Why Is Li Auto Stock Dropping?

On a single trading day last month, shares of Chinese automaker Li Auto (NASDAQ:LI) shed 10 percent of their value.

What had been a stellar year by Li Auto was suddenly upended by the share price slide. But what caused the stock to fall so sharply and will it bounce back?

What Is Going on With Li Auto?

Despite its sudden drop, Li Auto’s recent financial performance has actually been quite positive.

In its Q2 earnings report, the company detailed a 230 percent increase in vehicle sales to $3.86 billion. Vehicle margin, meanwhile, was a healthy 21 percent.

Net income was impressive, climbing to $318.6 million, and free cash flow rose to $1.3 billion.

Li Auto is a young automotive company, just 8 years old, and yet in a phase of rapid growth thanks to a warm reception from the Chinese luxury vehicle market. Its signature SUV, the L7, is an extended-range hybrid with a maximum range of up to 817 miles.

By next year, the company aims to outsell Western brands such as BMW and Mercedes in China. To meet this goal, Li is working toward a monthly delivery capacity of 40,000 vehicles by the end of this year.

This augmented production volumes will also help as Li Auto to extend its range of vehicles. By 2025, the company plans to offer 11 different vehicle models. Its 2025 plan also includes the construction of some 3,000 charging stations, up from just 300 today.

Why Is Li Auto Stock Dropping?

The primary cause for Li Auto’s share price decline is the emergence of a new competitor in the Chinese EV marketplace.

Smartphone and electronics manufacturer Huawei recently announced that it was teaming up with state-owned automaker Chery Auto to make its own entry into the EV space.

The two companies plan to roll out an EV sedan called the Luxeed S7, which will serve as a direct competitor to the popular Tesla Model S.

The prospect of competing with Huawei could put pressure on other Chinese automakers, including BYD, NIO and Li Auto.

With Huawei’s resources and Chery Automotive’s existing vehicle manufacturing infrastructure, the Luxeed brand could make a rapid and dramatic entrance into the Chinese market.

These same factors could also help the brand compete on pricing, potentially pressuring other Chinese automobile majors.

Will Li Auto Recover?

Before examining Li Auto’s chances for recovery, it’s first important to put the recent price drop in proper context. While the stock is down 17.2 percent in the last month, it has still increased by 71.9 percent YTD.

Although recent concerns around increased competition have driven the stock off of its highs, investor sentiment about Li Auto’s prospects is still much higher than it was at the beginning of the year.

Examining Li Auto’s current pricing, it’s possible that the stock is currently undervalued. Although its forward P/E ratio of 38.3 is fairly high, the company’s earnings are expected to nearly double over the course of the coming year.

Li also trades at 5.3 times sales, which is a fairly low multiple for a company with such high growth potential. For reference, the much more mature Tesla trades at 85.4 times forward earnings and 9.8 times sales.

While Tesla’s premium reflects its dominance in the EV market, Li Auto’s current price may not adequately reflect the company’s potential for future growth.

Glimmer of Hope for Li Auto

It’s worth noting that the new Huawei-backed Luxeed brand may not compete directly with Li Auto at first. As the S7 is a sedan designed to compete with Tesla’s Model S, Luxeed’s first vehicle will likely have limited appeal to SUV buyers.

Li Auto already controls a 20 percent share of the Chinese SUV market, and this early advantage could give the company an effective moat that new brands like Luxeed may find difficult to breach.

A final point that’s worth considering is the fact that the Chinese EV market is growing quickly enough to support the growth of several competing companies.

Between now and 2028, the market for electric vehicles in China is expected to more than double from $260.8 billion to $575.6 billion. This represents a compounded annual growth rate of about 17.2 percent.

In such a rapidly expanding market, the introduction of one more major competitor may not appreciably affect a company like Li Auto that has already found significant popularity within a market niche.

Taking all of these factors into consideration, it seems very likely that Li Auto’s drop in value is not fully justified by the news of potential competition from Huawei.

While increased competitive pressures could put some downward pressure on Li’s long-term performance, it seems unlikely that the company is fundamentally worth 17 percent less than it was at the same time last month as a result.

What Is the Future Prediction for Li Auto?

Over the next 5 years, analysts expect Li Auto’s earnings to increase at a compounded rate of over 75 percent. This rapid growth corresponds with both the expansion of the company’s production capacity and the gradual growth of its product line.

It’s also important to consider Li Auto’s ability to fund this projected growth. The company currently has an attractively low debt-to-equity ratio of just 0.03.

As of the end of Q2, it also held $10.2 billion in cash, cash equivalents and short-term investments. As such, Li Auto’s balance sheet appears to give it ample room to fund further research, development and production investments without resorting to excessive borrowing.

What Is the Target Price for Li Auto?

Over the next 12 months, analysts predict a median target price of $52.91 for Li Auto shares. Against the most recent price of $34.98, this would give Li Auto a potential upside of 51.2 percent.

Even more positive for investors is the fact that the lowest standing target for Li Auto is $48, suggesting that the stock could have significant upside in even a bearish case.

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