Leapmotor (9863.HK) released its second-quarter financial report for 2024 after the Hong Kong stock market closed on May 17th. Here are the key points:

1. Both gross margin and revenue in the second quarter were lower than expected, with the issue lying in unit price: Compared to the previous quarter, the unit price in this quarter continued to decline by 0.4 thousand yuan. Dolphin believes that this is mainly due to the increased proportion of the lower-priced C10 pure electric version and the impact of price reductions on 24 models compared to the old models, leading to a decline in the price of each vehicle.

2. Operating expenses hit a new high, with a significant increase in R&D expenses: Operating expenses hit a new high this quarter, all exceeding market expectations. Specifically, the expense that exceeded expectations the most was R&D expenses, mainly due to increased investment in intelligent driving. Leapmotor has started the research and development of an end-to-end large-scale intelligent driving system, increasing manpower, computing power, and equipment investment in this direction.

3. Operating profit declined compared to the previous quarter, below market expectations: This quarter, due to the continued decline in unit price on the gross margin side not meeting expectations, and on the operating expenses side, with R&D expenses hitting a new high, operating profit continued to decline compared to the previous quarter to -1.3 billion this quarter, significantly below the market expectation of -0.8 billion.

4. Positive outlook: Leapmotor expects a significant increase in sales volume in the third quarter compared to the second quarter, and anticipates a better performance in gross margin in the second half of the year.

Looking at the second-quarter performance, Leapmotor did not deliver a satisfactory answer to investors. Both revenue and gross margin were below market expectations, with the core reason for underperformance being the unit price of the cars.

The market expected the gross margin to rebound to 5.5% this quarter due to improvements in the vehicle structure: the proportion of T03 small cars decreased (from 28% in the first quarter to 25.4%), while the high-priced and high-margin C16 was launched and delivered in June, increasing its proportion by 1.7%. Additionally, the decrease in manufacturing costs due to the increase in sales volume will drive the overall gross margin up. However, the unit price in the second quarter continued to decline compared to the first quarter. Dolphin believes there are two main reasons for this:

1) 24 models were launched in March, with prices slightly lower than the old models. The price reductions in March only partially reflected in the first quarter, but in the second quarter, the impact of price reductions was fully realized.

2) The proportion of the lower-priced mid-size SUV C10 in the vehicle structure increased, especially the pure electric version of C10, which saw the fastest increase in sales volume in the second quarter. The price of the electric version is lower than the extended-range version, dragging down the unit price.

Due to the continued decline in unit price, although sales volume increased in the second quarter and manufacturing costs decreased, the gross margin of the automotive business still fell below expectations.

Looking at the core operating profit, this quarter's operating profit was also significantly below expectations. On one hand, this was due to the underperformance of the gross margin, and on the other hand, due to the operating expenses hitting a new high in the second quarter: all three expenses exceeded market expectations. The R&D expenses, which saw the largest increase, were mainly due to the company's increased investment in intelligent driving. Leapmotor has started the research and development of an end-to-end large-scale intelligent driving system, increasing manpower, computing power, and equipment investment in this direction Fortunately, the company's guidance for the third quarter shows a significant increase in sales compared to the second quarter, and it is expected that the gross profit margin will perform better in the second half of the year.

Currently, the stock price corresponds to a P/S multiple of 1.2-1.4 for 24 years, which is a decrease from the P/S multiple of 1.8-2 in the first quarter. Although the performance this quarter is below expectations and the stock price is expected to adjust, the anticipated improvement in gross profit margin and sales in the second half of the year indicates that the valuation remains relatively reasonable for the year as a whole.

Dolphin believes that the long-term upside potential of Leapmotor's stock price lies in the incremental contribution from overseas markets. Currently, due to the positioning of its models (mainly priced in the 100,000-200,000 RMB range), Leapmotor's pricing power is still dominated by BYD. Leapmotor can only adopt a follow-up strategy in terms of pricing. There may be a ceiling for domestic sales and gross profit margin improvement (as seen in the second quarter, the launch of BYD's Honor version + DMI 5.0 models did impact the sales of Leapmotor's extended-range models).

