CSIHawaii
I am a licensed professional engineer specializing in control systems. I originate from near Liverpool England and now live in Maui, Hawaii - which gives me a sense of great achievement :) I am a long term investor with 30 years experience and a focus on businesses with exceptionally high growth... More
Kandi Simply Explained, And Its Valuation 2
2014 Q4 10K Update....
Kandi has been quietly progressing for several years manufacturing a variety of products, now known as its legacy business. During this time, Kandi was developing its Electric Vehicle [EV] technology and production capability as a first mover. In about 18 months, Kandi has transformed itself into the leading Chinese EV manufacturer it was always intended to be. The new Kandi EV business model consists of 3 entities, Kandi, the Kandi JV and ZZY. Although ZZY is essentially independent, these 3 entities operate under the Kandi brand and Kandi management, and their operations are often reported in the media as "Kandi." The Kandi business model was conceived by Mr Xiaoming Hu, Kandi Chairman/CEO and Kandi JV Chairman, who manages the overall operation. The 3 entities form a supply chain: Kandi sells parts to the Kandi JV, the Kandi JV sells EVs to ZZY, and ZZY rents or leases EVs to the public. The Kandi JV makes direct sales to government and corporate and just announced it will commence direct sales to the public.
Kandi Business Model
Kandi continues operating the more profitable components of its legacy business, continues manufacturing EV parts to supply the ever-growing needs of the Kandi JV, receives 50% of the Kandi JV profits. Kandi continues to be the brains and management behind the business model operation, hiring, innovation, R&D, government relations and individual city government negotiations.
The Kandi JV manufactures and sells EVs, primarily to ZZY. It is a 50/50 partnership with Geely, the largest auto manufacturer in China (and owner of Volvo). Both Kandi and Geely have transferred manufacturing facilities into the JV and additional manufacturing facilities are currently under construction in Hainan and Jiangsu Provinces. Kandi and Geely will both be equally responsible for the planned additional manufacturing facilities as the Kandi JV grows rapidly. Production capacity is 230,000 EVs/year with 1 shift, expanding to 430,000 EVs/year with 1 shift. Soon, due to this rapid growth, the Kandi JV entity will dwarf Kandi.
ZZY (aka Zhejiang ZuoZhongYou Electric Vehicle Service Co.) is 19% owned by the Kandi JV and 81% owned by Jia Xing Jia Le Investment Partnership Enterprise. This gives Kandi a 9.5% interest. ZZY is the revenue engine for the business model. ZZY purchases only Kandi model EVs, from the Kandi JV. The cost of the EVs, after applying central and local government subsidies, is approximately 30% of full sale price. ZZY therefore has reduced capital costs and can offer competitive pricing. ZZY raises revenue through 3 programs, collectively called Micro Public Transportation:
Car-Share Program which is an extension of the city public transport system, similar to existing bike-share programs. Users rent by the hour from/to multiple locations within the city and the cost is much cheaper than would be taxi. Renters can reserve and pay via Alibaba's mobile Alipay with no deposit required.
Group Long Term Lease Program available for residential communities via their community organization, or business enterprises, or government entities. Leases are normally for 3 years.
Individual Long Term Lease Program. Leases are for 1, 2 or 3 years and cost is higher than for Group Leasing.
Subsidies
National government subsidies are claimed by the Kandi JV at the end of each quarter and payments are received about 4- 5 months later. The Kandi JV sells the EVs with the subsidy deducted and the subsidy amount goes into the Kandi JV's accounts receivable until the national subsidy is paid. Local government subsidies are claimed by the buyer, predominantly ZZY and paid after a yet to be determined delay. In the meantime the increasing subsidy amounts that are due to ZZY go into ZZY's accounts receivable. Local governments have procrastinated, firstly in passing the subsidy laws and secondly in implementing the administration. Different local governments are at different levels of progress. Since local governments are in contract agreements with the national government it is certain that the local subsidies will be paid.
The national government has declared that subsidies will be extended through 2020. 2020 is also the national government's target for having 5 million NEVs on the roads. NEVs (new energy vehicles) include Hybrid EVs and Pure EVs. Since 5 million will be only 1/50 of the cars and trucks currently on the road, expect the subsidies to be extended beyond 2020. When subsidies finally end the market will be huge and mass production costs will be much lower, and battery technology much improved and also with much lower costs.
