I never want to presume anything. But I genuinely believe that if we’re being honest, the meteoric rise of China’s electric vehicle industry is reminiscent of the internet bubble of the late 1990s to early 2000s. During that cray-cray period, anything associated with the burgeoning world wide web became a gold mine … until it wasn’t. And that fear has paused many investors from taking the dive into Li Auto (NASDAQ:LI) stock.
Then again, you look at the direct competitors and the broader alternative energy vehicle space, from Tesla (NASDAQ:TSLA), compatriot Nio (NYSE:NIO) and Plug Power (NASDAQ:PLUG). These and many other names have skyrocketed, offering blistering profits to stakeholders at a time when many of our fellow Americans are contemplating suicide because of the stress and massive job losses linked to the novel coronavirus pandemic.
But then, some of us comfort ourselves with the fact that China is the biggest automotive market in the world. At that point, another emotion becomes even more powerful than fear – the fear of missing out (or FOMO). Certainly, when the industry is booming and naysayers are routinely ridiculed on the blogosphere, LI stock seems incredibly compelling.
Let me be fair though. Not everything about the bullishness in LI stock is associated with collective investor emotions. Far from it. Instead, Li Auto has the foundations to be wildly successful:
- A dynamic, visionary founder in the form of Li Xiang, the Elon Musk of China? Check.
- An attractive product at a compelling price, in this case an electric SUV? Check.
- Strong financial performances, such as being the first Chinese EV startup to post a profit? Check.
You can go down into the granularity and find many other positives that are incredibly encouraging for LI stock. Yet the bullishness in a consumer segment at a time when people from first-world countries are thinking about ending their lives because of the economic hopelessness should make you uneasy, despite the awestriking data.
What the heck gives? Frankly, I think we’re asking the wrong question.
Retention, Not Revenue Is the Key for LI Stock
I know a few people that have made the switch to Tesla EVs and all rave about the innovation. From the quiet cabin to the myriad technologies available, they swear that they’ll never go back. Anecdotal? Yes, but there’s a long history of consumer satisfaction that indicates that my friends’ feedback is the rule, not the exception.
Therefore, if an analyst wanted to throw out crazy price targets for TSLA, I’d still be skeptical to a degree. Admittedly, though, there’s more than enough credibility to justify the bullishness. But modeling that assumption into something like LI stock may be a serious mistake. Bluntly, American manufacturers generally have greater quality control mechanisms and a higher level of integrity than their Chinese rivals.
I justify this “outrageous” statement because as Bloomberg contributor Adam Minter stated, Chinese EV makers have been plagued with poor quality and reliability issues. Sure, the quantity component in terms of auto deliveries are impressive. Still, Minter encourages a holistic perspective:
But quantity can’t obscure what one Chinese energy journal last month referred to as the industry’s “Qualitygate” scandal. The numbers are damning. In 2018, Chinese manufacturers recalled 135,700 NEVs for a crushing 10.8% industrywide recall rate. Already this year, another 23,458 electric vehicles have been recalled.
Batteries are the most common source of problems. Some don’t perform as advertised. Others drain unusually fast. Still others run dangerously hot. More than 40 NEVs spontaneously combusted in China in 2018.
More importantly, this isn’t a random hit job. Interestingly, Reuters detailed the testimony of Wang Haichun, who bought a Nio ES8 and almost immediately felt buyer’s remorse. The ES8 failed to live up to its range capacity and Wang ended up buying a Lexus NX300h gasoline-electric SUV.
By the way, Lexus is the luxury brand of Toyota (NYSE:TM). Toyota is a Japanese company. More on that soon.
Wang’s awful story isn’t alone. According to a Chinese consumer survey, 70% of respondents stated “they regretted buying an electric car, mainly due to problems with battery quality.”
In other words, to buy LI stock is to assume that somehow, poor quality that is notorious in China didn’t creep into the underlying company. But if you’re thinking that, I would recommend taking a moment to rethink the narrative.
Quality Isn’t in the Blood for Chinese EVs
A few weeks ago, I was speaking with a commodities expert regarding the international steel market. I’ll never forget what the expert told me: German and Japanese steel is the best in the world because quality is in their blood.
I was startled when I heard this. But at the same time, it was a revelation. You see, the main difference between Chinese and Japanese business culture – there are always exceptions, we’re not talking about that – is that the former expends effort primarily for the money, while the latter does it for honor as well as for the capitalist motive.
In Japan, I’ve never seen advertisements encouraging people to go the extra mile. There, the extra mile is expected.
You’re probably not going to hear this blunt assessment from any other writer or analyst. But I genuinely believe that the reason the Chinese haven’t cracked the battery quality code, as stated by Green Car Reports, is that it’s not in their nature.
If it were, Chinese customers wouldn’t jump ship to Japanese cars! Believe me, more than a few big city Chinese (Shanghai particularly) have made it clear that we’re enemies for no other reason than immutable characteristics for which I have zero control. There is no love lost in this centuries-old rivalry.
Now, that’s not to say that Chinese manufacturing is flawed. No one – and I mean no one – can hold a candle to Chinese production at scale. That is certainly in their blood.
But this is also the quandary of LI stock and other Chinese EV makers. Cars are expensive. They’re supposed to go the distance. That means the investor framework is all twisted up. Prospective buyers shouldn’t care as much about deliveries – everyone knows the Chinese can sell low-priced goods at ridiculously high volumes.
The question is, will the customer come back? Unless Chinese quality control and corporate integrity magically skyrocketed over the course of a year, you should be at least cautious about LI stock.
On the date of publication, Josh Enomoto did not have (either directly or indirectly) any positions in the securities mentioned in this article.
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.