Leapmotor's main competitive advantage lies in its collaboration with Stellantis. Not only can it leverage Stellantis' existing sales channels, but also in the high policy risks and tariffs in the U.S./European markets, Stellantis has high brand recognition. Leapmotor can flexibly sell through SKD mode and utilize Stellantis' existing overseas factories for production and assembly, reducing trade barrier risks.

The models the company is currently developing are focused on B-class cars (between T03 and C-class cars), and the European market prefers smaller cars. Dolphin believes that B-class cars are the main models developed for overseas markets, and Leapmotor is expected to make a significant contribution to sales in 2025 through overseas markets (expected sales of 60,000-100,000 units).

Here is a detailed analysis:

I. Second quarter gross profit margin lower than expected, issue lies in unit price

The most concerning aspect of Leapmotor's performance this time is the gross profit margin. After coming out of the first quarter's bottom in car sales in the second quarter, and with Leapmotor's guidance on the second quarter gross profit margin in the conference call showing a quarter-on-quarter increase, the market was generally optimistic about Leapmotor's second quarter gross profit margin. However, Leapmotor's actual gross profit margin in the second quarter was only 2.8%, lower than the market's expected 5.5%, and the issue lies in the unit price.

2) Unit price continues to decline on a quarter-on-quarter basis!

a) Average unit price is only 100,000 RMB, down 0.4 RMB from the previous quarter

In the second quarter, the average unit price was only 100,000 RMB, lower than the market's expected 111,000 RMB. The market originally believed that due to the improvement in the model structure: the proportion of T03 small cars decreased (from 28% in the first quarter to 25.4%), and the high-priced, high-gross-profit C16 was delivered in June, increasing by 1.7%, which would drive the increase in unit price. However, the results show that the unit price in the second quarter continued to decline compared to the first quarter. Dolphin believes there are two reasons for this:

1) 24 models will be launched in March, with prices slightly lower compared to the old models. The price reduction in March only partially reflects the impact in the first quarter, but the impact of the price reduction will be fully reflected in the second quarter. The high-priced and high-gross-margin C16, which started delivery in June, will not contribute much to the second quarter, and the improvement in unit price is expected to be reflected in the second half of the year.

2) In the vehicle structure, the lower-priced mid-size SUV C10 has increased its proportion. Especially in the second quarter, the pure electric version of C10, which saw the fastest increase in sales volume, has a lower price compared to the extended-range version, dragging down the unit price.

b) The rebound in sales volume is driving down unit manufacturing costs:

In the second quarter, the unit cost was 98,000 yuan, down 8,000 yuan from the previous quarter's 106,000 yuan.

The decline in manufacturing costs in the second quarter is partly due to the rebound in sales volume from the low point in the first quarter, with a 59% increase in sales volume in the second quarter. The improvement in production capacity utilization has led to a decrease in unit manufacturing costs. Additionally, the increase in the proportion of the lower-priced and lower manufacturing cost C10 in the vehicle structure has driven down unit manufacturing costs.

c) Although the gross profit margin has turned positive, it is below expectations:

The average unit price decreased by about 4,000 yuan, while the unit cost decreased by about 8,000 yuan, resulting in the unit gross profit margin turning positive this quarter, but still below the market's expected 5.5%.

II. Sales volume increased by about 59% in the second quarter, with the sales volume of pure electric models increasing faster than the extended-range versions.

In the second quarter of this year, due to the impact of price reductions on old Leapmotor models and the introduction of 24 new models at lower prices, deliveries have rebounded from the low point in the first quarter. In the second quarter, a total of 53,000 vehicles were sold, a 59.5% increase in sales volume compared to the previous quarter.

Looking at the sales volume of different vehicle categories, an interesting phenomenon is observed in the sales volume rebound of Leapmotor: the sales volume of pure electric versions has generally increased faster than the extended-range versions. Excluding the high-volume low-priced T03, the sales volume of the extended-range version only increased by 26%.

The proportion in the vehicle structure decreased by 10% to 31% this quarter, while the sales volume of pure electric versions increased by 93%, increasing their proportion in the vehicle structure to 69%.

The reasons for this phenomenon may include:

1) Leapmotor's main price range is between 100,000 and 200,000 yuan. In February of this year, it faced the impact of BYD's "price butcher". Starting in February, BYD's Honor Edition was launched, shifting the main price range of plug-in hybrids from 100,000 to 200,000 yuan down to 50,000 to 150,000 yuan

BYD took advantage of its leading DMI 5.0 technology in May to start its product cycle, achieving the ultimate in range and fuel consumption to seize a share of the hybrid market in this price range.

