Stock Market

Lay Off Li Auto Stock Until the Chinese EV Sector Shows Signs of Cooling

Over the trailing one-month period, Li Auto (NASDAQ:LI) stock is up more than 22%.

A front view of the Li Xiang One SUV from Li Auto (LI).

Source: Carrie Fereday / Shutterstock.com

It turns out that despite the many challenges that the global economy faces from the lingering impact of the novel coronavirus pandemic, the electric vehicle sector continues to hum.

The Chinese EV segment has really come alive, and LI stock has been one of the many beneficiaries.

In the trailing year, LI stock nearly doubled, which speaks volumes about the worldwide push for vaccination against Covid-19.

Specifically for China, the boon in both LI stock and its burgeoning EV manufacturing industry could be considered a milestone achievement.

Even though the SARS-CoV-2 virus originated from there with China suffering the heaviest casualties early on, its economy rebounded impressively.

Don’t make the mistake that Li Auto is merely ridding the coattails of events outside its control.

The company reported robust June deliveries to the tune of 7,713 vehicles, beating out compatriot XPeng (NYSE:XPEV). The latter reported June deliveries of 6,565 vehicles.

Further, while China’s EV poster child Nio (NYSE:NIO) delivered 8,000 vehicles, Barron’s contributor Al Root argued that Li Auto has the much more superior growth rate of 78% between May to June.

In contrast, Nio has a 20% growth rate during the same period. Thus, momentum is on the side of LI stock.

A Closer Look at LI Stock

So, it appeared a bit strange that in the week heading into the Fourth of July weekend, LI stock shed nearly 2% and, on the Friday session right before America celebrated its independence, shares tanked nearly 6%.

What’s up with the sudden volatility on the back of encouraging fundamental developments?

On paper, it seems that this is a rising tide that should lift all boats, but Root argued that LI hasn’t swung higher in part because investors are concerned that the sector might be stretched.

If you’re looking for the best explanation as to why LI stock tumbled recently, that could be it.

Yes, it’s a simple argument but at the end of the day, the market runs on collective human emotions. If people are worried about holding the bag, that might be more than enough reason to take some profits, even if the company enjoys much upside potential.

Still, Xpeng’s loss is conspicuous because of the strong delivery numbers. True, people have an inherent fear of holding the bag but let’s back up a second.

Speculation in the market is rampant and the rise of U.S. benchmark indices isn’t helping matters. In this context, then, you’d assume fundamental justification for said risk-taking would be beneficial for LI stock.

As I’m writing this, it’s not. Why?

Deeper Issues Than Just Risk

If I had to guess, I’d point you to research conducted by the Massachusetts Institute of Technology regarding holistic costs associated with the EV rollout.

Among the many insights that MIT provided, I’d like to point out two: the financial costs post-government subsidy in China and unforeseen consequences of government intervention.

First, China’s EV infrastructure has been incredibly robust because of very favorable government subsidies. However, these subsidies are also expensive for the government and it decided to scale back these offers.

Therefore, in a future subsidy-less EV market, the battery plug-in variety could actually be more expensive on a long-term ownership basis than a combustion car.

Second, China has a rather draconian approach to the EV rollout, essentially forcing customers to go electric.

Moving forward, the government’s pricing strategy will likely see it lower the price for EVs while raising the price of combustion cars. But the latter would price out many low-income consumers that can only afford the gasoline option.

What About Lower Battery Costs?

A counterargument to MIT’s research is that rapidly declining battery costs could swing the needle in favor of LI stock and other EV-related investments.

While MIT acknowledges that battery costs are indeed declining, the process of mining the commodities — along with the commodities’ market valuation — will not get much cheaper.

Therefore, the takeaway is that as battery costs get closer to the price of the incorporated raw materials, the favorable drop in battery prices will slow considerably.

I’ll add that if this point arrives without EVs achieving at least price parity with similarly equipped combustion cars, it’s going to be very difficult to convince average-income households to make the switch.

Should that be the case, then you have the problem of competitor saturation. It’s a long shot but it’s possible that investors are considering these factors for LI stock.

As for the nearer-term implications, I think it might be a good idea to wait. As mentioned above, China’s EV market may have moved too far, too fast.

On the date of publication, Josh Enomoto did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.

A former senior business analyst for Sony Electronics, Josh Enomoto has helped broker major contracts with Fortune Global 500 companies. Over the past several years, he has delivered unique, critical insights for the investment markets, as well as various other industries including legal, construction management, and healthcare.

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