China/Hong Kong Market Pulse: Challenges and Opportunities in China’s Electric Vehicle Industry

Key Points

• The Chinese EV industry saw a slowdown in April
• The introduction of trade-in subsidies in late April might improve demand
• Plug-in or extended-range EVs outperformed pure battery EVs
• Li Auto’s Q1 Results Reflect Disastrous BEV Expansion Attempts and Market Challenges
• Volkswagen Partnership Adds Service Revenue for XPENG
• Europe likely to impose a 15%-30% tariff on Chinese EV Imports
• Potential opportunities in BYD, Li Auto, XPENG, Xiaomi and intelligent vehicle solution vendors

Modest Performance of the Chinese EV Industry in April

The electric vehicle (EV) industry has been a showpiece of China’s industrial innovation, manufacturing prowess, rapid growth, and the potential to penetrate overseas markets en masse. The stocks of Chinese EV makers have been popular among investors. However, last month, the once-rapid volume growth in the EV industry, particularly domestic sales, started to show signs of slowing. Data from the China Passenger Car Association (CPCA) showed that China’s passenger EV retail sales were 674k units in April 2024, representing a 28.3% Y/Y increase but a 5.7% M/M decline. This weakness might be attributed to consumers waiting for the well-anticipated rollout of trade-in subsidies, which finally arrived in late April. For the first four months of the year, passenger EV retail sales grew by 32.9% Y/Y to 2.45 million units.

On April 26, China’s Ministry of Commerce announced a trade-in scheme that will last through the rest of the year, providing a fixed subsidy of up to RMB 10,000 (approximately $1,500) to consumers who scrap vehicles that fall below China III emission standards or old EVs registered before April 30, 2018, and purchase a new NEV. Some improvement on a month-on-month basis was noted, as from May 1 to 19, according to CPCA, China’s EV retail sales amounted to 412k units, which was 10% higher than the first 19 days in April. Nonetheless, a modest 26% Y/Y rate of increase slightly dragged down the year-to-date rate to 32% from April’s 32.9%, mainly due to some weakness in the period.

As demand was muted, EV makers have engaged in a price war. According to the National Bureau of Statistics, EV prices on average declined 6.5% Y/Y in April, weaker than the internal combustion engine (ICE) passenger vehicles’ 4.8% decline.

PHEVs/EREVs Outperformed

Pure battery EVs (BEV) accounted for 405k units or 60% of aggregate EV sales in April, while plug-in or extended-range EVs (PHEVs/EREVs) accounted for 269k units or 40% of sales. PHEVs/EREVs outperformed BEVs with a staggering 72.6% Y/Y growth rate, reaching 1.01 million units compared to the latter’s 14.3% Y/Y growth rate, reaching 1.44 million units. With a supplementary internal combustion engine that either powers the vehicle directly in the case of PHEV or recharges the battery in the case of EREV, PHEVs/EREVs reduce the range anxiety of running out of battery while being far from a charging station.

Li Auto’s Q1 Results Reflect Disastrous BEV Expansion Attempts and Market Challenges

Li Auto’s Q1 2024 financial results, released last week, reflected market challenges. The company delivered 80,400 vehicles in the quarter, marking a 52.9% Y/Y increase but a 39% Q/Q decline. In a quarter featuring competitive price cuts among EV makers, the average selling price of Li Auto’s vehicles fell by 2% Q/Q. The gross margin contracted by 3.4 percentage points (pp) from the previous quarter and 0.4pp from the year-ago quarter to 19.3%. Q1 revenue fell 36% over the quarter to RMB25.6 billion, while the year-on-year revenue growth slowed to 36% Y/Y from the previous quarter’s 136%.

As operating expenses declined much less than revenues over the quarter, Li Auto fell back to operating losses after four consecutive quarters of operating profits. Nonetheless, the company remains profitable overall as net income came in at RMB593 million after a remarkable RMB1.07 billion interest and investment income. Given the competitive market conditions and the disappointing reception of its first pure EV model, Mega, plus the postponement of the launch of its other three pure EVs to next year, the company’s guidance of delivering 105,000 to 110,000 units and achieving revenue of RMB29.9 billion to RMB31.4 billion may be challenging and indicate pressure to cut vehicle selling prices further. The failure of execution in launching its BEV models and the related investor lawsuit in the U.S. also caused some concerns among investors.

