BYD: Should you follow in Buffet’s footsteps?

BYD has now become the largest manufacturer of electric vehicles in the world, in addition to having built one of the largest electronics companies in the world. This phenomenal entrepreneurial story at the crossroads of genius and opportunity could not be better described than by Li Lu himself:

“BYD’s story is relatively simple. Wang Chuanfu, Founder and CEO of BYD, who is a really great engineer, started the company with just a loan of $300,000 with no extra money until the IPO. He’s built a company with $8 billion in revenue and 170,000 employees and tens of thousands of engineers, he’s solved a whole bunch of different problems, so the track record is impressive, they’re in the right industry and in the right environment, and they get the right support from the government.

The company now owns a large electric car company, a small gasoline car company, a huge battery company and a lithium mine near Tibet. It is also in talks to buy six lithium mines in Africa.

“We have an interesting venture capital type business, and BYD has got into a business that it has never been in before, which is monorails. And they’re selling monorails like you can’t believe (…) And they also sell these big buses, etc. Wang Chuanfu is a combination of Thomas Edison and Jack Welch – something like Edison to solve technical problems, and something like Welch to do what needs to be done. ‘ve never seen anything like it,” Charlie Munger said in 2018.

It all started in 2001 when a Shenzhen-based lithium-ion (“li-ion”) and nickel rechargeable battery maker, BYD (“Build Your Dreams”) enjoyed a huge tailwind due to the boom in the use of mobiles, electric and electronic. devices. The company is already the world’s third largest Li-ion battery manufacturer.

The dramatic rise in demand for li-ion batteries, driven by the mass adoption of cell phones, laptops and other devices, is increasing the company’s revenue and profit. The company makes several acquisitions, including a 15% stake in BYD Auto in 2004 – aimed at using the latter as a platform to develop battery-powered vehicles.

By 2010, BYD was already selling 500,000 vehicles a year and entered into a memorandum of understanding with Daimler, under which the two parties will cooperate in China to develop passenger vehicles powered by electric motors. In the handset component business, management says betting on a vertically integrated model has created a lasting price advantage – a claim backed up by impressive results.

Revenues have jumped in recent years

Just before the start of the pandemic, a third of vehicles sold were new energy vehicles. Similarly, sales of electric buses are progressing thanks to numerous foreign orders.

How have they fared since 2018? Revenue doubled again in the past five years, from $18 billion to $36 billion. This means that over the past fifteen years, revenues have increased thirty-six times. But that epic run has also been accompanied by perpetual margin compression, with BYD’s operating profits trending sideways for several years.

Growth in the electronics sector has slowed, and Chinese electric vehicle producers have been overly dependent on state subsidies, which are being reduced or redirected elsewhere. No one knows how BYD’s sales will fare in an environment without subsidies. There is no visibility on BYD’s real ability to generate cash income, as growth consumes all resources.

From a free cash flow perspective, the last two earnings reports have been impressive, but they have benefited from unusual inventory releases due to the pandemic, which freed up huge amounts of working capital. Other than that, capital expenditure is higher than ever and is expected to eat up all the money for the foreseeable future.

Not for just any investor

Market cap and enterprise value are roughly equal at $130 billion. Apart from all the usual precautions for investing in China, we can say that in the end it remains a story of believers. Much of the appeal is that Berkshire Hathaway still owns one-fifth of the share capital. But this investment is not easy to understand because it is changing so quickly, on such a large scale.

A distinct competitive advantage that needs to be highlighted is BYD’s fully owned and integrated supply chain, from the lithium mines in Tibet to its vast battery manufacturing base. Other automakers depend on external suppliers for batteries and raw materials. BYD’s vertical integration model should deliver the same kind of cost advantage as in its electronics business.

Either way, conservative investors will likely pass on this one. After all, Warren Buffett, Charlie Munger and Li Lu invested when BYD shares were trading at rock bottom valuations. To quote Munger: “It was pounded so hard, it was Graham-like stock. Graham stock in a start-up.”

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