Market Forces
In the past year the China Central Government and Local Governments have declared war on the internal combustion engine (NYSE:ICE) vehicles. Government is compelled to do this due to deadly pollution levels and to protect their economy from future astronomic increases in oil imports. They are additionally developing a strong EV manufacturing base that can dominate world trade as ICE vehicles gradually become extinct. Government has introduced many deterrents to ICE ownership and obstructions to their operation. At the same time they have introduced incentives to ownership of EVs and benefits to their operation. Inevitably, public demand is moving from ICEs to EVs.
China has a population of 1,368 million. In 2014 annual car and truck sales, almost all ICE powered, reached 23.5 million units. At a 9% annual growth rate 2020 car and truck sales will reach 39.4 million units - a huge and still growing market. What percentage of this market will be buying an NEV in 2020 after 6 more years of government pressure and technological development? In 2014 the China NEV annual growth rate was 380%. Pause and think about that - now give this paragraph a 2nd read.
Kandi Growth
Kandi's FY 2014 showed that Kandi has returned to profitability. This is nice but the real key to Kandi's value is GROWTH. For 2014 over 2013 Kandi's income statement top line appears to show growth was 1.8x but that would be an incorrect assumption because it excludes Kandi's primary business, EV manufacturing. Kandi reported elsewhere the Kandi JV top line which appears to show growth was 14.2x. This is also misleading because EV manufacturing operations were transferred from Kandi's financials to the Kandi JV's financials in 2014 and true growth rate cannot be determined without looking at both sets of financials. Kandi's earnings PR failed to even mention growth rate, leaving investors to figure it out for themselves. Since Kandi owns 50% of the Kandi JV:
Revenue = 100% Kandi Revenue + 50% Kandi JV Revenue
2014: $170,229,006 + $107,768,602 = $277,997,608
2013: $94,536,045 + $7,606,174 = $102,142,219
Kandi's complete business GROWTH was 2.7x
In 2013 Kandi sold 4,694 EVs, of which 3,463 went into the ZZY Micro Public Transportation program. In 2014, the new Kandi JV sold 10,935 EVs, all of which went into the ZZY Micro Public Transportation program. The Micro Public Transportation sales increased 3.2x and a similar increase is very likely in 2015 as cities and provinces move to meet their 2015 target commitments to the central government which total 500,000 NEVs.
At the end of 2014Q3 Kandi had sold EVs to ZZY in Hangzhou and Shanghai. At the end of 2014Q4 Kandi had expanded EV sales to 9 cities, mainly provincial capitals: Hangzhou, Shanghai, Chengdu, Nanjing, Guangzhou, Wuhan, Changsha, Changzhou and Rugao. The total EVs in Micro Public Transportation was 14,398, up from 3,463 one year earlier, up 4.2x. Most Chinese cities have populations of several million and Shanghai 22 million. Hangzhou has a population of 6 million and the original estimate of Micro Public Transportation EVs required was 100,000. The 2014Q4 total of 14,398 is therefore just the beginning.
Future Progress
Many more 1st and 2nd tier cities are interested or currently in negotiations with Kandi and ZZY. News could break on Beijing, Zhengzhou, Haikou and Shenzhen. Hainan and Jiangsu provinces (where Kandi will soon complete building new manufacturing facilities) each have agreements to put a minimum of 20,000 Kandi EVs into service per year. In January 2015 Kandi made its first sales to government.
ZZY is at the beginning of an exponential growth phase. ZZY purchases have enabled the Kandi JV to be the top Pure EV seller in China in 2014 with 10,935 units sold. Kandi is ranked 10th in world NEV sales and 4th in Pure EV Sales - and Kandi is only selling in China. In 2015 3x 2014 growth in EV sales should be easily achieved due to government targets, pressure and incentives. Mr Hu expects production (and therefore sales) to reach 100,000 EVs/year within 1 to 2 years.
In 2015 Kandi will release 4 new technologically advanced models, the not yet named SMA7002BEV05 (luxury sedan), the Cyclone (sedan), City Beauty (mini) and City Cowboy (mini). The new models will have improved technology batteries providing increased driving range and longer battery life at less cost. The luxury sedan will target government and enterprise fleet sales and leasing. Central and local governments are mandated to have 30% new energy vehicles (NYSE:NEV) by 2016 and this percentage will be increased beyond 2016.
Improving technology is the basis for Kandi's decision to commence direct sales to the public and therefore it is only relevant to the new models. This will be a second revenue generator in addition to sales to ZZY and government. Geely already has nearly 1,000 sales outlets (4S stores) throughout China and nearly 200 abroad, and is the owner of Volvo which has many more sales outlets. A direct sales network is already in place.
