With a continuous increase in gross margin, can Leapmotor lead the way in its international expansion?

Leapmotor (9863.HK) released its 2023 fourth-quarter financial report after the Hong Kong stock market closed on March 25th. Here are some key points:

1. Continued Increase in Gross Profit Margin in the Fourth Quarter: The gross profit margin in the fourth quarter continued to rise to 6.7% on a quarter-on-quarter basis. The key to this increase lies in the cost savings of per vehicle due to the self-developed technology across the board.

2. Significant Decline in Unit Prices Resulting in Revenue Below Market Expectations: The significant decline in unit prices, driven by the increased proportion of the low-priced T03 model this quarter and the overall price reduction for promotional purposes by Leapmotor, led to a substantial revenue shortfall compared to market expectations.

3. Expected Pressure on Delivery Volume and Gross Profit Margin in the First Quarter of This Year: Sales volume in January and February only reached 18,800 units, with market share dropping from its peak of 2% to 1.5% in February. The introduction of 24 models by Leapmotor led to a slight recovery in weekly sales, but the first-quarter delivery volume is still expected to decrease by about 39%-44% on a quarter-on-quarter basis. With price reductions for the 24 models/old models and pressure on delivery volume, the gross profit margin is expected to be under pressure.

4. Operating Expenses at an All-Time High: Both research and development expenses and sales expenses reached all-time highs this quarter, with the operating expense ratio increasing from 20% in the previous quarter to 27% in this quarter. However, the brand upgrade requires dual efforts in research and development and marketing, which can be understood by the market.

5. Cash Flow Safety Issue Resolved: The cooperation with Stellantis has become the best solution to Leapmotor's cash flow shortage, not only directly addressing the urgent cash flow shortage but also opening up a high-margin new model for technology monetization. A preliminary safety cushion for the stock price has also been established.

Overall, revenue significantly missed market expectations mainly due to the increased proportion of the low-priced T03 model (priced at 49,900-69,900 RMB) in the sales structure this quarter (increasing from 19.5% in Q3 to 37.7% in Q4), along with the full range price subsidies in November (reducing prices by 10,000-20,000 RMB).

Leapmotor has always been plagued by the issues of cost-effectiveness and low brand value, coupled with a lack of expertise in internet marketing, leading to insufficient brand appeal and making it difficult to increase unit prices. This quarter, due to the model structure, prices dropped to a historical low, below 100,000 RMB.

Although sales volume increased by 25% compared to the previous quarter, the significant decline in unit prices led to a 6.7% quarter-on-quarter decrease in revenue, well below market expectations.

However, leveraging the advantages of self-development across the board (under the leap 3.0 architecture, Leapmotor's self-developed components account for 70% of the total vehicle cost) and the scale effect and natural decline in the cost of lithium carbonate batteries this quarter, costs reached a historical low with a quarter-on-quarter decrease of 37,000 RMB. Leapmotor's cost reduction efforts have made significant progress, with the gross profit margin increasing by 5.5% quarter-on-quarter to 6.7% this quarterIn terms of operating expenses this quarter, both R&D expenses and sales expenses have reached a historical high. R&D expenses were mainly invested in intelligent catch-up and the development of new car models, while sales expenses increased mainly due to the increase in marketing activities (although the number of stores decreased compared to 2022). Finally, the operating expense ratio increased by 7% compared to the previous period, offsetting the increase in gross profit margin, resulting in a basic flat operating loss.

Currently, in terms of valuation, the current stock price corresponds to a 24-year P/S ratio of 1.2-1.5 times (estimated sales volume of 200,000-250,000 in 2024). Compared to Li Auto, the valuation is no longer considered cheap. The biggest issue for Leapmotor at the moment lies in the lack of brand recognition, and the pricing advantage dominated by BYD in the 100,000-200,000 RMB range. It is difficult to increase the unit price, leading to limited room for further increase in gross profit margin (this year's gross profit margin target is 5%-10%). From the sales perspective, Dolphin believes that Leapmotor's biggest upside potential in the medium to long term still comes from overseas markets, but its impact in 2024 is limited. Starting from 2025, it is expected to contribute meaningful sales volume and profit growth.

