BYD is our top pick for an exposure in China’s NEV market
BYD Company (HKEX: 1211) is best known as China’s leading New Electric Vehicle (NEV) manufacturer. It primarily produces all-electric vehicles and hybrid-electric vehicles, as well as electric commercial vehicles (NECV) like heavy-duty trucks, battery-electric buses, electric forklifts and energy storage facilities. It is also third largest NEV battery manufacturer in the world, behind Contemporary Amperex Technology (CATL) and Panasonic (Chart 1).
Chart 1: BYD is also the world’s 3rd largest NEV battery manufacturer.
Unlike other NEV manufacturers like Tesla (NASDAQ: TSLA), BYD is the only automaker in the world with its own integrated NEV battery R&D and production business units. Such vertical integration of its battery and NEV manufacturing capabilities grant BYD a strong competitive edge against other automakers, especially its domestic peers, which have largely lagged behind in the NEV trend.
While auto sales posted its first annual decline in China in 2018 after nearly two decades, sales of NEV has been growing steadily in the past few years, thanks to the strong regulatory support rendered by the Chinese government. Sales of electric vehicles passed 1 million last year, which is three times more than that in 2015, making China the single biggest market for electric vehicles in the world. We believe BYD is well-positioned as a main beneficiary of the sustained growth potential in China’s NEV market, as China advances its NEV ambitions (NEV is one of ten high-tech sectors outlined in ‘Made in China 2025’).
Booming NEV market as China advances its NEV ambitions
Sales of New Energy Vehicle (NEV) has been growing steadily within the last few years, even as sales of traditional fossil fuel vehicles fell in the first time in two decades. NEV sales grew at a CAGR of 96.7% in the last four years and now accounts for about 5% of all auto sales (Chart 1). This is mainly due to the strong push toward NEV adoption by China government, via a series of supportive policies, ranging from NEV subsidies to restrictions on availability of fuel vehicle license plates in major cities.
Chart 2: Sales of NEV in China have been accelerated quickly over the last five years.
To support the NEV adoption, China has quickly expanded its NEV-charging infrastructure, reaching over 219,000 public NEV-charging outlet in 2017, more than double that of prior year. Along with private operators, China aims to install a total of 4.8 million charging points nationwide by 2020. Starting this year, China has also implemented a new emission tax credit scheme, which mandates that NEV has to account at least 10% of total sales (in China) for all automakers. Any automakers who could not meet the requirements would have to purchase credits from fellow peers, or face harsh penalties from the regulators
China has plenty of good reasons to establish its position as the global production powerhouse for NEV. To the Chinese leaders, any short-term costs for the push towards NEV are worth the expected long-term gains: cleaner air, reduced reliance on imported oil and the opportunity to lead globally in a novel technology. In addition, the auto industry is one significant contributor to China’s GDP and plays an important role in jolting its consumption-driven economy back on the growth track.
Despite the robust growth in recent years, NEVs still make up less than 3% of all vehicles on China’s roads. This means that NEV industry has ample of room for growth, especially as China target to increase the output of NEVs to 2 million by 2020, and expect 25 per cent of all vehicles sold in 2025 to be NEV. Given the ongoing improvements in technology and growing popularity of NEVs in China, we expect NEV sales to continue ascending moving forward.
Commercial and public transport system the next frontier for China’s NEV drive
Besides electric passenger cars, China’s NEV push has extended into electric taxis, buses and other commercial vehicles. Taking cues from the central government, most provinces and major cities are adopting policies to convert their public transport fleets to NEVs. This comes as China acts to cut down on harmful CO2 emission and air pollution in its cities, amidst a worsening nationwide chronic respiratory health crisis.
Starting with buses and taxis, local governments have pledged targets to convert majority of fleets to fully or partly electric by 2022 (Table 1). Shenzhen, the city where BYD is headquartered, has mandated that all buses and taxis in operation be electric by 2020 – a target they achieved earlier this month. Following close behind is the city of Shanghai, where the conversion to NEV extend beyond buses and taxis to other commercial vehicles like mail delivery vans and cleaning trucks.
Table 1: Major cities and provinces have pledged to commit to the NEV push
With such concerted drive towards NEV, local automakers like Geely (HKEX: 175), BAIC (HKEX: 1958) and BYD have much to benefit. Priced more affordably and more utilitarian in nature, NEV produced by these domestic players are top options sought after by local fleet operators, in contrast to foreign NEV makers like Tesla whose products are positioned towards the luxury end. BYD is one prime example, where it supplied 80% of the 16,200 e-buses and all 19,000 e-taxis currently operating in Shenzhen.
NECV (New Energy Commercial Vehicles) is starting to emerge as a sizable segment to generate revenue streams and opportunities for NEV makers. Monthly sales volume of NECV has registered an upward trajectory across 2018, rising by an average of 40% month-on-month (Chart 3). We expect to not only see an increase in sales of E-Buses and E-taxis, but also the expansion across NECV categories like industrial and public utility vehicles. BYD has even ventured into monorail mass transit system through its SkyRail projects.
Chart 3: Sales NECV is growing quickly across 2018 and is emerging as a revenue boost to NEV makers.
