Newcomers vs. Old players, can LI Auto successfully defeat AITO?

Li Auto (LI.O) released its third-quarter earnings report for 2023 after the Hong Kong stock market closed and before the US stock market opened on November 9th Beijing time. Although many may have already received news alerts about Li Auto' revenue and profit exceeding expectations, Dolphin Research was initially pleasantly surprised. However, upon closer examination, the results were not particularly impressive:

1.The third-quarter gross profit margin was not surprising: The gross profit margin for the car sales business was 21.2%, slightly lower than the market's expectation of 21.5%. Overall, the decrease in the average selling price of cars due to the September promotion of 10,000 cars only amounted to 3,400 yuan. The slightly lower gross profit margin is mainly due to the market's possible overestimation of the factory's depreciation effect. However, overall, the third-quarter gross profit margin is only a minor flaw.

2. The quality of the results exceeded expectations: While the overall revenue and profit exceeded market expectations, the revenue exceeding expectations means that the decrease in the average selling price of cars was not as significant as expected, which is positive. The profit exceeding expectations is due to the high growth of other businesses (insurance, used cars, etc.) and their revenue growth and gross profit margin performance far exceeding expectations. Additionally, as a cost control expert among new forces in the industry, Li Auto achieved high sales growth in the third quarter without a significant increase in sales expenses, demonstrating excellent store productivity. Overall, upon closer scrutiny, the results that exceeded expectations are not of high quality.

3. Fourth-quarter sales guidance is barely satisfactory: The company expects sales in the fourth quarter to be between 125,000 and 128,000 vehicles. After seeing the sales exceeding 10,000 vehicles per week announced by Li Xiang, the "King of Weibo," the latest market expectations are generally above 130,000 vehicles. This guidance does not meet expectations. However, considering that Li Auto' official guidance has always been conservative, this guidance may provide some room for maneuver, and the issue is not significant.

4. The real "bug" lies in the fourth-quarter expected unit price: Under this sales guidance, the company's revenue guidance for the fourth quarter is between 38.45 billion and 39.48 billion, implying an average selling price of approximately 298,000 yuan, a decrease of more than 20,000 yuan compared to the third quarter!

Regarding this issue, Dolphin Research has two preliminary thoughts:

a) Considering the difference in unit prices between the third and fourth quarters, as well as the relatively strong third-quarter gross profit margin, it is necessary to consider the true impact of Li Auto' September promotion of 10,000 cars, which will actually be reflected in the fourth-quarter financial statements.

b) In terms of the vehicle lineup in the fourth quarter, since the same few models are still being sold, the significant drop in implied unit price by 20,000 yuan likely means that after the limited-time promotion in September, Li Auto will have a greater promotional effort before the end of the year to cope with intense market competition (M7). However, regardless of the circumstances, such guidance is actually a manifestation of intensified competition.

Dolphin Research's overall view:

Looking closely at Li Auto's performance this time, we can only say that "the third quarter was mediocre, and the fourth quarter was impressive." Behind the strong sales performance of Li Auto, it is still operating in a fiercely competitive new energy market.

However, unlike the situation after the release of last quarter's performance, the current market's expectation for Li Auto's stock price of $35-40 per share is not as high. The current price is considered reasonably high and does not require close scrutiny.

In fact, as we approach the end of 2024, after the market has digested the impact of Li Auto's competition with M7 in terms of unit price and potential gross profit margin, what needs more attention is the expectations and outlook for next year.

Dolphin Research has noticed that most major institutions in the market have only estimated Li Auto's sales volume for 2024 to be around 550,000-650,000 vehicles. However, based on Li Auto's weekly sales of 10,000 units (52 weeks in a year), this expectation implies almost no additional sales volume for Li Auto in 2024.

But if we piece together the information: a) Li Auto's previous target of achieving 1.6 million vehicles by 2025; b) Li Auto's recent strategic conference proposing a target of 3 million vehicles by 2028 to secure a place in the final competition, based on this target, Dolphin Research tends to believe that the market's estimated sales volume for 2024 is significantly lower than Li Auto's self-set target for 2024.

