decreased from 76.5 days in the second quarter to 74 days in the third quarter.

Based on the data disclosed by CATL before, Dolphin Research roughly estimates that this level of inventory corresponds to approximately 50 GWh. In terms of stocking level, it only corresponds to about 50% of CATL's quarterly battery shipments. A one-and-a-half-month inventory level is relatively short from the perspective of the procurement cycle and can adapt to the changing speed of raw material prices in the market.

The gross profit margin in the third quarter was 22.4%, which is an improvement compared to 22% in the second quarter, despite the continued decline in lithium prices. In the third quarter, the company also made some provisions for rebates to automakers, so the actual gross profit margin may be higher.

In an industry with excess capacity, CATL's gross profit margin has even improved. In addition to the bargaining power brought by CATL's own product competitiveness, there is also a logical factor that is evident:In the face of its own production capacity and excess inventory, as an industry leader, CATL did not engage in price wars like Tesla, violently eliminating competitors. Instead, it maintained its gross profit margin by controlling capacity utilization and digesting inventory to a certain extent, rather than adopting an offensive market share strategy.

This is in stark contrast to Tesla's approach, which is a typical strategy of sacrificing gross profit margin for market share, resulting in a third-quarter automotive sales (excluding credits) gross profit margin of only 15.7%.

Under this line of thinking, Dolphin Research tends to believe that in the continuous process of lithium ore inflation, CATL's gross profit margin performance should be relatively controllable, with a main focus on stability rather than following the ups and downs of lithium ore prices.

2. Lower-than-expected profits, but an increase in core profit margin on a MoM basis

In the third quarter, net profit attributable to shareholders was 10.4 billion yuan, with a profit margin of 9.8%, a slight decrease compared to the previous quarter. Dolphin Research found that this was mainly due to the increase in interest expenses caused by the company's borrowing in this quarter. What Dolphin Research is more concerned about is the column that is separately pulled out for comparison with its counterparts in the US stock market, which is the core operating profit (revenue - taxes - three expenses - asset & credit impairment).

Looking at this core profit, it can be seen that the profitability in the third quarter has improved, from 9% in the previous quarter to 10.2% in this quarter. The main reasons for the improvement are the increase in gross profit margin and, more importantly, the reasonable control of the three expenses.

3. Expense control: Strengthened cost control

Although the growth rate of operating income weakened in the third quarter, there was no dilution of management, research and development, and sales expenses due to economies of scale. However, all three expenses showed a downward trend on a MoM basis in this quarter, with the total expense ratio decreasing from 11.6% in the second quarter to 10.4% in this quarter, both lower than market expectations.

In this quarter, there was a relatively large reduction in sales and administrative expenses, which on one hand reflects CATL's strengthened cost control ability. However, Dolphin Research also questions whether this may be related to the slowdown in the growth of energy storage and overseas markets, as energy storage requires more sales and operation maintenance, and expanding overseas markets requires higher operating expenses, both of which decreased in this quarter. Correspondingly, the battery shipment volume in this quarter also slowed down.

In terms of R&D investment, Ning Wang has always focused on creating product differentiation through high-intensity R&D to achieve product premium. With its leading battery technology, Ning Wang has built its competitive barriers. Not only does Ning Wang continue to strengthen the energy density of its batteries, but it also seizes the opportunity of fast-charging batteries. It has a continuous iteration of new products and is ahead of its industry competitors in terms of progress and planning.

In terms of improving battery energy density, the first passenger vehicle equipped with CATL M3P (lithium iron phosphate manganese) battery passed the Ministry of Industry and Information Technology's new vehicle list in August 2023. It is expected to be shipped in Q4 2023, about one year ahead of the industry in terms of M3P battery progress and planning.

In terms of fast-charging batteries, Ning Wang released the "Shenxing Battery" iron lithium 4C fast-charging technology in August, which uses integrated grouping technology to achieve a range of over 700 kilometers and can drive 400 km after charging for 10 minutes. Compared with the current mainstream LFP batteries with a 0.5-1C rate, it has obvious advantages. "Shenxing Battery" focuses on the mid-range market and is expected to promote the popularization of "800V+4C" fast charging in the 200,000-300,000 RMB price range (currently only a few car companies such as Xiaopeng equip fast-charging batteries). It will be mass-produced at the end of the year and launched in the first quarter of next year, driving Ning Wang's market share in the mid-range market.

IV. Increase in order backlog

Although the revenue growth rate in the third quarter has slowed down, the contract liabilities have increased by 4.4 billion compared to the second quarter, indicating a rebound in Ning Wang's order backlog. Dolphin Research estimates that this may be related to the release of the Shenxing Supercharge Battery in August, and the high demand for 4C supercharge batteries may drive the shipment volume of power batteries in the future.

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