Li Auto: Exploring Upside Potential and Risks in Chinese EV Market

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Amy Swift 12 months

Li Auto, a Chinese electric vehicle (EV) maker, has witnessed a remarkable 43% year-to-date rally, showcasing significant upside potential. However, with the risks associated with investing in Chinese stocks, caution is warranted. In this article, we'll delve into Li Auto's financials, growth prospects, and the challenges investors need to consider.

Li Auto boasts strong financials, with an impressive 256% compound annual growth rate (CAGR) in revenue over the past four years. Its solid 20% gross margin is on par with industry leader Tesla (TSLA). The company's heavy investments in research and development (R&D) and sales, general, and administrative (SG&A) expenses have contributed to a sustainable positive free cash flow (FCF) and a stable net cash position.

Li Auto's upcoming quarterly earnings, scheduled for August 15, are expected to reflect a significant YoY revenue increase of 175% due to favorable comparisons with the COVID-affected period in the previous year. The company's strong delivery numbers for April and May 2023, which exhibited a 244% YoY growth, indicate a high probability of beating consensus estimates for Q2.

Using a discounted cash flow (DCF) approach, Li Auto's valuation indicates a fair value of $65 billion, more than double its current market cap. Even under more conservative revenue growth assumptions, the stock appears undervalued. Additionally, the stock's low forward price-to-sales (P/S) ratio compared to industry leader Tesla suggests significant undervaluation.

Investing in Chinese companies poses inherent risks, as highlighted by past instances such as political challenges faced by Alibaba and the accounting fraud case of Luckin Coffee. Geopolitical tensions between China and the U.S. further add to the risks, potentially impacting Chinese stocks on American exchanges. Furthermore, ambitious consensus forecasts for Li Auto's revenue growth and fierce competition in the premium EV segment raise doubts about the company's ability to meet expectations.

While Li Auto presents a vast upside potential, the risks associated with investing in Chinese companies, geopolitical tensions, and ambitious growth forecasts warrant caution. The article concludes that the risks outweigh the potential rewards, making Li Auto a hold rather than a buy. However, for investors seeking exposure to Chinese EV makers, the stock may still be an attractive option.

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