Vertical integration of NEV and battery value chain is BYD’s strongest competitive edge
Vertical integration of its NEV business through internal battery sourcing is a strong competitive moat for BYD. The NEV battery industry is fast consolidating in China, with the top ten players accounting for 83% of last year’s sales, up 9% from 2017 (Chart 4). The rising concentration in tier-one battery supplier could shift pricing power towards the battery-makers, and exert considerable margin pressure on NEV makers, since the battery is the single most expensive component of any NEV.
Chart 4: BYD and CATL cornered the NEV battery segment of the industry chain
As the second largest producer of NEV battery in China, BYD has the capability to develop critical auto parts such as NEV batteries and electric drivetrains required in the production of its NEV. This not only minimise a key supplier risk for its NEV business, but also ensures that its NEV will always have priority access to the latest battery technology, especially as NEV batteries are still in their early innovation phase of the technology life cycle.
With the accelerating demand in NEV, demand for NEV batteries are projected to grow rapidly in the next few years. To capitalise on the secular growth trend, BYD has plans to double its NEV batteries production capacity from 16 Gwh in 2017 to 40 Gwh in 2019E. We expect the NEV battery segment to emerge as a significant revenue stream, as BYD start to sell its NEV batteries to its first external customers this year. BYD has also expressed intention to spin-off its NEV battery business by 2022.
New product cycle with redesigned NEV models to boost near-term sales
At the same time, BYD is also China’s second largest NEV manufacturer, accounting for 19.5% market shares in China NEV market. Into 2019, we believe BYD is entering a highly competitive model cycle, thanks to its better design and engineering of powertrain technology by the ex-Audi and Daimler team BYD hired back in 2016. The new model pipelines launched in second half of 2018, which includes Tang (唐), Song (宋), Yuan (元) SUVs and Qin (秦)-pro sedan, has since recorded significant sales volume growth (Chart 5).
Redesigned with the “DragonFace” appearance, the new NEV models were well-received by Chinese consumers and ranked among the top 20 best-selling NEVs in China. The surge in popularity of BYD’s NEV was also partially driven by improvement in its driving range, spurred on by a mid-2018 policy update to China’s NEV subsidies. The updated subsidies scheme grants higher subsidies for NEV with longer driving ranges and better energy densities.
Powered by BYD’s in-house battery technology, its new EVs were able to meet higher requirements set by regulators. It enables BYD to take advantage of the greater subsidies, which provides BYD wiggle room to adjust its pricing strategies. We believe this is another testament of the competitive edge of BYD’s unique vertical battery integration.
Chart 5: Sales of BYD’s New NEV models accelerated after Mid-2018 refresh
BYD to retain dominance as low technology NEV makers are pushed out of the industry
As the NEV industry booms, China’s policies are getting more selective and nuanced in nature. It has started to rein in some of the generous subsidies it previously lavished onto NEV makers, rewarding only those with strong technological innovations. The mid-2018 update to China’s NEV subsidy program not only granted higher subsidies to electric vehicles that can travel longer ranges, it significantly reduced subsidies to those automakers with low-efficiency NEV (Table 2).
Table 2: China refined its NEV subsidies scheme, favouring only those with high-performance NEV technology
BYD, having benefitted greatly from the lenient subsidies schemes in the past, are among the few domestic automakers that have built capabilities to produce those high-efficiency NEV. As a result, BYD’s new NEV fall comfortably within the favourable driving range of 400 km and battery energy density 140-160 Wh/kg, taking full advantage of the updated policy. This will likely boost profitability of BYD’s NEV business as it receive higher subsidies for the new NEV models moving forward.
In addition to the updated subsidies scheme, China is also tightening rules to prevent overheating of NEV industry, culling majority of the smaller NEV players in the process. The new legislation requires all NEV makers to have a minimum annual capacity of 100,000 units, effectively erecting a high barrier to deter NEV start-ups from entering the market. This is great news for the top NEV makers like BYD, enabling them to retain their dominance and avoid further margin pressures that may arise from unhealthy price wars.
At the same time, BYD is also one of the biggest beneficiary of the dual-credit emission policy starting this year, considering the level of credit surplus. The new policy, which mandates that NEV has to account at least 10% of total sales for all automakers in China, will dent profitability of peers who lagged behind on the NEV trend. BYD will also be able to generate a one-off gain this year as it sell off the excess earned NEV credits to less-productive rivals who are obligated to purchase them.
Investment Risks
Fair Valuation
Our fair valuation for BYD Company (HKEX: 1211) is HKD 58.0, based on a Sum-Of-The-Parts (SOTP) analysis (Table 3), given that it has multiple business operations in different subsectors.
This represents an upside potential of 28.4%, from the closing price of HKD 45.15 on 30-Jan-19. The fair value also implies a 2019E P/E ratio of 32.5X for BYD Co.
Our SOTP calculation includes a PS multiple of 2.1X for the NEV business, consistent with other pure-play NEV makers, considering that BYD has the one of the highest revenue contribution percentage from NEV in China.
Other key assumptions include:
The respective multiples (i.e. P/S, P/E and P/B) used in our SOTP calculations are based on industry peers’ average, which we have carefully selected and are detailed in Table 4. More than 70% of the fair valuation is accounted for by the NEV business, where we believe is the key driver to BYD’s promising growth potential (Chart 6).
Table 3: BYD’s fair valuation by Sum-Of-The-Parts
Chart 6: Waterfall chart of BYD’s fair valuation by SOTP. NEV forms the bulk of BYD’s fair valuation
Table 4: Industry peers comparison for the respective business segments
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