Philippine Markets Newsletter

Renewable energy tailwinds are driving this battery company forward, resulting in Uniform ROAs 4x stronger than as-reported

September 1, 2021

This company’s offerings are gaining a lot of demand, thanks to the renewable energy trend. However, as-reported metrics do not seem to take into account these industry tailwinds and the company’s partnership efforts, reporting lackluster returns.

Also below, Uniform Accounting Embedded Expectations Analysis and the Uniform Accounting Performance and Valuation Tearsheet for the company.

Philippine Markets Daily:
Wednesday Uniform Earnings Tearsheets – Asia-listed Focus
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The energy storage industry plays an important role in the renewable energy trend, as technology would be crucial in deploying clean energy. Solar and wind energy are popular sources of clean energy. However, since their output is as fickle as the weather, grid operators may have trouble with energy distribution. 

To lessen the use of non-renewable energy, governments around the world support the use of its alternative: renewable energy. With this, the energy storage industry will also benefit and is projected to witness significant growth going forward.

Another trend in the energy storage market is consumers shifting from the traditional lead-acid batteries to lithium-ion batteries. With the latter’s higher recharge rate, longer lifespan, and higher energy density, it is expected to continue to grow going forward.

Moreover, lithium-ion batteries are seeing huge demand from the current electric vehicle (EV) trend. These batteries are currently seen to be the most feasible choice to make EVs more economical, given its advantages relative to the traditional ones.

These industry tailwinds are benefiting the company in focus today.

Contemporary Amperex Technology Co., Limited (CATL) is an energy storage solutions provider based in China with chief business interests in the development, manufacturing, and sale of lithium-ion batteries. It’s also known to be the second-biggest producer of Lithium-ion batteries in the world.

To take advantage of the growing demand to go green, specifically in electric vehicles, the company has formed partnerships with some of the biggest names in the automobile industry.

CATL has been in agreement with Tesla to supply lithium batteries through 2022. It recently extended its contract with the EV maker, effectively making CATL the supplier of batteries for Tesla’s electric vehicles until 2025.

Furthermore, CATL has also partnered with Volkswagen AG. Volkswagen’s Group and its joint venture of EVs are currently equipped with CATL batteries, and the company plans to adopt more CATL-made batteries going forward.

In 2019, the company entered into an agreement to supply lithium-ion batteries to Daimler Truck AG. It recently announced that these two companies are intensifying their partnership, with CATL being the supplier of batteries for Mercedes-Benz’s eActros LongHaul battery-electric truck, which was planned for production in 2024.

Given these massive contracts with automobile manufacturers, one may expect CATL to generate robust returns. However, it’s as-reported ROAs are weak, ranging only from 3% to 11% for the past five years.

This is not the real profitability story of CATL. Uniform Accounting shows that the company’s real profitability is a lot stronger than what as-reported metrics imply.

For the past five years, Uniform ROA have ranged from 11% to 55%.

What as-reported metrics fail to do is to consider the company’s excess cash on the balance sheet. While most companies inherently need some level of cash to operate, the portion of that balance that is earning limited or no return—or excess cash—ends up diluting as-reported ROAs.

When excess cash remains included in the company’s asset base while computing its performance metrics, the company’s profitability and capital efficiency may appear weaker than it actually is.

Removing excess cash allows investors to see through the distortions that come from management carrying much more cash on the balance sheet than what is operationally required.

From 2016 to 2020, CATL has had a significant amount of excess cash sitting idly in its balance sheet, ranging from 24% to 38% of its as-reported total assets.

After excess cash and other necessary adjustments are made, we can see that CATL’s current returns are actually a lot stronger than what as-reported metrics show. Without these adjustments, it appears that the company’s product diversification initiatives are not translating into profitability, leading to significantly poorer valuations.

CATL’s profitability is much more robust than you think 

As-reported metrics are distorting the market’s perception of the firm’s profitability. If you were to just look at as-reported ROA, you would think that the company is a weaker business than real economic metrics reveal.

