BYD Stock: Surprisingly Strong Q2 Earnings, But Challenging Outlook (OTCMKTS:BYDDY)

Investment thesis

We remain cautious on BYD, despite its continued revenue and profit growth in the second quarter and resilient margin. This is because industry conditions have deteriorated further recently, with total car sales declining year-on-year for the second consecutive year. months. The outpacing growth of EVs will not be sustained for long as EV penetration exceeded 50% in July. BYD’s high valuation of 21x 2024 PE has already embedded its industry lead and may face downward pressure once EV sales begin to slow.

Introduction

BYD (OTCPK:BYDDY) (OTCPK:BYDDF) is a Chinese electric vehicle manufacturer. As of 2023, the company has sold more than 3 million cars worldwide, surpassing Tesla as the world's largest EV manufacturer. The largest electric vehicle manufacturers by volume. The company also manufactures batteries, automotive components, automotive electronics and power semiconductors in-house, making it one of the largest lowest cost car Manufacturers in the world.

I started coverage of this action in April, which recognizes its clear leadership in China’s EV industry. However, I was cautious about its headwinds to its earnings due to price discounting, weak demand and overcapacity. Despite these challenges, BYD showed remarkable resilience in the performance of the first half of 2024.

Thanks to the launch of the fifth-generation, highly fuel-efficient DMI engine for plug-in hybrid vehicles (PHEVs), its PHEV sales grew by 40% year-on-year in the first half of 2024, a significant turnaround from the 9% year-on-year decline in the first two months before the model launch. This new product has enabled BYD to maintain its share in a highly competitive market.

Chart 1: BYD vehicle sales in the first half of 2024

Review of second quarter results

BYD reported strong second-quarter results, with revenue up 26% year-on-year and net profit up 30% year-on-year.

Chart 2: BYD Q2 Results Summary

The results are roughly consistent with Sell-side forecasts But it is much stronger than its EV peers, such as Li Auto. Even Tesla suffered a 20% year-over-year drop in sales in China in the second quarter.

Chart 3: Tesla's sales in China fell 20% year-over-year in the second quarter

Gross margin remained surprisingly stable, despite a Deep price reduction In March, the Honor Editions will be launched on the market. BYD's economy scale, lower battery costs and unique vertical integration model may help alleviate some of the pressure. Operating expenses also grew at a slower pace than revenue, thanks to the company's strict expense control.

The outlook remains challenging in the domestic market

While BYD outperformed its peers in the first half due to better cost control and superior products, it is unlikely to be immune to weak domestic demand and intense price competition forever.

Total auto sales declined year-on-year for two consecutive months in June and July, even though electric vehicle sales grew at a year-on-year rate of more than 30%. The divergence was due to foreign brands (mostly internal combustion engine vehicles) being Squeezed The Chinese market is in sharp decline due to tough price competition. In my opinion, if the price war is not stopped, BYD is unlikely to experience a sustained recovery of its margins.

BYD is on track to reach its 500,000-unit mark Foreign sales In 2024, the company reached 270,000 units in the first seven months. However, the overseas market, with a relatively high margin, accounted for only 14% of its total sales, so its positive impact on margin will be limited. In addition, as the EU imposed an additional 17% tariff on BYD, while the US and Canada applied a 100% tariff, the export business also faces increasing headwinds until BYD's overseas production base is up and running.

Valuation

BYD is currently trading at a 2024 P/E ratio of 21x, which seems a bit over the top for an automaker. Except for Tesla, most major automakers trade at single-digit P/E. We recognize that investors are willing to pay a premium for BYD because it is a pure-play EV company, which has shown higher growth compared to the broader auto market. However, as EV penetration exceeded 50% in July 2024, its faster-than-industry growth may not be sustainable for too long, in my view.

Chart 4: BYD valuation

Chart 5: BYD's valuation comparison with other car manufacturers

Risks

Risks to our call include the government rolling out further tax cuts and subsidies for EV buyers, which seems unlikely in the near term given China's ongoing negotiations with the EU over auto subsidies.

Cooperation between BYD and Huawei Advances in autonomous driving solutions are also encouraging, but the product will only be adopted in a high-end model, the Bao 8 hybrid SUV.

Conclusion

BYD delivered a strong second-quarter result, but it fell short of market expectations. Notably, its margin remains stable despite deep price discounts. Its 30% net profit growth has also outpaced its revenue, indicating positive operating leverage and tight expense control. The outlook remains challenging for both the EV industry and BYD, given weak consumption and sustained industry overcapacity. We therefore remain negative on the stock.

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