While maintaining the number 5 position on the Chinese EV maker league table in terms of retail sales volume with 25.8k units and a 3.8% market share in April, ahead of NIO’s 15.6k units or 2.3% and XPENG’s 9.4k units or 1.4%, its year-on-year growth of a mere 0.4% lagged significantly behind the 134.6% and 32.7% in NIO and XPENG respectively. It was also weak compared to the 31.1% Y/Y growth at BYD (254.1k units; 37.7% market share) in April.

On the other hand, the silver lining of the dark cloud hovering over Li Auto is the management’s decision to return its focus to extended-range EVs, in which the company has had a proven track record and is less likely to be disrupted by the highly competitive new entrant Xiaomi, which is focused on BEVs for the time being. Overall, recent industry data discussed above show that sales of EREVs are growing faster than BEVs. Li Auto has already received orders for 34,000 of its L6, an EREV model priced around RMB250,000, launched on April 18, 2024, and ramped up the production capacity for this model to over 20,000 units by June. However, the L6 is in head-to-head competition with Huawei’s AITO M5 and M7 EREVs, manufactured by Seres, which target similar buyers.

Developing and launching BEV models has incurred heavy costs and diverted sales efforts and store spaces from its more successful EREVs. According to the management, the contribution from the 18% staff cut and the postponement of the launch of the three planned additional BEV models will help stabilize the deterioration in operating margins in the second half of the year.

Volkswagen Partnership Adds Service Revenue for XPENG

Also having announced Q1 results last week, XPENG’s revenue declined by 50% Q/Q while increasing by 62% from a year ago. The contribution from its first MPV model X9, launched on January 1 this year, selling at RMB360,000 to 420,000, led to better-than-expected revenue and smaller losses. The company has also started booking the revenue from its technical and R&D services rendered to Volkswagen in Q1. As a result, operating losses narrowed to RMB1.9 billion from RMB2.4 billion in Q4 and RMB2.6 billion in Q1. Net loss also narrowed to RMB1.4 billion from RMB2.4 billion last year. However, vehicle shipment increased 19.7% Y/Y, but it came down by 63.7% Q/Q, reflecting a highly competitive market environment.

XPENG plans to launch a mass-market BEV sedan model under the MONA brand in June, followed by several new models every subsequent quarter. In addition, the company is seeking to expand its export markets to over 20 countries, including the Nordics, Western Europe, Middle East, Southeast Asia, and Australia. However, as a BEV-only EV maker, XPENG will feel some heat from the entry of Xiaomi into the BEV market, particularly its P7i model, which targets similar buyers as Xiaomi.

Smartphone Giants Xiaomi and Huawei as Formidable Disruptors to the EV Industry

Xiaomi launched its first EV, a BEV sedan SU7, selling at price points between RMB200,000 and RMB300,000 on March 28, gathering strong momentum. According to the company, it secured orders for 88,063 vehicles in April, and Xiaomi’s CFO said at the earnings call that the company plans to deliver shipments of as many as 120,000 vehicles for the whole year in 2024. If this is achieved, Xiaomi will have secured approximately 1% market share of the Chinese EV market in 2024 in nine months and potentially enter the league table of the top-10 EV car makers. This will pose significant pressure on XPENG, ZEEKR, Tesla China, and the Han series BEV sedans of BYD.

The fact that Xiaomi and Huawei can become formidable EV makers in a short time indicates one of the important features of EVs different from traditional fossil fuel-powered internal combustion engine (ICE) vehicles. EVs powered by electric motors are engineeringly less complex and demanding than ICE vehicles. They are essentially made by assembling battery modules and electronics modules plus software, in which smartphone giants like Xiaomi and Huawei are well-versed. The rich know-how and successful experience in consumer electronics and the Internet of Things add to Xiaomi’s competitive edge in designing EVs over legacy ICE automakers. The extensive use of modules instead of complex engineering also makes EV production suitable for outsourcing, similar to making smartphones. Indeed, Huawei has adopted this outsourcing model in manufacturing the EVs it designs. It outsources the production of the AITO brand EVs to Seres Group, the Luxeed brand to Chery Automobile, and the Avatr brand to Changan Automobile.

Europe likely to impose a 15%-30% tariff on Chinese EV Imports

In 2023, export of passenger EVs amounted to 1.77 million units, a 67.1% Y/Y growth. Of these, 1.55 million units are BEV passenger cars with a value of RMB240 billion and an average selling price of 155,500 per unit. Europe was the largest export market, with 650,000 units, accounting for 41.3% in volume terms. In terms of value, it accounted for 55.1% as exports to Europe had a higher average selling price of RMB207,600 per unit. Within Europe, the largest markets were Belgium, the United Kingdom, Spain, the Netherlands, Germany, Slovenia, France, and Sweden. The second largest market in terms of volume was Southeast Asia, mainly Thailand and the Philippines, which accounted for 20.1% of the volume but only 9.3% in terms of value due to a lower average selling price of RMB71,800 per unit. Exports to the US were only 12,363 units or 0.8% of China’s EV exports in 2023.

