Interest charting…
if we exclude restricted cash, and cash borrowed from WC, and recent equity injection, here is Nio’s quarterly end net cash position.
What’s the problem?
Chinese companies’ stock price dropped sharply in the recent months, which seems to be an opportunity for entry. Should people take it?
We need to address a few questions.
Why the drop?
On the surface, China’s economy is entering a slow/no growth mode, with a deteriorating global business environment (especially towards China).
More recently, the sell-off accelerated as many retail investors were “forced” to deleverage. It’s not obvious, but on the personal finance level:
1) home prices declines triggered deleverage, where most Chinese families store most of their wealth. Especially for those who had taken out home equity in the forms of loans when housing prices were peaking in 2021, refinancing at similar level is nearly impossible now. To fill the gap, they need to sell other assets, or to give up the house for auction. Those who had bought stocks using the home equity are likely to suffer big losses in this process.
2) many high-yield investment products have stopped functioning, which may indicate potential meaningful loss in income and principle (those products are likely to have links to real estate developers or equity markets). If people were dependent on those investment products, it’s could cause troubles in personal finance which leads to deleverage.
Therefore, the buying power directly or indirectly built upon people’s home loans or purchases of investment products is liquidating.
Why bother to buy?
1/ Their are still unique companies / business models / edges that’s hard to find elsewhere.
e.g. CATL is still the most efficient and large-scale battery producer, with profits. There are geopolitical concerns but CATL is also building capacities overseas. If the edge in production over others can sustain, and it can grow overseas in a way that local authorities endorse, it looks to be an investable business.
More specifically, the criteria I would argue is that its products or services are incrementally positive to the global economy, or is unique on the global stage, not just among Chinese peers.
In another word, some companies are still a valuable part of global economy, so investors don’t necessarily need to be interested in China, and may choose to hedge some beta/macro risk.
2/ Valuation has come close to global standard.
When you can easily get a 4%+ risk-free rate in savings, it requires a much higher rate for Chinese equities to be attractive.
Depending on risk appetite, 15x p/e implies 6.7% earnings yield, and 12x implies 8.3% earnings yield.
E.g. CATL is around 15x LTM p/e, although we need to see if it’s sustainable as battery prices dropped pretty dramatically. The point is if it’s a normalized 15x p/e for a globally unique business and is growing, it does offer some value to a portfolio.
Self-fulfilling thesis seems everywhere.
Housing – rising home prices -> more people want to buy; banks willing to lend more -> more people can buy -> higher home prices..
Liquor/baijiu (Moutai) in China – buy Moutai stock & Moutai liquor-> Moutai will rise in value over the years (due to inflation etc. and company may raise prices) as an “investment product” -> you can even take “equity/cash” from the liquor you bought -> you can buy more Moutai or Moutai stocks -> excessive demand will drive Moutai price & Moutai’s financials thus stock price shall go up -> investors make profit on stocks and can buy more Moutai or Moutai stocks…
Tesla – buy Tesla stocks & put down reservations -> stock price rise due to higher demand -> use profits from Tesla stock to buy real Tesla cars, which can contribute to Tesla financials -> stock price rises… This may work well at early stage when volume is low.
Meat consumption is huge in China. But Beyond Meat didn’t win the market even it has a local factory.
In November’s q3 earnings call, Beyond Meat says it is doing “a review and potential restructuring of our operations in China”.
A local factory in Shanghai can’t solve Beyond Meat’s problems globally.
Why Beyond Meat didn’t work?
1) Price is too high. Retail price could be ~$10 per pound, or 40+% higher. In earnings releases, Beyond Meat in 23q3 sold 7.199 mn pounds of meat through US retail for 30.518 mn, which translates to $4.23 per pound (the price Beyond Meat sells to retailers). And Beyond Meat is mostly making gross profit loss at these prices. Not to mention the high interest rate and inflation pressure that lead to consumer trade-down.
Beyond Meat patties in Walmart – $9.68 / lb
normal beef patties in Walmart – $5.6 – $7 / lb
Products sold in China is actually at similar price in the US (40 rmb, or $5.6 for 2 patties; 60 rmb, or $8.45 for 4 patties, or 1 lb) – expensive compared with other meat options in China.