Next year, Li Auto has planned to launch 3 pure electric vehicles and a more affordable extended-range vehicle, L6. If Li Auto guides the market to anticipate a sales target of 800,000 units in this conference call, Dolphin Research believes it will truly provide upward support for Li Auto's stock price. It is worth paying attention to Li Auto's guidance on market competition and sales outlook for next year in the conference call.

The following is a detailed analysis:

Since Li Auto announces its sales volume on a weekly basis and has already announced monthly deliveries early on, the marginal information of this performance is important. And the biggest marginal information lies in: 1) third-quarter gross profit margin; 2) fourth-quarter performance outlook.

Ⅰ.Gross profit margin remains above 21%

Li Auto has solidified its position as the "sales leader" among new energy companies, but can its gross profit margin keep up with the high sales volume? This quarter continues to deliver stable results.

In the third quarter, Li Auto's automotive business gross profit margin was 21.2%, an increase of 0.2% compared to the second quarter, but lower than the market's expectation of 21.5% and the major institutions' expectation of 22.5%.

Next, let's look at the scale effect of which parts contribute to the gross profit margin of each vehicle through the unit economics:

1. L9 Pro and limited-time discounts make the bicycle price lower than expected

The average price of bicycles in the third quarter was 320,000 yuan, with 0.3 million fewer sales than the previous quarter

Although the proportion of higher-priced L8/L9 models in the vehicle structure this quarter increased by 10% compared to the previous quarter, accounting for 63%, the introduction of the L9 Pro in August reduced the price by 30,000 yuan, which had a certain impact on the unit price.

At the same time, in the price war since August, Dolphin Research has also taken certain measures, launching a limited-time insurance subsidy of 10,000 yuan until the end of September, which has also put downward pressure on the unit price this quarter.

2. However, cost savings from increased production volume and dilution of depreciation have stabilized gross profit margin

In the second quarter, the cost of Li Auto Cars was 252,000 yuan per unit, which was 3,000 yuan lower than the previous quarter. Dolphin Research analyzed the cost reduction effect brought by Li Auto Cars from variable and fixed costs:

a. Although Li Auto Cars has not yet announced the depreciation expense for this quarter, the depreciation expense is relatively stable and predictable. Based on the amortization depreciation expense of 430 million yuan for this quarter, compared with the previous quarter, the dilution effect of fixed costs brought by the continued increase in production volume to almost full production status in the third quarter contributed to a 0.2 percentage point increase in gross profit margin for Li Auto Cars.

b. However, the cost reduction effect brought by the purchase premium and lithium carbonate and other materials from the scale sales volume this quarter is not significant, and the variable cost rate is almost the same as the previous quarter.

3. The gross profit per unit is almost the same as the previous quarter, but the advantage lies in selling more

In terms of the profitability of each unit, Li Auto Cars earned a gross profit of 68,000 yuan per unit in the third quarter, which is the same as the previous quarter. However, after the price reduction, the sales volume skyrocketed, and the actual overall gross profit margin increased. The overall gross profit margin of car sales increased from 21% in the previous quarter to 21.2% in the third quarter.

(Note: The data for the gross profit margin of car sales in the third quarter of last year after deducting 800 million yuan + contract losses)

II. Fourth-quarter sales guidance is conservative, and gross profit margin expectations are different

a) Fourth-quarter car sales target: 125,000-128,000 units

Since Li Auto Cars has already surpassed the 40,000 sales mark earlier than expected, and Li Xiang has also stated that he wants to challenge the goal of delivering 50,000 units per month in the fourth quarter, the sales target of 125,000-128,000 units corresponds to an average monthly sales of 41,300 units in November and December. Compared with the market's expectation of 130,000-133,000 units of sales in the fourth quarter, it is a bit conservative, but considering Li Auto Cars' consistent conservatism in outlook, the sales guidance is not a big issue.

When Li Auto Cars' monthly sales have already exceeded 40,000 units, the market has priced Li Auto Cars' stock based on the delivery of 40,000-45,000 units per month. However, whether the goal of delivering 50,000 units can be achieved, the market is more concerned about the impact of the upcoming M7 and M9 on Li Auto Cars' orders.

b) Expectations of a Decline in Gross Profit Margin Implied by Unit Price

The Li Auto scenario for the fourth quarter revenue is between 38.5 billion and 39.4 billion. With an estimated contribution of 1.23 billion from other revenue sources, the unit price corresponding to the guidance for the third quarter is about 298,000 yuan, which is significantly lower than the market expectation of 324,000 yuan.