CATL’s Uniform ROA has been higher than its as-reported ROA in recent years. For example, when Uniform ROA was at 55% in 2016, as-reported ROA was only 11%.

The company’s Uniform ROA for the past five years has gradually declined from 55% to 11%, while as-reported ROA showed a decline at lower levels, decreasing from 11% to 3% in the same timeframe.

CATL’s Uniform earnings margins are weaker than you think but its robust Uniform asset turns make up for it

Volatility in Uniform ROA has been driven by trends in both Uniform earnings margin and Uniform asset turns, with peaks and troughs lining up historically with that of Uniform ROA.

Uniform margins gradually fell from 25% in 2016 to 9% in 2020. Meanwhile, Uniform turns followed a similar trend, declining from 2.2x in 2016 to 1.2x in 2020.

SUMMARY and Contemporary Amperex Technology Co., Limited Tearsheet

As the Uniform Accounting tearsheet for Contemporary Amperex Technology Co., Limited (300750:CHN) highlights, the Uniform P/E trades at 89.5x, which is above the global corporate average of 21.9x and its own historical average of 59.1x. 

High P/Es require high EPS growth to sustain them. However, in the case of CATL, the company has recently shown a 38% Uniform EPS contraction.

Sell-side analysts provide stock and valuation recommendations that in general provide very poor guidance or insight. However, sell-side analysts’ near-term earnings forecasts tend to have relevant information.

We take sell-side forecasts for  Chinese Accounting Standards (CAS) earnings and convert them to Uniform earnings forecasts. When we do this, CATL’s sell-side analyst-driven forecast is a 154% and 58% EPS growth in 2021 and 2022, respectively.

Based on the current stock market valuations, we can use earnings growth valuation metrics to back into the required growth rate to justify CATL’s CNY 502 stock price. These are often referred to as market embedded expectations. 

CATL is currently being valued as if Uniform earnings were to grow 66% annually over the next three years. What sell-side analysts expect for CATL’s earnings growth is above what the current stock market valuation requires in 2021, but below that requirement in 2022.

Furthermore, the company’s earning power is 2x the long-run corporate average. Also, cash flows and cash on hand are more than 4x its total obligations—including debt maturities, capex maintenance, and dividends. All in all, this signals a low credit and dividend risk. 

To conclude, CATL’s Uniform earnings growth is below its peer averages, and the company is also trading below its average peer valuations. 

About the Philippine Market Daily
“Wednesday Uniform Earnings Tearsheets – Asia-listed Focus”

Some of the world’s greatest investors learned from the Father of Value Investing or have learned to follow his investment philosophy very closely. That pioneer of value investing is Professor Benjamin Graham. His followers:

Warren Buffett and Charles Munger of Berkshire Hathaway; Shelby C. Davis of Davis Funds; Marty Whitman of Third Avenue Value Fund; Jean-Marie Eveillard of First Eagle; Mitch Julis of Canyon Capital; just to name a few.

Each of these great investors studied security analysis and valuation, applying this methodology to manage their multi-billion dollar portfolios. They did this without relying on as-reported numbers.

Uniform Adjusted Financial Reporting Standards (UAFRS or Uniform Accounting) is an answer to the many inconsistencies present in GAAP and IFRS, as well as in PFRS.

Under UAFRS, each company’s financial statements are rebuilt under a consistent set of rules, resulting in an apples-to-apples comparison. Resulting UAFRS-based earnings, assets, debts, cash flows from operations, investing, and financing, and other key elements become the basis for more reliable financial statement analysis.

Every Wednesday, we focus on one company listed in Asia that’s relevant to the Philippines and that’s particularly interesting from a UAFRS vs as-reported standpoint. We highlight one adjustment that illustrates why the as-reported numbers are unreliable.

This way, we gain a better understanding of the factors driving a particular stock’s returns, and whether or not the firm’s true profitability is reflected in its current valuations.

Hope you’ve found this week’s Uniform Earning Tearsheet on an Asian company interesting and insightful.

Stay tuned for next week’s Asia company highlight!

Angelica Lim
Research Director
Philippine Markets Daily
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