Here is a detailed analysis:

1. Significant decrease in unit price, but gross profit margin continues to rise due to cost reduction

As a leader in the second-tier of new forces, Leapmotor has always lagged behind the first-tier player, Li Auto, in terms of unit price and gross profit margin.

The performance this time shows a significant revenue miss compared to market expectations, but the gross profit margin continues to rise. In the fourth quarter, Leapmotor achieved a gross profit margin of 6.7%, up 5.5% from the previous period, mainly due to a significant reduction in per unit cost.

2) Economies of scale + self-developed technology significantly reduce per unit cost

Dolphin will start by analyzing the increase in gross profit margin this quarter from the perspective of per unit price and cost:

a) Increase in the proportion of T03 small cars leads to a significant decrease in average unit price:

In the fourth quarter, the average unit price per car was 95,000 RMB, a decrease of 32,000 RMB from the third quarter's average unit price of 127,000 RMB, but significantly lower than the market's expected 129,000 RMB. The decrease in unit price mainly came from the increased proportion of the low-priced small car T03 in the sales structure, as well as the time-limited discounts applied to all models in November.

In terms of sales structure, the proportion of the low-priced T03 model (49,900-69,900 RMB) in the sales structure increased significantly this quarter (from 19.5% in Q3 to 37.7% in Q4), coupled with the November across-the-board price discounts (reducing prices by 10,000-20,000 RMB), which significantly lowered the unit price in the fourth quarterb) Significant reduction in unit cost:

In the fourth quarter, the unit cost was 90,000 yuan, a decrease of 37,000 yuan compared to the previous quarter's 127,000 yuan, mainly due to the decrease in unit cost, leading to an improvement in gross profit margin this quarter.

In addition to the dilution of amortization expenses and purchase premiums brought by the increase in sales volume, as well as the decrease in lithium carbonate costs, Dolphin estimates that the significant reduction in unit cost this time is due to the technical cost reduction brought by Leapmotor's self-developed technology (under the Leap 3.0 architecture, Leapmotor's self-developed and self-manufactured components account for 70% of the vehicle cost, and Leapmotor's previous performance disclosures indicated that technical cost reduction could bring about a 15% cost reduction).

c) Unit gross profit turns positive:

Despite a decrease in average unit price by around 32,000 yuan, the savings of 37,000 yuan in unit cost resulted in an improvement in unit gross profit margin to 6.7% on a quarter-on-quarter basis, exceeding market expectations of 5%.

3) Price reductions for all 24 models have led to a slight recovery in sales volume, but first-quarter delivery volume and gross profit margin are expected to remain under pressure

Looking ahead to the first quarter of this year, the overall sales volume of new energy passenger vehicles has declined slightly, which also affected Leapmotor. In January and February, only 18,800 vehicles were delivered, and the market share dropped from its peak of 2% to 1.5% in February.

In early March, Leapmotor launched updates for all 24 models (with the C10 model delivered in January). The new models have seen significant price reductions compared to the old models, with the C01 model seeing a price reduction of 13,000 to 50,000 yuan.

At the same time, Leapmotor has also offered limited-time discounts for the 23 old models, reducing prices by 15,000 to 32,000 yuan. This is expected to slightly impact the first-quarter gross profit margin. However, the proportion of the lower-priced T03 model in the product mix has decreased, providing some buffer to the declining gross profit margin.