However, the decrease in unit price by 22,000 yuan compared to the third quarter cannot be explained by the increase in the proportion of lower-priced L7 deliveries in the sales structure. It is likely due to the following reasons:

1) Some of the orders from the September limited-time promotion of 10,000 yuan discount were delivered in the fourth quarter, affecting the overall unit price.

2) Li Auto may continue to lower prices or offer discounts in order to compete with other brands and achieve its sales target.

Regardless of the reasons, this reflects the intensifying competition in the market.

The market expectation for the gross profit margin in the fourth quarter is 21.3%. However, with a decrease of 20,000 yuan in unit price, there is limited room for further reduction in the cost of raw materials, particularly lithium ore in the unit cost. The dilution of cost through increased production alone is not enough to offset the impact of the decline in unit price. Therefore, it is highly likely that the gross profit margin in the fourth quarter will be lower than the market expectation.

III. Can Li Auto Maintain Its Position as the Leader in the Electric Vehicle Market?

Compared to Li Auto L7, the advantages of Wanjie M7 are as follows:

1) Price: The entry-level model of M7 is priced 70,000 yuan lower than the entry-level model of Li Auto L7, giving it a price advantage.

2) Marketing: Wanjie M7 has benefited from the halo effect brought by the popularity of Huawei Mate60 Pro, attracting customers to test drive and place orders.

3) Distribution Channels: Huawei operates more than 5,000 high-end experience stores in China, and Wanjie has entered 1,000 of them, indicating a stronger presence in distribution channels compared to Li Auto.

4) Autonomous Driving: M7 has the support of Huawei, a leader in the first tier of autonomous driving technology. However, the starting price of the autonomous driving version is as high as 310,000 yuan, which is similar to the starting price of Li Auto L7. Additionally, the urban NOA feature requires an additional fee (limited-time discount of 18,000 yuan).

However, Dolphin Research is not overly concerned about the impact of Wanjie M7 on L7 orders. Currently, hybrid vehicles are still in the incremental stage, and Li Auto has not fully tapped into the market potential due to insufficient penetration in distribution channels (there is a greater demand for extended range in second and third-tier cities due to the lack of charging stations). There is still significant room for growth in sales, and the quality and after-sales service of Wanjie M7 are still behind Li Auto.

IV. R&D expenses are inflexible, while sales expenses are lower than expected

1) R&D expenses: Continuously inflexible, need to fill gaps in pure electric and intelligent areas

In this quarter, Li Auto's R&D expenses were 2.82 billion yuan, an increase of 400 million yuan compared to the previous quarter, showing continued inflexible growth.

At the current stage, Li Auto needs to invest funds in developing pure electric platforms and models, and the investment in intelligence was delayed by half a year, requiring continuous strengthening of investment. The current plan is to "implement NOA commuting in 100 cities" by the end of the year, and investment is still being increased to fill the gaps in intelligence.

2) Sales and management expenses: Lower than market expectations, but further channel sinking is needed

In this quarter, sales and management expenses were 2.54 billion yuan, an increase of 200 million yuan compared to the previous quarter, but lower than the market expectation of 2.72 billion yuan.

Looking at the third quarter, Li Auto did not have any new models launched, so marketing expenses were basically under control. The monthly sales volume per store in October has reached 110 units, showing continued improvement compared to around 100 units at the end of the second quarter.

However, the number of new Li Auto stores added is almost the same as in the second quarter, indicating a slow store opening speed. In the case of high demand for extended range in second- and third-tier cities, the degree of channel sinking is still insufficient, and there is still significant room for sales growth from these cities.

V. Revenue and gross profit margin exceed expectations, but automotive business falls short of expectations

With the announced sales volume, Li Auto's total revenue in the third quarter was 34.68 billion yuan, a year-on-year increase of 271%, exceeding the market expectation of 33.7 billion yuan. The gross profit margin in the third quarter was 22%, slightly higher than the market expectation.