While Leapmotor in this price range can also reduce manufacturing costs through self-developed (three core electrical components are basically self-supplied (except for battery cells), with self-developed and self-produced parts accounting for 60% of BOM) + high degree of commonality in vehicle architecture (up to 99%), it still lacks advantages in terms of cost and new generation technology compared to BYD: for example, Leapmotor's C10 range extender has the same starting price as BYD's DMI 5.0-equipped model Song L, but it falls short of Song L in terms of vehicle size/fuel consumption/comprehensive range. The market share of Leapmotor's range extender has been impacted by competition from BYD, dropping from a peak of 1.9% in November 2023 to 1% in June 2024.

2) The smallest price difference between Leapmotor's range extender and pure electric versions, with the pure electric C10 version even having a lower starting price than the range extender version, driving the market share of pure electric vehicles up:

Compared to the pure electric and range extender versions of vehicles launched by companies in this price range, due to the larger battery capacity and higher battery cost, the price difference between plug-in hybrid and pure electric versions is around 10,000-40,000 RMB. In contrast, the starting price difference between Leapmotor's range extender and pure electric versions is only 3,000-6,000 RMB, with the pure electric version of C10 even having a lower starting price than the range extender version. The pure electric price is more competitive compared to competing models, creating a competitive advantage.

In terms of sales rebound, the fastest-growing model in the second quarter was the Leapmotor C10 pure electric, with a 162% increase in sales quarter-on-quarter, driving the overall market share of pure electric vehicles from a low of 1.7% in February to 2.7% in June. However, the lower unit price of the C10 pure electric version also dragged down the average vehicle price for the quarter.

III. Revenue lower than market expectations

Leapmotor's total revenue in the second quarter was 5.36 billion RMB, a 54% increase quarter-on-quarter, but lower than the market's expected 5.94 billion RMB, mainly due to the continued decline in average vehicle prices this quarter, falling below market expectations.

IV. Operating expenses at an all-time high, with a significant increase in R&D expenses

In terms of research and development, Leapmotor insists on self-development across the board. Previously, self-development focused more on electrification, but in 2024, the focus of research and development shifted to new vehicle models and intelligent development. 24 new models were launched with intelligent driving capabilities successfully brought down to the 150,000-200,000 RMB price range. In terms of sales, Leapmotor's positioning still leans towards a manufacturing-oriented company and mainly uses dealerships, so the proportion of manufacturing personnel is the largest, while sales personnel have actually decreased compared to the end of 2023

1) R&D Expenses:

In terms of research and development, Leapmotor insists on full-domain independent research and development. The company independently develops all key software and hardware components of intelligent electric vehicles, with the company's core components and some controllers being self-produced. The vertical integration capability of the supply chain is strong, with self-researched and self-manufactured parts accounting for about 60% of the BOM.

Currently, the vehicle architecture universalization rate based on the LEAP 3.0 architecture has reached 88%. With universalized products, the development cycle of the company's C-platform models is expected to be shortened by 25%, and development costs are expected to be reduced by 40%, resulting in significant cost reduction and efficiency improvement.

In terms of the number of employees, Leapmotor's R&D team has seen the largest growth among all departments, increasing by 31% compared to the end of 2023, reaching over 3800 employees.

This year, Leapmotor's R&D focus is mainly on intelligent development. Leapmotor is implementing the development of an "end-to-end large-scale model" intelligent driving system and will continue to increase investment in manpower, computing power, and equipment in this direction. This move is mainly seen as a response to the upcoming competition from XPeng's MONA intelligent driving system, which is expected to enter the 150,000 yuan price range.

Currently, Leapmotor's intelligent driving version has reached the 160,000 yuan price range (24 models of C10/C11/C16 high-end intelligent driving versions equipped with Qualcomm 8295 chip and NVIDIA ORIN X dual high-end chips, with 254 Tops computing power, as well as more than 30 sensors including LiDAR, 8 million pixel high-definition cameras, etc.). Compared to models in the same price range, the use of intelligent driving technology creates differentiation and competitive advantage.