Pork (main protein) is ~$1.3 / lb in China.
Beef price is ~$4.6 / lb in China.
2) In restaurants (fast-food chains), the products didn’t take off – not welcomed by consumers. McDonald’s discontinued McPlant in mid-2022, which is a Beyond Meat burger. Burger King, the early adopter of vegan burger (from Impossible Burger) now says “it’s not a big part of the current focus.”
3) There are some fundamental issues with the product: e.g. plant- based protein is less likely to be absorbed compared with real meat.
Market news nowadays are saying that Fed is bullied by the market.
e.g. FT article: The Fed should resist market bullying
What’s “bullying”? Seems to me that market is leading and Fed is just following the market.
Why is this the case? I got three reasons:
1/ 2024 is election year. Market knows Fed needs to help the economy.
2/ Market understands data better, and Fed has been saying it’s “data-dependent”; no wonder why market (e.g. hedge funds) is leading with all those high-frequency data. Hedge funds can simply simulate what data Fed is receiving and even have better real-time data than the Fed.
3/ Some market players can “influence” or “control” the data. Sounds absurd. Just an example – what if hedge funds can buy up goods which would cause inflation when needed, or sell them at low prices to cause deflation when needed. As long as they can make huge profits in the market, it can be worth the cost.
Read the q3 quarterly report on US household debt and credit (here). One interest takeaway is how divergently different loans perform, vs. the GFC era.
When the GFC hit, both all loans perform badly. Transition into delinquency (30+ days) for credit cards, mortgages, and auto loans reached over 10%. Mortgages delinquency were picking up faster and looks worse than auto loans.
This time around, mortgages looks fine (as of 23q3), and delinquency is going up not only slowly but at the level even lower than 2005-06, while auto and credit cards are deteriorating at a faster rate.
By age groups, for 18-29 and 30-39, the percentage of auto loan balance falling 3-month behind is reaching about the similar level of GFC era. (Another theme: younger generation is under more pressure than the older for the past 2 years)
To reflect back, there was a shortage of cars during the pandemic and used car prices were shooting up. It could cost some money if someone bought a car back then and sold it this year, as 2nd-hand car price has been on a downward path.
The selling and downward pricing trend could be a self-reenforcing process.
Meanwhile, house is a more resilient asset class and current macro is still ok. After 10 years, houses are very likely to worth more but cars very likely won’t.
As shown with the FHFA house price index, which is keeping up.
…which is very different from the GFC era when HPI declined and under pressure for years.
Meta’s bottom-line looks amazing – diluted EPS almost tripled from a year ago (+168% yoy).
How?
Cheers to Susan Li, the new CFO announced back in 2022q2 earnings. Delivering numbers that investors needed.
Efficiency has improved dramatically – quarterly operating income per full-time employee more than tripled from $65k to $208k.
AI story is impressive; and Metaverse is not dead.
What are the concerns?
1) two-year cagr not impressive: at the midpoint of 2023q4 guidance, two year revenue cagr (vs 2021q4) is <7%.
Two year ads revenue carg for US, Canada and Europe is 6.7% in 2023q3.
Remember, most of Meta’s revenue is ads in US, Canada and Europe (2/3 in 2023q3). User growth obviously is not meaningful. It needs ARPU to grow. While ads pricing won’t be strong given macro uncertainties, it will then rely on showing more ads to users, which won’t be something people would enjoy.
2) operating cost would be higher: infrastructure cost would rise due to AI investments. Reality Lab operating cost would be higher. Two large layoffs were done; hard to cut further. More importantly, new revenue streams are less lucrative than ads (which has over 80% gross margin).
2) regulation, fine: Meta was sued – that has hit the headline. Meanwhile, EU’s DMA would take effect next year. Plus, AI is very data-driven. However, can companies easily get data this time around?
Will EPS continue to grow at 15% or above for 2024, 2025 and beyond? I think doable, but is AI an easily profitable business? Let’s see.
Two biggest component would be electric vehicles and AI.
