Leapmotor: Has it become the accelerated "leading little ideal"?

$LEAPMOTOR(09863.HK) released its Q3 2024 financial report after the Hong Kong stock market closed on November 11, Beijing time. Here are the key points:

1. Car prices back on the rise: In Q3, the average price of Leapmotor vehicles increased by RMB 14,000 to RMB 114,000, recovering from the low point of car prices in Q2, mainly due to the sales structure improvement brought by the high-priced C16's explosive sales.

2. Surprising gross margin for vehicles: The gross margin for vehicles in Q3 also increased by 5.5% to 8.2%, exceeding market expectations of 6.4% and the major banks' expectations of 6.7%. The increase was mainly due to the price increase from the high-priced, high-margin C16's explosive sales, as well as the scale effect on the cost side and the release of battery cost reductions.

3. Operating expenses continue to rise significantly, but leverage effect is released: This quarter, the three expenses continued to rise significantly. R&D expenses were mainly invested in new models and end-to-end intelligent driving development. Leapmotor increased its investment in manpower, computing power, and equipment. Sales expenses rose mainly due to advertising and an increase in sales personnel, but due to the explosive sales this quarter, the leverage effect was released, and the operating expense ratio decreased by 10% quarter-on-quarter.

4. Significant reduction in losses: This quarter, operating profit improved significantly due to the substantial quarter-on-quarter increase in gross margin and the release of the leverage effect driven by explosive sales. Leapmotor achieved a significant reduction in losses, with operating profit improving by RMB 530 million to -700 million, and the operating profit margin improving by 16% to -8% this quarter, with the turning point to profitability not far away.

5. Positive guidance for Q4: Leapmotor expects to exceed its annual sales target of 250,000 units, with Q4 gross margin expected to steadily increase following the trend of Q3, and net losses are also expected to continue to narrow.

Overall, Leapmotor delivered a good report card in Q3, with the most impressive aspect being the quarter-on-quarter increase in vehicle gross margin, which directly contributed to Leapmotor's significant reduction in losses this quarter.

As mentioned repeatedly in previous analyses, I believe Leapmotor is a company focused on solid vehicle manufacturing, with models that offer great value compared to competitors. However, it has previously been hindered by marketing and brand awareness issues. From Leapmotor's recent sales momentum, it appears that its brand recognition is gradually increasing. I believe the reasons for Leapmotor's sustained high sales growth recently are:

① The upgrade of the trade-in policy further benefits new energy vehicle companies like Leapmotor that price their vehicles between RMB 100,000 and 200,000.

② High cost-performance ratio of models, creating differentiated competition with competing models: Leapmotor has positioned its 800V and intelligent driving features in the RMB 150,000 price range, offering extremely high cost-performance. At the same time, the model positioning is accurate, such as the explosive sales of the C16, which is positioned as a 6-seat family SUV, priced significantly lower than similarly positioned family SUVs like Li Auto's L6 and Huawei's M7, covering the gap in the RMB 150,000 to 200,000 family SUV market Thus forming differentiated competitive advantages.

Looking ahead to the fourth quarter, Leapmotor's current order momentum remains strong, with a net increase of over 40,000 orders in October. With the sales peak season and overseas expansion driving further growth in delivery volumes, Dolphin Jun expects Leapmotor's fourth-quarter delivery volume to reach 120,000 to 130,000 units, which will drive the annual delivery volume to 290,000 to 300,000 units, far exceeding Leapmotor's previously set sales target of 250,000 units for 2024.

At the same time, as the model structure continues to improve in the fourth quarter, along with the scale effect and the annual reduction from suppliers, the gross profit margin will further improve on a quarter-on-quarter basis, achieving continued loss reduction and ongoing operational improvement.

Regarding overseas expansion, the impact on Leapmotor in 2024 is still limited (expected to contribute only 6,000 to 10,000 units this year), while the full release of the impact from overseas expansion on Leapmotor will occur in 2025 (Leapmotor expects overseas models to contribute 60,000 to 100,000 units in 2025).

Leapmotor still has differentiated advantages compared to other new forces in overseas expansion:

1. With the recognition and channels of Stellantis, it can help Leapmotor quickly open up the market in Europe, providing a first-mover advantage in overseas expansion. Additionally, by leveraging Stellantis' own sales channels, it eliminates the need for discounts, resulting in greater profit margins.

2. Utilizing Stellantis' overseas factories, Leapmotor will export to Europe using the SKD model: Leapmotor will sell components to Leapmotor International, which will assemble and produce them using Stellantis' existing overseas factories. Although there are still restrictions on the localization ratio of component production in Europe, the export resistance has significantly decreased compared to other new forces.