Leapmotor's increased investment in intelligence this year is also aimed at strengthening this competitive edge. Leapmotor plans to launch higher-level intelligent driving capabilities and further functional optimizations in the second half of 2024, including open road point-to-point commuting capabilities and parking memory parking, and plans to launch urban intelligent driving functions (CNAP) based on end-to-end intelligent driving models by 2025. R&D expenses are expected to continue to increase this year.

2) Sales Expenses:

Leapmotor's sales expenses in the second quarter were 470 million, higher than the market's expected 380 million.

The higher sales expenses this quarter are mainly due to the delivery of 24 models, with increased advertising and promotional efforts. However, compared to other new forces, sales expenses are still relatively low, and the positioning is more towards a manufacturing-oriented company.

Leapmotor's plan for this year is to increase the total number of channels from 560 at the end of last year to 800 this year. As of July, Leapmotor already has 665 stores in China and is expected to continue to increase sales in the second half of this year.

3) Administrative Expenses:

Administrative expenses this quarter were 300 million, an increase of 160 million compared to the previous quarter. On the one hand, this increase is due to the increase in option expenses this quarter, which increased by 40 million compared to the previous quarter's 76 million. On the other hand, this increase is also due to the increase in the number of administrative personnel.

In this quarter, due to the high increase in R&D expenses driving operating expenses to a new high, and the gross profit margin falling below expectations, although sales have increased, the operating profit is only -1.3 billion, a decrease compared to the previous quarter, significantly lower than the market's expected -0.8 billion. The net profit is -1.2 billion, also lower than the market's expected -0.9 billion.

V. Leapmotor expects sales and gross profit margin to continue to rise in the second half of 2024

After discussing the points where Leapmotor fell short of expectations in this financial report, fortunately, the company provided guidance that sales in the third quarter have significantly increased compared to the second quarter, and the gross profit margin is expected to perform better in the second half of the year. The Dolphin believes that Leapmotor's sales and gross profit margin will continue to rise in the second half of the year, with the main positive factors being:

1) In terms of vehicle positioning, the 800V+ intelligent driving models are priced between 150,000 to 200,000 yuan, forming a competitive advantage compared to competing models.

The higher-priced and higher-margin mid-to-large SUV C16 in Leapmotor's lineup started deliveries in June, with C16 being the first in the industry to bring 800V technology down to the 160,000 yuan price range. Positioned as a 6-seater family SUV, it creates a differentiated competitive edge.

Additionally, 24 models have added intelligent driving versions, equipped with the NVIDIA Orin X chip (with 254 TOPS computing power) + 1 LiDAR, with the starting price of the intelligent driving version being as low as 165,800 yuan (C10 extended range version), making it the lowest-priced model with similar intelligent driving hardware configuration. This creates a differentiated competitive edge against competing models.

The Dolphin predicts that plug-in hybrid models priced between 100,000 to 150,000 yuan are expected to have the fastest sales growth this year, while pure electric models priced between 150,000 to 200,000 yuan still have penetration opportunities. Leapmotor is also expected to benefit from this trend (but it is important to note the competition from XPeng's Mona model, which also brings intelligent driving down to the 150,000 yuan level).

2) Improvement in vehicle structure + contribution from overseas markets

The C16, which is positioned in the price segment with the highest margin in Leapmotor's vehicle lineup, started deliveries in June, with minimal impact on the vehicle structure in the first half of the year. Significant impact is expected in the second half of the year. Among the new orders in July, over 10,000 orders came from the C16 (with cumulative orders exceeding 10,000 units in the first month of launch). It is expected that the stable sales volume of C16 will reach 5,000 to 6,000 units, driving the recovery of the gross profit margin.

As for the overseas market, due to only contributing for one quarter this year, Leapmotor expects overseas sales to reach 6,000 to 10,000 units this year. The main models for overseas markets in 2024 are T03 and C10, with higher pricing (but Leapmotor currently mainly supports Leapmotor International with cost-based pricing, with the majority of profits staying in Leapmotor International, so the impact on the gross profit margin is currently minimal, mainly reflected in Leapmotor's investment income). The significant growth in sales volume in the overseas market will be seen in 2025, with an estimated contribution of 60,000 to 100,000 units from overseas models in 2025.