EV: BYD is <$100bn; BYD delivered higher profits than Tesla; BYD also has energy storage business
AI Models (FSD): OpenAI is <$100bn; latest valuation appeared to be $86bn
AI Chips: AMD is ~$160bn. Tesla should be years behind in terms of external revenue profits (as a business) etc. Let’s just use $160bn, as Tesla has some other business.
Then it sums up to be $360bn = $100bn + $100bn + $160bn
Last time I checked (before earnings), it’s more than doubling that number…
Robots? Boston Dynamics was $1.1bn back in Dec 2020.
Charging? ChargePoint ($CHPT) is ~$1bn market cap.
If someone wants to add ride-hailing services I mean Lyft is <$5bn, not significant.
Even additionally add Enphase and First Solar, which were ~$13bn and $16bn, still not big enough to move the needle.
Insurance could be big. However, if it’s not good enough/taking over now, why it should be in the future? It shouldn’t be a futuristic thing; auto insurance has a history of over 100 years.
$400bn or lower sounds about right.
With macro uncertainties, it looks like global consumers are focusing more on small items purchases.
In China, happiness starts with $1.
1/ coffee chain Luckin grew 88% in revenue yoy, and has over 10k store now.
For $2 per cup, if people get it every workday, it’s only $40 per month.
There are additional promotions: with $3 membership card/month, coffee can be almost half priced. $1.5 x 20 + $3 => $33 per month.
2/ mobile gaming (mostly micro transactions) market grew most 60% in 2023 summer. See previous post.
for $30-40, you can get a decent new skin on HoK or Justice Mobile. Some skins are as low as $1.
Globally, $20 per month can also buy lot of happiness.
3/ Netflix added 9mn subscribers in 2023q3 and is going to raise price again in the US. After 3 years, 50mn+ more subscribers joined Neflix, vs 2020q3, when the initial covid impact calmed down (2020q3 added 2.2mn vs. 2020H1 added 26mn).
After raising price, it’s only $23 per month.
4/ OpenAI, whose ChaGPT, although a productivity tool, is mostly paid by consumers with $20 per month plan. It has over $100mn revenue per month now, or 4-5mn subscribers, assuming most revenue is from subscriptions.
5/ Midjourney subreddit members grew to almost 1mn. Midjourney entry-level (Basic) plan is $10 per month. It’s reported that its 2023 revenue is over $200mn. Midjourney might have ~2nm subscribers by year end ($24-30mn revenue run rate).
Are they supposed to be growth stocks?
Well, Tesla does have new stories besides FSD -> AI chips (Dojo) + robots (Optimus), which sound to be pretty exciting.
What about CATL’s future strategy?
Is it like Intel?
Similarities: They are both the supplier for industry-leading products, and has in-house manufacturing (part of the edge is manufacturing. They can expand into other end markets: Intel also serves server market, while CATL serves energy storage market.
Differences: “Wintel” is amazing; however, auto industry hasn’t been winner take all, even for Tesla. Unless auto OEMs are willing to become PC makers and there is one superior EV structure (asset light) and uses CATL exclusively.. << a very unlikely picture. If Tesla had delivered FSD fast enough and good enough, there is a chance to be a layer that takes most market share, but that doesn’t have much to do with the battery layer.
Differences: Although CATL tech is very good and improves every year, it’s not like it created “Moore’s Law” / a long-term road map for the battery industry. It’s not just about visionary or “leadership”, but because the speed of improvements is fast enough – competitors are catching up instead of falling behind.
Is it like Qualcomm?
Similarities: Qualcomm’s SOC enables / provides a platform for smartphones and other IoTs. CATL enables lots of EV brands. Qualcomm faces competition from integrated player like Apple; CATL faces competition from integrated player like BYD.
Differences: similar to Intel, Qualcomm + Android is powerful and ubiquitous. CATL is lack of a powerful OS layer.
Differences: Qualcomm uses foundry for manufacturing and focuses more on design & licensing. CATL produces in-house, but doesn’t do licensing.
Is it like Denso?
Similarities: big player in auto parts.
Differences: Denso’s business lines is more mixed (no synergy), and centered around automakers. CATL focuses on batter-related products, and are supplying to non-auto customers.
Differences: Denso has ~15% gross margin and ~5% net margin. CATL has ~20% gross margin and ~10% net margin.