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Despite still being a more resilient corner in the broader auto sector, investors’ angst over EV demand risks are growing given the impending recession. Jitters in the EV industry have only intensified in recent months after Tesla (TSLA) – which has long touted supply chain constraints as the “biggest brake” on growth- saw an accelerated pace of inventory build-up in the second half of 2022 in tandem with deteriorating macroeconomic conditions.
But the major overhang for EV start-ups like Lucid (NASDAQ:LCID) remains on ramping up productions and converting hefty order books into realizable revenue before buyers take a step back on big-ticket purchase decisions ahead of the broader economic downturn. Following delivery and production misses at key rivals Tesla and Rivian (RIVN) reported earlier this month, Lucid’s full year production and delivery numbers are next on the watch list for EV investors. We remain confident in Lucid’s prospects of having achieved in line performance, which would be a breath of fresh air amid dour sentiment in recent weeks, albeit its much more tempered guidance stemming from two consecutive cuts that were painful to stomach earlier this year.
Looking ahead, continued production ramp-up and an ensuing pick-up in delivery volumes remain a key focus area for investors. Attention will also be directed to early take-rates on the Gravity SUV, which will open up reservations coming spring ahead of its planned start of productions in 2024, as the related figure will likely serve as a gauge for the brand’s traction gained in recent years from its flagship Air sedan, as well as resilience against looming macro challenges. And in line with the broader shift in investors’ preference for profitability over growth in times of elevated market uncertainty, any management commentary at the upcoming earnings report on how Lucid can benefit from tax incentives under the Inflation Reduction Act (“IRA”) would also be another point of interest – especially given Lucid’s outlook as an unprofitable automaker within the foreseeable future.
From a valuations standpoint, the Lucid stock’s valuation premium relative to peers has significantly diminished since our last coverage, which in our view would reduce its exposure to further multiple compression as a result of the looming recession’s drag on broader market performance. The company’s recent capital raise also bolsters its cash runway required to support multi-year growth initiatives including international expansion and new vehicle productions. While volatility will likely remain the theme for Lucid and its counterparts in the capital intensive and recession-prone auto sector – especially given its unprofitable nature – continued consistency in ramping up productions and positive progress on materializing its longer-term growth initiatives will be key to reinforcing investors’ confidence in the stock. In the following analysis, we will dive into why improving deliveries will be just as important as ramping up production volumes for Lucid as rising competition and looming recession risks make key themes within the auto industry this year.
Ramping Up Production and Improving Logistics
Lucid has continued to make meaningful positive strides in ramping up production and delivery volumes since re-strategizing its logistics plan at Casa Grande. Production volumes have been accelerating since supply pressures that have previously weighed on the broader auto manufacturing industry continue to ease. The latest results also highlight the positive impact of the company’s recent decision to internalize logistics capacities, eliminating a likely significant bottleneck pertaining to quality control and deliveries experienced during the first half of the year. Recall that Lucid has had a tough feat getting vehicles produced out the door during the first half of the year, after experiencing delivery delays and quality control issues due to inefficiencies of punting a part of said undertakings to “third-party logistics companies“, which has since been reverted to an internalized strategy:
We have made a significant decision to bring our logistics operations in-house. We’ve made key hires to the executive team, and we’ve restructured our logistics and manufacturing organizations accordingly.
We accelerated access to our logistics center as part of our Phase 2 expansion in Arizona. And within a couple of months, we expect to have our logistics center on site at AMP-1, which should help mitigate and begin to eliminate the logistics bottlenecks as well as reduce costs of the shipping and handling of parts. Furthermore, we’re overhauling our logistics processes and introducing a series of improvements to simplify the system and yet make it more efficient and robust.
Yet, narrowing the gap between production volumes and the number of cars actually delivered to customers remain a challenging feat for upstarts like Lucid, which management had cautioned during the third quarter earnings call:
The variance between production and deliveries was primarily a function of vehicles distributed across three areas of the delivery process, vehicles in transit, vehicles awaiting pre-delivery inspection and vehicles awaiting delivery to a customer.
As we mature as a business, we’ll continue to learn and refine our in-transit inspection and delivery processes. So in the near to medium term, we expect vehicles produced to place at a higher volume than vehicle deliveries as we accelerate our production and we initiate international deliveries in the fourth quarter, the latter which requires longer in-transit times.
Unlike Tesla, which has seen its production-delivery gap widen at an accelerated pace in recent quarters that can no longer be attributed solely to “outbound logistics capacity” constraints at period end, the case is different for Lucid. With an order book of more than 34,000 reservations as of November 7, any completed inventory remains the result of acute logistics challenges still at the young automaker. Having produced about 3,687 vehicles and delivered about 2,437 in the first nine months of 2022, Lucid has a delivery-to-production ratio of merely 66%, compared to Rivian’s 86% over the same period (or 84% for the full year 2022), underscoring the significant improvements required still on its recently internalized logistics capacity ramp.