In the first four months of the year, China exported 659,023 passenger EVs. The top five destinations were Belgium (88,816 units), Brazil (85,466 units), the United Kingdom (51,097 units), Thailand (46,570 units), and the Philippines (38,106 units). The most notable development was a surge in exports to Brazil. However, Tesla China, with an export (mainly to Europe) of 119,202 vehicles made in its Shanghai gigafactory, accounted for 18.1% of China’s EV exports for the first four months of 2024.

The United States is mostly irrelevant to Chinese EV makers, particularly after the recent action from the Biden Administration in raising the tariff from 27.5% to 102.5% and threatening to take further measures to prevent the export of Chinese EVs through Mexico. On the other hand, given the weight of Europe as a market for China’s EV exports and the fact that new ICE vehicles will be banned in the European Union and the United Kingdom, Europe is the most promising market for Chinese EVs in the coming decade. However, Chinese EV exports to the EU are likely to be subject to additional tariffs, on top of the current 10% this year.

In October 2023, the European Commission started an anti-subsidy investigation into China’s EV exports to the EU, focusing on EVs manufactured by BYD, Geely, and SAIC, but not Tesla or the China JVs of BMW and Renault, which export to the EU as well. According to the Rhodium Group, a research firm, the European Commission is likely to impose a 15%-30% tariff on imports of EVs from China. U.S. officials, including Secretary of Commerce Gina Raimondo and Treasury Secretary Janet Yellen, have called for the EU to act in alignment with U.S. policies. The EU is expected to announce its decision on the investigation by June 5, 2024. In anticipation of potential pushback, Chinese EV makers have been investing in building up production facilities in EU countries such as Hungary and Poland.

Opportunities Amid Challenges

The potential increase in EU tariffs on Chinese EVs could further dampen the already subdued sentiment towards Chinese EV makers, which are facing intensifying domestic competition and price wars. The effectiveness of the Chinese government's recently introduced trade-in subsidies for EV buyers remains uncertain.

Meanwhile, market leader BYD stands out with its comprehensive product mix and vertical integration. Trading at an undemanding 16.3x 2024 EPS estimate and 13.5x 2025 EPS estimate, and boasting a trailing 12-month return on invested capital of 15.8%, BYD may be well-positioned to maintain its share price despite the turbulent EV market and export challenges. Investors favoring companies with diversified portfolios and strong integration will find BYD attractive.

Li Auto, despite a stellar 2023 marked by strong volume growth and solid margins, stumbled with its expansion from EREVs to the highly competitive BEV market. The botched launch of its Mega model tarnished its reputation. Nonetheless, investors confident in Li Auto's ability to navigate these challenges and refocus on its strengths might see potential. However, formidable rivals like Huawei and its manufacturing partners pose significant competition in the EREV segment.

XPENG, a BEV-only manufacturer, faces fierce competition from new entrants like Xiaomi. However, its strategic plans to launch a mass-market BEV sedan under the MONA brand and expand into export markets offer promising growth opportunities. Moreover, XPENG's partnership with Volkswagen, generating revenue through technical and R&D services, enhances its market position and technological credibility. Investors optimistic about XPENG's product roadmap and strategic collaborations may find the company appealing.

NIO's innovative battery-as-a-service model, allowing customers to subscribe to battery packs rather than owning them, could provide a competitive edge. However, the long-term viability of this business model remains uncertain. NIO's persistent unprofitability, coupled with the threat of higher European tariffs on Chinese EV imports, could impact its overseas ambitions.

Xiaomi's entry into the EV market with its SU7 model has generated strong initial demand. Leveraging its brand recognition, supply chain expertise, cost advantages, and extensive knowledge in consumer electronics, software, and the Internet of Things (IoT), Xiaomi has the potential to significantly disrupt the EV industry. Investors bullish on Xiaomi's EV ambitions and its capacity to capture market share may consider investing in the company.

In this increasingly competitive market, EV makers are striving to differentiate themselves by developing more advanced intelligent cockpits and autonomous driving technologies. Investors might also look beyond EV manufacturers to leading vendors of intelligent vehicle equipment and solutions. Notable examples include Huizhou Desay and Foryou, which are at the forefront of providing these technologies and solutions.