3. Furthermore, Stellantis not only has the second-largest market in Europe but also the largest market in North America. However, due to policy and tariff reasons, North America currently lacks the presence of new energy vehicle companies (including Leapmotor). Nevertheless, in the long term, with the support of Stellantis' channels and local factories, Leapmotor still has room for imagination.

From Leapmotor's current valuation perspective, the P/S ratio for 2024 is at 1.5 times. With its brand recognition already established domestically, ongoing operational improvements in the fourth quarter, and overseas expansion just beginning, Dolphin Jun believes that such a valuation is still not expensive compared to other new forces with differentiated advantages.

The following is a detailed analysis:

I. Third Quarter Gross Profit Margin Exceeds Expectations

The most concerning aspect for investors regarding Leapmotor's performance is the gross profit margin of its automotive business.

Leapmotor had previously guided in a conference call that the gross profit margin for its automotive business in the third quarter would rebound quarter-on-quarter, with July's gross profit margin reaching over 5%. Therefore, the market and major institutions had expected Leapmotor's third-quarter automotive gross profit margin to be around 6.4%/6.7%, while Leapmotor's actual automotive gross profit margin in the third quarter was 8.2%, exceeding market and institutional expectations.

From the perspective of single vehicle economics:

a) Average vehicle price of 114,000 yuan, benefiting from improvements in model structure In the third quarter, the average price per vehicle was 114,000 yuan, an increase of 14,000 yuan compared to the previous quarter, mainly benefiting from the improvement in the model structure:

In the product structure, the high-priced, high-margin C16 began deliveries in June, with the third quarter being a complete delivery season. The proportion of C16 in the model structure increased by 19.4% to 21% compared to the previous quarter, while the low-priced, low-margin T03 continued to decline by 3%-4% in the sales structure. Ultimately, the improvement in the sales structure drove the increase in the average price per vehicle this quarter.

b) The cost per vehicle is 105,000 yuan, lower than the market expectation of 107,000 yuan

This quarter, due to the increased proportion of the high-priced, high-margin C16, manufacturing costs were higher, leading to an increase of 7,000 yuan in the cost per vehicle compared to the previous quarter, but it still remained below the market expectation of 107,000 yuan.

The reasonable control of costs is mainly due to: benefits from ongoing cost management efforts, the scale effect created by increased sales, and the continued decline in battery costs driven by upstream lithium carbonate prices.

c) The gross profit per vehicle is 9,000 yuan, exceeding the market expectation of 7,000 yuan

The gross profit per vehicle increased by 6,000 yuan compared to the previous quarter, driven by the recovery in the average price per vehicle and reasonable cost control, resulting in an overall gross margin increase of 5.5% to 8.2% this quarter.

II. The gross margin in the fourth quarter is expected to continue to rise due to explosive sales

In the third quarter, Leapmotor's delivery volume increased by 62% compared to the previous quarter, ranking among the top in delivery volume among new forces. Dolphin Jun believes the reasons for Leapmotor's explosive sales are as follows:

① The trade-in policy has been further upgraded, benefiting new energy vehicle companies priced between 100,000 to 200,000 yuan:

In the third quarter, the trade-in policy was further upgraded, with subsidies for purchasing new energy vehicles after scrapping increased from 10,000 yuan to 20,000 yuan. The scrapped models are approximately 13 years old, and users of scrapped models are more sensitive to price and are more inclined to choose models with lower subsidized prices, further benefiting new energy vehicle companies positioned in the 100,000 to 200,000 yuan

② The model has high cost performance and forms dislocation competition with competing models

The deliveries of mid-to-large SUV C16 began in June, which the price set and gross margin are higher among the Leapmotor's cars. C16 is the first to set price aroung RMB160,000 for cars equipped with 800V platform in the automative industry, targeting at 6-seat family used SUV market. Its price is also significantly lower than cars like LI L6 and Huawei M7 in the same SUV market, filling the gap between 150,000 and 200,000 in the family used SUV market, thus establishing a differentiated competitive edge.

Additionally, the 2024 models introduce an Intelligent Driving version, equipped with NVIDIA Orin X chip (254 TOPS computing power) and a single LiDAR sensor. The Intelligent Driving version starts at a minimum price of 165,800 RMB (C10 extended range version), making it the lowest-priced vehicle among delivered models with such high-end intelligent driving hardware, offering differentiated competition against similar models.

However, looking forward to the fourth quarter, the orders of Leapmotor still stay strong currently, with more than 40,000 orders added in October. It predicted that:

① Sales peak season + overseas expansion drives further growth in delivery volume: The fourth quarter is the sales peak season for new energy vehicle companies. Coupled with Leapmotor's official overseas expansion starting in the fourth quarter, primarily with the T03 and C10 models, it is expected to contribute around 6,000 to 10,000 units to the 2024 sales volume.

