As a group, electric vehicle (EV) stocks have been among the biggest winners of 2020 — and maybe the biggest. But even by the standards of the sector, the recent rally in XPeng (NYSE:XPEV) stock has been spectacular.
In just 16 trading days, XPEV stock has gained 232%. We’ve seen huge moves in EV stocks, but in recent trading I can’t think of a bigger, faster spike than the one XPeng stock has posted.
From a long-term perspective, the gains should be sustainable. This rally isn’t a bubble. In fact, this rally makes sense.
Investors are reacting to good news on the ground in China, as well as blowout results from XPeng itself. I’ve long been a bull on EVs myself, and in a way, the market is simply catching up.
But from a near-term perspective, I do think XPeng stock has a pullback in it at some point. These kinds of parabolic rallies often lead to a reversal. The market as a whole looks jittery, especially for high-valuation stocks.
Overall, as I said before, XPEV stock is going to be a long-term winner. But a little patience should result in a better near-term price.
Why XPEV Stock Has Soared
There have been two pieces of headline news that have led to this parabolic rally.
First, XPeng posted strong delivery numbers for October. Total deliveries more than tripled year-over-year.
That’s a huge acceleration in growth: September deliveries were up just 31%. That figure was enough to move XPEV stock higher, if modestly so. And so it’s no surprise that investors cheered the October figure.
Ten days later, XPeng provided more reason for optimism. Third-quarter earnings smashed expectations, as revenue more than quadrupled year-over-year.
Admittedly, the sales figure was somewhat known, given that XPeng had given color on deliveries. But what surprised, and heartened, the market was that the company posted a positive gross profit.
That doesn’t sound like much. A business is supposed to make net profit — which covers operating expenses and taxes — not just gross profit. The 4.6% gross margin XPeng reported in Q3 at first glance looks bearish, not bullish.
But this is an auto manufacturer that is still ramping its business. Auto manufacturing is a fixed-cost business, which takes years to scale. XPeng’s two plants, according to a recent prospectus, have combined annual capacity of 250,000 units. That said, XPeng delivered less than 9,000 vehicles in Q3.
In other words, XPeng isn’t yet harvesting the benefits of scale. Yet, it’s already able to price the vehicles well enough to make a gross profit in the early going. Investors, correctly, believe that shows the potential for far greater gross profits down the line — which, in turn, will lead to bigger net profit.
XPeng has an obviously massive opportunity. China is the world’s most populous nation: nearly one in five people on Earth live in the country. The Chinese government also continues to push (and subsidize) electric vehicles, as a part of fight to improve some of the world’s worst pollution.
Additionally, that opportunity might be getting larger, as Chinese EV growth is picking up steam. A prime example is how EV sales in the country more than doubled in October.
Thus, we can see why this story is so attractive. XPeng is growing deliveries at a rapid pace. The gross profit surprise in Q3 shows the company isn’t using aggressive pricing or discounting to make those deliveries. Rather, Chinese consumers simply want to buy XPeng’s P7 sedans and G3 sport utility vehicles.
Meanwhile, the market itself is posting explosive growth.
In turn, this is the combination that has underpinned most of the best equity investments of the past few years: strong performance in a fast-growing market. Investors obviously are betting that XPEV stock will be the next big winner. In that context, this huge rally makes some sense.
Patience Will Pay Off With XPEV Stock
All that said, there’s a case to be made that investors shouldn’t necessarily chase these gains.
XPEV stock’s trading itself suggests some caution. The company only went public in late August. And after an initial public offering (IPO), stocks generally see some volatility, as the supply of the stock is limited. That both amplifies demand and leads to the potential for short squeezes, a possible minor catalyst for the recent rally.
Additionally, it’s also worth noting that investors weren’t really that excited for the XPeng IPO. It priced at $15, but after the usual first-day “pop,” XPEV stock went nowhere for two months. (In fact, the stock actually faded from its initial close.)
Again, the results of late do change the story. But it doesn’t appear there was an enormous base of buyers as the company went public.
Finally, some investors are going to question valuation. Analysts will as well: XPEV stock has raced past the consensus price target of $35. I personally don’t put a ton of faith in Wall Street, but other investors do. And they may see the gap between the target and the price as a reason to sell — or, at least, stay on the sidelines.
Collectively, it bears repeating: I like the long-term story here. Owning a major EV manufacturer in China will be a profitable endeavor. And if an investor wanted to buy, or stick with, XPEV stock at this price, I certainly wouldn’t blame them.
However, we’ve seen this story before, even with many of the market’s biggest winners. Parabolic rallies usually lead to at least a modest reversal before the upward climb resumes. And I wouldn’t be surprised to see the same trend play out here, meaning nimble investors should have an opportunity to own this attractive story at an even more attractive price.
On the date of publication, neither Matt McCall nor the InvestorPlace Research Staff member primarily responsible for this article held (either directly or indirectly) any positions in the securities mentioned in the article.
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