3) Further upgrade of the trade-in subsidy

The trade-in subsidy amount has been increased, with the subsidy for purchasing new energy vehicles after scrapping old vehicles raised from 10,000 yuan to 20,000 yuan. The scrapped vehicles are approximately 13 years old, and users of scrapped vehicles are more price-sensitive, tending to prefer models with lower subsidized prices, further benefiting new energy vehicle companies positioned in the 100,000 to 200,000 yuan range (such as Leapmotor)

4) The new round of cost reduction cycle is expected to be reflected in the second half of the year:

In the fourth quarter of last year, despite the decline in unit prices, Leapmotor's gross profit margin reached a historical high (6.7%). This was mainly due to the results of the previous cost reduction cycle being reflected in the fourth quarter of last year. The current round of cost reduction cycle is expected to replicate the trend of the fourth quarter of last year and will be reflected in the second half of 2024.

Specific sales volume and gross margin guidance will be disclosed in the 2Q earnings conference. Please pay attention to the summary of Leapmotor's conference call that Dolphin will release.

VI. Leapmotor's medium to long-term stock price upside still lies in the incremental contribution from going global

Leapmotor's cash and cash equivalents (including restricted cash) in the second quarter were 16.5 billion, a decrease of around 1 billion compared to the first quarter of this year. However, operating cash flow turned positive this quarter, increasing by 2.6 billion compared to the previous quarter. This is mainly expected to be due to the gross margin turning positive again, as well as an increase in operating advances to upstream suppliers due to increased sales volume. Currently, with the investment from Stellantis, Leapmotor's cash security remains relatively sufficient.

Leapmotor's sales target for 2024 is 250,000 to 300,000 vehicles, with a gross margin target of 5%-10%. Based on the current sales trend, achieving the sales target bottom of 250,000 vehicles implies an average monthly sales volume of around 28,000 vehicles for the next 5 months. However, as the overseas contribution is expected to be minimal this year (Leapmotor is expected to contribute only 6,000-10,000 vehicles to the 2024 sales volume), Dolphin conservatively estimates that the sales volume for 2024 will be between 220,000 and 250,000 vehicles.

The current stock price corresponds to a 2024 P/S multiple of 1.2-1.4 times, a slight pullback from the 1.8-2 times P/S multiple during the first quarter. Although this quarter's performance is below expectations, the stock price is expected to experience a slight pullback. However, in the second half of the year, gross margin and sales volume are expected to continue to improve. Overall, the valuation remains at a relatively reasonable level this year.

Dolphin believes that Leapmotor's medium to long-term stock price upside still lies in the incremental contribution from going global. Looking at Leapmotor's new car cycle, the two B-class cars to be launched in 2025, A12 and A03, are positioned between the T03 and C-class cars, designed mainly for overseas markets (especially Europe, where compact cars are more popular).

Compared to domestic car companies going global, Leapmotor has several advantages in cooperation with Stellantis:

1) Utilizing Stellantis' channels: Domestic car companies going global usually need to seek local distributors to sell products overseas, while the company can sell through Stellantis' own channels, eliminating the need for distribution partnerships and allowing for greater profit margins.

The company is expected to have 200 sales outlets at the end of 2024 at the overseas end, aiming to expand to 300-400 outlets by 2025, and increase to 500 outlets by the end of 2026.

2) Utilizing Stellantis' existing brand awareness to reduce trade barrier risks:

Stellantis has high brand awareness overseas, with a strong presence in Europe and North America (accounting for 80.7% of sales revenue in 2023), which are the two largest automobile markets globally outside of China. Currently, Chinese car companies face high tariffs when exporting to these markets (up to 100% to the U.S. and over 30% to Europe). Export by Chinese car companies is hindered, and it is expected that the export model will shift towards establishing overseas factories

Leapmotor can flexibly utilize 1) SKD model: Leapmotor sells components to Leapmotor International, which uses Stellantis' existing overseas factories for assembly production, 2) Utilize Stellantis' existing overseas factories for production and assembly; to achieve exports to Europe and the United States, significantly reducing export barriers compared to Chinese car companies, with obvious export advantages.

Therefore, Leapmotor expects that exports will contribute 60,000 to 100,000 units by 2025, with exports significantly contributing to sales volume. The "A12" mid-size SUV to be launched in 2025 should be the main contributor to sales and profits, more in line with the overseas market's demand for compact cars.