Dolphin Jun expects Leapmotor's fourth-quarter delivery volume to reach 120,000 to 130,000 units, driving the annual delivery volume to 290,000 to 300,000 units, far exceeding Leapmotor's previously set sales target of 250,000 units for 2024, further releasing scale effects.

② Model structure continues to improve: In October, the proportion of C series models further increased to 80%, driving the average selling price (ASP) per vehicle to rise further;

③ Supplier annual reduction by year-end: The previous round of supplier annual reductions was reflected in last year's fourth quarter, and this year's fourth quarter may also benefit from cost reductions brought about by supplier annual reductions.

Fourth-quarter sales are expected to continue to rise by 39%-50% quarter-on-quarter, and gross margins are also expected to maintain the steady upward trend seen in the third quarter, with net losses continuing to narrow.

III. Operating expenses continue to grow significantly, but operating leverage is released

In terms of R&D, Leapmotor insists on comprehensive in-house development. Previously, in-house development focused more on electrification, but the R&D focus for 2024 will be on new models and intelligent technology. In 2024, new models will be launched with intelligent driving versions, successfully bringing intelligent driving down to the price range of 150,000 to 200,000 yuan. In sales, Leapmotor still positions itself as a manufacturing company and primarily uses dealers, so the proportion of manufacturing personnel is the largest.

1) R&D expenditure: Used for intelligent technology and new model development

In the third quarter, Leapmotor's R&D expenses were 780 million yuan, a quarter-on-quarter increase of 80 million yuan:

In R&D, Leapmotor insists on comprehensive in-house development, focusing on independently developing all key software and hardware for core systems and electronic components of smart electric vehicles. The company produces its core components and some controllers in-house, with strong vertical integration capabilities in the supply chain, currently accounting for about 60% of the BOM.

The company's R&D expenses are mainly used for:

1) Leapmotor is continuously increasing its investment in intelligent driving R&D. Based on the already achieved high-speed NAP and urban NAC intelligent driving functions, it focuses on the R&D of "end-to-end large models" for intelligent driving and will continue to increase investment in manpower, computing power, and equipment in this direction to ensure the R&D of end-to-end AI large models and mass production delivery in 2025.

Leapmotor plans to configure high-level intelligent driving functions based on "end-to-end large models" on the new LEAP 3.5 architecture in the first half of 2025, aiming to rank among the top tier in intelligent driving and create differentiated competitiveness using intelligent driving compared to models in the same price range.

2) The release of new models: Leapmotor will launch the new model B10 in October, positioned as a compact SUV, focusing on the 100,000 to 150,000 yuan market, which is expected to be launched domestically around the first quarter of 2025. In the next two years, seven new models will be released, and R&D expenses will also be invested in new model development.

Leapmotor previously expected that the total R&D expenses for 2024 would increase by 50% year-on-year, implying fourth-quarter R&D expenses of over 880 million yuan, with at least a 100 million yuan increase compared to the third quarter.

2) Selling Expenses: Advertising and Increased Sales Personnel Drive a Month-on-Month Growth of 80 Million

Leapmotor's selling expenses in the third quarter were 550 million, a month-on-month increase of 80 million, mainly due to an increase in sales personnel and a greater investment in advertising.

Leapmotor continues to adhere to the "1+N" channel development model, accelerating channel expansion and transformation, further expanding coverage in blank cities and accelerating penetration into county-level cities.

In the third quarter, Leapmotor net added 19 sales stores and 34 service stores, with new coverage in 17 cities. The channel penetration also reached more customers with budgets of 100,000 to 200,000 yuan for car purchases, accelerating sales conversion.

3) Management Expenses: Relatively Reasonable Control

This quarter's management expenses were 340 million, a month-on-month increase of 40 million, which is relatively reasonable, mainly due to the increase in administrative personnel with business expansion, as well as an increase in taxes and additional fees.

Compared to the previous quarter, there was a month-on-month increase of 160 million, partly due to an increase in option expenses this quarter, which rose by 40 million compared to the previous quarter's 76 million, and partly due to an increase in the number of administrative personnel.

Due to a significant month-on-month increase in gross profit margin and the release of leverage effects from explosive sales, the operating profit this quarter achieved a significant reduction in losses, improving by 530 million to -740 million this quarter, better than the market expectation of -1.3 billion. The net profit improved to -700 million, higher than the expected -1 billion, and the net profit margin also improved by 15% to -7% this quarter, indicating that the turning point to profitability is not far away.