Valuation - based on 14Q3+Q4
Method:
Slow-growth and no-growth businesses can be evaluated based on earnings (preferably adjusted earnings) and therefore their P/E ratio can be used for valuation. Kandi has solid earnings (unlike fellow EV manufacturer Tesla) but at this stage of growth those earnings are not representative of Kandi's true value.
Start-ups and high growth businesses often have no/low earnings (due to the extra costs of growing a business) and therefore their Price/Sales (P/S) ratio is best used for valuation. Businesses in this category can support high P/S ratios, e.g. Baidu (NASDAQ:BIDU) 9, Facebook (NASDAQ:FB) 18, Google (NASDAQ:GOOG) 6, LinkedIn (NYSE:LNKD) 15, Alibaba (NYSE:BABA) 19, Tesla (NASDAQ:TSLA) 8 (was previously 12), Kandi (NASDAQ:KNDI) 3.5 GAAP [2.2 non-GAAP].
Kandi's EV business is a start-up and a high growth business with a disruptive technology and can therefore support a P/S ratio greater than 6. I am tempted to choose in Tesla's range of 8 to 12, but to be conservative I will use a P/S ratio of 6. If P/S = 6, P = S x 6.
Kandi's financial reporting accounts for its interest in the Kandi JV and ZZY by using the equity method and therefore does not consolidate the Kandi JV and ZZY revenues into its financials. The reported revenue excludes Kandi's primary business, EV manufacturing, and tertiary business, EV rental/leasing. A proportion of the Kandi JV and ZZY sales revenues are attributable to Kandi using non-GAAP accounting. For business valuation purposes it is appropriate to combine sales revenues from all parts of Kandi's business.
i.e. Sales = 100% Kandi Sales + 50% Kandi JV Sales + 9.5% ZZY Sales.
Since ZZY Sales have not been disclosed, I will conservatively exclude that entity from the calculation.
Since Kandi's business growth rate is high, I will use the last 2 quarters sales (as most relevant) and x2 to create an annualized value.
Calculation:
All values taken from 2014 Q3 10Q and 2014 Q4 10K
Q3+Q4 Sales = (100% x $97,097,657) + (50% x $135,620,966) = $164,908,140
Q2+Q3 Sales Annualized = $164,908,140 x 2 = $329,816,280
Weighted Average Diluted Number of Shares = 43,530,185
Sales Per Share = $329,816,280 / 43,530,185 = $7.58
Price Per Share = $7.58 x 6 = $45.48
Share Value as of December 31 2014 = $45.48
The above is a trailing valuation, not a forward valuation.
Trailing valuations are based on hard facts whereas forward valuations are based on informed guesses.
The Kandi JV sold 10,935 EVs in 2014.
Those that study Kandi guess that the Kandi JV will sell 30,000 to 50,000 EVs in 2015.
There may be additional shares issued, although Company has stated it will not be necessary.
My conservative guess is that in Q3+Q4 2015, Sales Per Share will be at least triple to $22.74
Forward Price Per Share = $22.74 x 6 = $136.44
Forward Share Valuation for December 31 2015 = $136.44
PPS Analysis
Why is the current share price ($13.02) severely lagging the trailing valuation?
Four reasons...
Poor investor relations. Lack of communication. Communication with understatement, brevity and poor word choice and no concept of Wall Street marketing. This may be tempered soon because Kandi will be hiring a well known US PR firm. It will likely be a partial solution because management in China will likely continue to hold back information. Kandi also fails to release monthly production and sales numbers to the Chinese media resulting in it looking bad in comparison to other EV manufacturers. The Company's website is not used effectively and the server is often inaccessible. The veil of secrecy may be a deliberate strategy to keep ahead of the competition.
Hedge fund short manipulation. Short has sustained a major loss, is trapped, pays average of 60% APR to borrow shares, and incurs additional losses to control the trend. Short interest is currently 1.2 million below its all time high at 6,781,969 on 2/27. This is like a coiled spring under the stock price. Kandi will produce a steady stream of good news as the business expands, eventually triggering a release of the energy stored in the spring. The result will be a short squeeze or a series of mini short squeezes.
Many investors do not do serious due diligence and their perception of value is based on current stock price and recent trend. This enables the hedge fund short to control the trend - until he can't.
It is normal for share prices to be either much lower or much higher than reasonable valuation for micro and small cap stocks. When a business is succeeding, the transition from much lower to much higher can happen rapidly.