The revenue exceeding expectations is mainly due to the smaller-than-expected decline in unit prices, which is better than market expectations. However, the unexpected profit in this quarter is due to the high-growth other businesses (insurance, used cars, etc.) with a gross profit margin of 48.9%, exceeding the market expectation of 45%. Looking solely at the gross profit margin of the automotive business, it falls short of expectations due to the decline in car prices, indicating a relatively lower quality of the unexpected profit.

VI. Improved profitability, but not significantly outstanding

Li Auto's net profit in the third quarter reached 2.8 billion yuan. In terms of operating profit, which carries more weight, the absolute value increased from 1.6 billion yuan in the previous quarter to 2.34 billion yuan in the second quarter, which is quite good but not particularly outstanding.

The operating profit margin increased from 5.7% in the second quarter to 6.7% in the third quarter, higher than the market expectation of 5.2%. Looking at the core factors, the gross profit margin remained stable, R&D expenses remained inflexible, and the leverage effect of sales expenses played a major role in the improvement.

Ⅶ. Outlook for 800,000 units of sales in 2024 will become a upward support for the stock price

As 2023 comes to an end, after the market has digested the competition faced by Li Auto's M7 in terms of its unit price and potential gross margin impact, it is more important to focus on next year's expectations and outlook.

Looking ahead to 2024, Li Auto's pure electric journey has just begun. In order to stay in the fiercely competitive battlefield and secure a leading position in the industry, Li Auto needs substantial investment, but it may also experience a period of pain.

1) In terms of capital expenditure, there is a need to make up for the shortcomings in pure electric vehicles, including infrastructure construction such as charging stations and capacity expansion. In terms of sales expenses, it is necessary to continue opening stores and increase the level of channel penetration. On the R&D side, there is a need to make up for the shortcomings in intelligence. These factors may have a certain drag on performance.

2) In terms of gross margin, the battery cost of pure electric vehicles is higher compared to extended-range vehicles. Next year, the main incremental contribution is expected to come from the L6 model priced between 200,000 and 300,000 yuan, with prices continuing to decline. There may be a risk of further decline in Li Auto's profit margin in 2024.

However, in terms of sales volume, according to 36Kr, Li Auto is expected to exceed 800,000 units in 2024, which means Li Auto needs to achieve a monthly sales volume of 67,000 units. Dolphin Research found that the market generally expects Li Auto's sales volume in 2024 to be between 550,000 and 650,000 units. In fact, based on the weekly sales volume of 10,000 units that Li Auto has already achieved (52 weeks in a year), this expectation means that there is almost no expectation for the additional sales volume of Li Auto in 2024.

Previously, Li Auto announced its goal of achieving 1.6 million units in 2025 and the target of 3 million units by 2028 to secure a spot in the final competition. Dolphin Research believes that the market's sales volume forecast for 2024 may be too conservative.

Li Auto's product lineup strategy has also been determined, with plans to launch 8 models next year. In terms of product planning:

1) Li Auto will release the 5C pure electric MPV Mega at the end of this year, with a target price of over 500,000 yuan. It will enter the pure electric race track at a high price and start user deliveries in February next year. However, this model has generated a lot of controversy. Referring to the monthly sales volume of less than 2,000 units for the similarly priced pure electric MPV JiKe 009 in October, Dolphin Research is relatively conservative about the incremental contribution of this model and estimates that the possibility of monthly sales exceeding 10,000 units is not high, based on an estimated annual sales volume of 50,000 units next year.

2) In 2024, Li Auto will release four models, including an extended-range SUV and three pure electric vehicles. For the extended-range SUV, the L6 model is expected to leverage the success of the current extended-range models and become the main contributor to sales volume, further penetrating the price range of 200,000 to 300,000 yuan. It is estimated that the monthly sales volume can reach 10,000 to 15,000 units, with an annual sales volume of over 100,000 units, depending on the launch time of the L6 model.

As for pure electric vehicles, the competition is currently fierce, and Li Auto's pure electric ecosystem and recognition have not yet been established. Dolphin Research estimates that the annual sales volume of the three pure electric vehicles next year will be around 100,000 units.

Based on this product planning, Dolphin Research believes that the achievability of Li Auto's target of 800,000 units in annual sales next year is quite high. If Li Auto guides the market to look forward to a sales volume target of 800,000 units in this conference call, it will truly provide upward support for Li Auto's stock price.

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