In March, with the impact of price reductions and the launch of 24 new models, delivery volume has started to recover, with weekly sales reaching 3,200 units. However, based on the current trend, it is expected that the delivery volume in March will be between 12,000 to 15,000 units, and the first-quarter delivery volume is estimated to be between 30,000 to 34,000 units, representing a decrease of 39% to 44% compared to the previous quarter3. The significant decrease in unit price results in revenue significantly lower than market expectations

In the fourth quarter, Leapmotor's total revenue was 5.28 billion, a decrease of 6.7% from the previous quarter, significantly lower than the market's expectation of 7.73 billion, mainly due to the unit price of vehicles being significantly lower than expected.

Leapmotor has always been plagued by issues related to cost-effectiveness and low brand value, coupled with a lack of expertise in internet marketing, leading to insufficient brand perception and making it difficult to increase vehicle prices. This quarter, due to the vehicle structure, prices dropped to a historical low of less than 100,000 RMB.

Although sales volume increased by 25% compared to the previous quarter, the significant decline in unit prices led to a 6.7% decrease in revenue this quarter, significantly lower than market expectations.

4. Operating expenses reach a new high

In terms of research and development, Leapmotor insists on self-research in all areas, with a previous focus on electrification, but intelligence continues to be catching up. In terms of sales, Leapmotor is more positioned as a manufacturing company, with manufacturing personnel accounting for 49% and sales only accounting for 14% (mainly due to the use of a dealer model).

This quarter, despite the increase in sales volume, the leverage effect of operating expenses was not realized, with the operating expense ratio increasing from 20% in the previous quarter to 27% this quarter.

1) Research and development expenses:

In research and development, Leapmotor insists on self-research in all areas, focusing on key areas such as the three-electric system (excluding battery cells), intelligent cockpit, intelligent driving hardware, and algorithms. In the fourth quarter, R&D expenses were 620 million, an increase of approximately 150 million from the previous quarter, reaching a historical high.

Leapmotor's R&D investment in the fourth quarter mainly focused on catching up in intelligence and developing new models. Leapmotor upgraded its LEAP 3.0 technology architecture (released in January 2024), with self-developed components accounting for 70% of the vehicle's total cost and a general architecture utilization rate of 88%, effectively reducing costs.

In terms of intelligence, Leapmotor has been striving to catch up, with the 2024 high-end models equipped with Orin X and Qualcomm 8295 dual high-end chips. The high-speed intelligent driving version based on high-precision maps will be launched in the first quarter of this year, and the urban NOA will be introduced in the second quarter.

Leapmotor also adheres to self-built factories. The Jinhua factory currently has a monthly capacity of 30,000 vehicles, and the Qiantang factory is also nearing completion, with a planned capacity of 400,000, which will be more than sufficient.

2) Sales expenses:

Leapmotor's sales expenses in the fourth quarter were 530 million, an increase of approximately 110 million from the previous quarter, with a sales expense ratio of 10%. The sales expenses this quarter were mainly used for increased marketing activitiesThe company has made changes in its sales strategy, no longer simply pursuing the expansion of stores (with 22 fewer stores in 23 compared to 22, totaling 560 stores), but focusing more on increasing the sales volume per store and adopting a survival of the fittest model for dealers.

However, the company's positioning has always been more towards a manufacturing-oriented company. Although Leapmotor's product strength is very cost-effective at the same price point, the previous low investment in marketing expenses has led to insufficient brand power for the company. At the same time, the company's strategy is to first penetrate the market and then upgrade the brand. It is much more challenging compared to Nio and Li Auto, who set the tone for themselves with high-priced cars before exploring lower prices.

The current strategy of the company is to enhance brand power by improving product strength and to gain survival space and time through a strategy of trading price for volume. However, the downside of this strategy is that it will make it difficult to further increase product prices in the medium to long term. To achieve brand upgrade, the company not only needs high product strength brought by R&D investment but also a dual effort on the marketing side. The increase in investment in R&D and sales sides is currently understandable by the market.

3) Operating Expenses:

This quarter's operating expenses were 250 million, slightly higher compared to the previous quarter. The operating expense ratio increased from 4% in the previous quarter to 5% in this quarter.