Common Questions
1. Are you recognizing Kandi sales to the Kandi JV twice?
No but at first glance it appears so.
Only profit is of value, not sales. However P/S ratio is a valuation method used in start-up/high growth stages of a business when profit is negative/zero/spotty. Currently both Kandi and the Kandi JV profits cannot be considered as a reliable basis for valuation. For sales based valuation, the sales used have to be indicative of future profit as the business matures.
The Kandi JV will buy parts from various parts manufacturers including Kandi. Kandi sells parts at market price. Buying from Kandi is a legitimate "cost of sales" that does not diminish gross margin and indication of future profit. Therefore 50% of the Kandi JV sales are attributable to Kandi for P/S valuation purposes. It is immaterial that Kandi is one of the parts manufacturers.
Parts is one of Kandi's new high growth revenue channels and it makes little difference whether it sells parts to the Kandi JV or any other EV manufacturer since Kandi sells the parts at market price. Parts sales have their own independent gross margin and indication of future profit.
On this basis both sets of sales are indicative of separate future profits and can legitimately be attributed to Kandi for P/S valuation purposes.
2. Is Kandi selling to itself?
No under GAAP rules which Kandi follows. Yes in lay terms because we can say that the Kandi JV is 50% self and ZZY is 9.5% self, however it would be better for investors if each was 100% self.
If Kandi owned 100% of the Kandi JV and 100% of ZZY it would be better for Kandi investors because they would get all the profit from all 3 stages of the supply chain. Of course, if this was the case, Kandi would be following GAAP rules and restructuring its financials differently.
Shorts tell lies via distortion and innuendo and have been blurring the distinctions in GAAP reporting rules by saying Kandi is selling to itself and inferring that this is both fraudulent and bad for investors. Tell that to an oil company that owns a supply chain producing, refining and marketing product.
3. How can you justify valuation with a P/S of 6 when Ford has a P/S of 0.44?
Growth rate and future growth rate are the primary justification.
Ford is a lumbering giant, not a growth stock, and its valuation is largely based on earnings. Modest growth over 3 years is likely to have less affect on earnings than other factors. Investors are pricing the company for low growth, which causes the P/S to be very low.
Tesla (TSLA) has a P/S of 8 with no earnings and no prospect of significant earnings for 5 years. Current earnings is not of prime importance to growth investors. Investors are pricing the company based on growth and growth prospects, and they presume that after growth will come earnings. Analysts are predicting a Tesla growth rate of almost 2x per year.
Kandi is already growing earnings. In 2014/2013 Kandi's attributable revenue growth was 2.7x, and this is at the same time as transitioning EV manufacturing operations from Kandi to the Kandi JV. EV unit sales growth was 2.3x but due to unit price increases, EV $ sales growth was 4.6x. EV unit sales into ZZY Micro Public Transportation growth was 3.2x. The market forces in 2015 are greater than in 2014. I therefore conservatively expect Kandi growth rate and future growth rate to be >3x.
Take a 3 year period: Tesla is expected to grow <2x per year, so total growth is <6x and this warrants a P/S of 8. If Kandi grows 3x per year, total growth is 27x and this therefore warrants a P/S of [off the scale]. To be conservative let's just say Kandi warrants a higher P/S than Tesla but to be ultra conservative I choose a lower P/S than Tesla, i.e. 6.
4. Will Kandi face competition?
Yes. The growth prospects are irresistible but Kandi is a 1st mover and 2014 EV sales leader.
5. Why is air pollution in China a major force for change?
Watch the brilliant, moving, explicit Chinese documentary "Under the Dome."
6. Who is Mr Xiaoming Hu?
An engineer and entrepreneur with strong business and political associations, well respected within the PRC and frequently honored.
From Bloomberg: Mr. Xiaoming Hu has been Chief Executive Officer and President of Kandi Technologies Group, Inc. since June 29, 2007. From October 2003 to April 2005, Mr. Hu served as the Project Manager and Chief Scientist in the PRC Pure Electric Vehicle Development Project. From October 1984 to March 2003, he served as a Factory Director in Yongkang Instrument Factory, Factory Director in Yongkang Mini Car Factory, Chairman and General Manager in Yongkang Vehicle Company, General Manager in Wan Xiang Electric Vehicle Developing Center, and General Manager in Wan Xiang Battery Company. He owns 3 Invention patents, 5 utility model patents, over 10 appearance design patents.