And making up for the shortfall in this aspect is gaining urgency. Given the looming economic downturn and increasing competition, delaying deliveries and conversion of reservations to sales could elevate risks of customer loss altogether. Specifically, new vehicle pre-order volumes are already showing cracks in auto demand, as surging borrowing costs and sticker prices continue to deter buyers.
The average monthly auto financing payment has steadily climbed to $717, up 50% from 2010 as the average annual percentage rate (“ARR”) reached a record-setting 6.5% in the December-quarter, versus 5.7% in the September-quarter and 4.1% in 2021, in response to the Fed’s aggressive rate hiking cycle to tame generation-high inflation. And close to a fifth of new car buyers that have opted for the financing option – the preferred payment method on new vehicle purchases in the U.S. – are paying monthly installments of more than $1,000, up 10.5% from in 2021 and about 7% in 2020. As the cash stash among Americans continues to dwindle ahead of growing macroeconomic uncertainties and tightening financial conditions, affordability concerns will likely become a more prevalent overhang on auto demand in the near-term. This is further corroborated by increasing consumer bargaining power observed in the used car market – a typical gauge for where “new car demand is headed” – in recent months, as “average daily sales conversion ended December at 50.7%”, which is meaningfully lower than the pre-pandemic average of more than 52%.
Yet, as discussed in our previous coverage on the stock, we believe Lucid’s premium pricing strategy remains a competitive advantage amid mounting macroeconomic challenges to the broader auto demand environment:
Lucid’s pricing power as a luxury premium EV maker also makes a competitive advantage by absorbing some of the near-term cost pressures and safeguarding auto gross margins from macro-driven erosion in addition to higher ramp-up costs at early-stage production…the company is expected to see more evident auto margin improvement in the fourth quarter and through 2023, when it plans to ramp-up production to capacity and roll off of legacy orders placed prior to the June MSRP increase. The upcoming start of productions of the higher-priced Lucid Air Sapphire trim is also expected to contribute positively towards the company’s forward auto margins, offset by related ramp-up costs in early-stage production of said vehicle variant.
Source: “Is Lucid Stock A Buy After Q3 Earnings? Double Miss Implies More Turbulence“
While looming recession risks continue to weigh on the broader auto sector, with growing investors’ angst spilling over to the more resilient EV segment as of late, there is still a meaningful population of Americans – about 4 million to 7 million – still in the market for a new rig. Much of this cohort represent prospective buyers that were either previously priced out of the hot auto market or still waiting for availability of their preferred pick. And with inventories coming back after two years of acute supply chain constraints, many remain incentivized to return to auto show rooms this year. In addition to mass market offerings, demand for premium ($100,000-plus) choices like the Lucid Air and upcoming Gravity SUV are likely to prove more resilient ahead of the looming downturn, since affluent buyers are relatively less sensitive to tightening financial conditions. Despite heading towards more normalized levels as discussed in the earlier section, excess American savings still topped $1.7 trillion as of the second quarter last year. And a significant portion remains “held by the top two quartiles”, which could be a crucial trend for buffering demand in the premium vehicle segment despite recession headwinds this year.
But on the other hand, the U.S. is expecting to gain more than 20 new EV models this year, underscoring increasing saturation within the nascent, yet highly competitive, industry. While the demand environment for Lucid will likely remain relatively resilient against what is expected to be a “mild recession” this year, whether it can capitalize on said growth opportunities will continue to hinge significantly on its ability to both ramp up productions and improve its logistics capabilities. Although internalizing logistics at Casa Grande earlier last year was a swift and prudent call by management to mitigate unnecessary weight on already acute supply chain bottlenecks, the next hurdle will be on getting finished inventory out the door at a pace in tandem with an accelerating production ramp-up.
The Bottom Line
The Lucid stock has been resilient relative to sharp declines observed across rival EV pure-plays entering into the new year, despite aggressive bounce-backs across the sector in recent weeks. This is further corroborated by the stock’s intraday gains of as much as 10% before paring to 6.6% at close on Monday trading (January 9), outperforming Tesla’s rally which helped the tech-heavy Nasdaq 100 defy risk-off sentiment over Fed officials’ reiterated hawkishness, and underscoring a gradual return in investors’ confidence. But whether it is sustainable will continue to hinge on the company’s ability to demonstrate consistent positive progress on its longer-term growth plans, spanning production ramp-up, and global market share expansion – especially as mounting macroeconomic uncertainties like persistent inflation and rising borrowing costs in the near-term turn investors “more exacting in terms of which companies they are willing to back” with a broad-based risk-off sentiment for “negative free cash flow projects” still.
Looking ahead, Lucid’s announcement of full year 2022 delivery numbers and earnings results will be a key determinant for its shares’ near-term performance. Specifically, in line production volumes with its guidance, which is still a reasonable expectation given the accelerated pace of ramp-up observed in the third quarter, would further bolster its valuation prospects at current levels, which have already been subjected to a significant correction in 2022 to reflect both difficulties in the capital-intensive auto-making business as well as broader macroeconomic challenges. But we believe delivery volumes will also be admitted to investors’ rolling list of key watch items for the stock going forward, as near-term recession risks and more structural competition headwinds pick-up over the coming months.
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