However, due to a 7% increase in operating expense ratio this quarter, which offset the incremental increase in gross profit margin, it resulted in operating losses and net profit remaining basically flat on a quarter-on-quarter basis.

VI. Establishment of Cash Safety Net, Incremental Contribution in the Medium to Long Term Lies in Overseas Expansion

Leapmotor's cash and cash equivalents (including restricted cash) in the fourth quarter were 19.4 billion, an increase of 7.76 billion compared to the second quarter's 11.6 billion, with net cash of 16.9 billion, mainly from Stellantis' subscription proceeds of 8.5 billion. The cooperation with Stellantis is the most direct way for Leapmotor to solve its cash flow shortage problem and build a safety net for its stock price.

With its self-developed capabilities across the board, Leapmotor has established a differentiated competitive advantage in the 100-200 thousand RMB price range, successfully reducing costs and gaining a foothold in the 100-200 thousand RMB price segment.

Currently, compared to competitors, Leapmotor's 24 high-end intelligent driving version (priced at over 150,000 RMB) is equipped with the Qualcomm 8295 chip and the NVIDIA ORIN X dual high-end chip, with 254 Tops computing power. In terms of intelligent hardware, it also has more than 30 sensors including LiDAR, an 8-megapixel high-definition camera, etc., making it very cost-effective compared to models in the same price rangeAt the same time, a new model C16 will be launched this year, equipped with an 800V high voltage, 2.4c fast charging platform, with an expected selling price of 170,000 to 190,000 yuan.

However, from the current valuation perspective, the current stock price corresponds to a P/S ratio of 1.2-1.5 times in 2024 (based on the current sales trend estimated at 200,000 to 250,000 units in 2024). Although the cash flow and stock price safety cushion have been established, the valuation compared to WeSmallLi is not considered cheap anymore. This valuation already includes some overseas sales volume and profit expectations.

Leapmotor's biggest issue currently lies in the lack of brand awareness, and the 100,000 to 200,000 yuan price range is dominated by BYD's extreme scale cost effect. It is difficult for the individual vehicle price to continue to rise, leading to limited room for further increase in gross profit margin (this year's gross profit margin target is 5%-10%). It can only be achieved through the scale effect on the sales side and continuous cost reduction on the R&D side.

From the sales perspective, Dolphin believes that the 100,000 to 200,000 yuan range is a penetration rate gap for passenger cars (with a penetration rate of about 30%), and passenger car sales account for the highest proportion (almost half of passenger car sales). Leapmotor has also gained a foothold through differentiation advantages and cost-effectiveness. Dolphin predicts that Leapmotor's sales will continue to increase this year, with domestic sales reaching approximately 180,000 to 220,000 units.

However, in the medium to long term, Leapmotor's greatest room for growth comes from overseas markets. Leapmotor has the advantage of brand and channel brought by Stellantis, but the impact in 2024 is limited (Leapmotor is expected to contribute only about 20,000 units overseas). Starting from 2025, it will contribute meaningful sales and profit increments. Leapmotor is expected to achieve overseas sales of 86,000 units in 2025 and 182,000 units in 2026. In 2025, Dolphin estimates that cooperation will contribute approximately 600-700 million yuan in net profit to Leapmotor (of which 470 million yuan is licensing fees, and 230-330 million yuan comes from Leapmotor's sales of vehicles and parts to the joint venture company), accelerating Leapmotor's net profit turning positiveOn August 25, 2023, "Leapmotor: Gross Margin Continues to Fail to Turn Positive, When Will Xiaomi Lead the Car Circle?"

On September 29, 2022, "Leapmotor: After a 30% Crazy Decline in Listing, Is the 'Redmi Version of XPeng' Harvesting Leeks or a Real Opportunity?"

Risk disclosure and statement of this article: Dolphin Investment Research Disclaimer and General Disclosure