hapabapa
Electric vehicle (“EV”) stocks have been subject to violent valuation corrections this year, with many upstarts having lost more than half of their values since the start of 2022. For premium EV maker Lucid (NASDAQ:LCID), which has seen its shares lose 60% of their value this year, is already considered a resilient contender, hovering in the teens over the past six months despite shocking investors with a second slash to annual production guidance in early August due to protracted logistics and supply chain challenges.
As Lucid’s peers start to report preliminary 3Q22 delivery numbers – a metric that Lucid has not historically provided in advance of its earnings release – markets are starting to observe early signs of impact from softening consumer confidence amid a looming economic downturn. While EV demand remains resilient, auto sales are starting to slip beyond what can be attributable to ongoing supply chain constraints. And the market has also responded accordingly amid a risk-off environment for equities. For instance, Rivian’s (RIVN) rally on its reiterated production guidance earlier this week was short-lived, while Tesla’s (TSLA) elevated valuation also buckled on its 3Q22 delivery miss.
Turning to Lucid, although its revised guidance in 2Q22 was a tough pill to swallow, it might have done it some good by lower execution risks compared to peers as the axe drops further on valuations across the broader EV sector. While production ramp-up remains a key focus area, investors are also increasing their attention to deliveries, which are crucial to sales realization needed to alleviate inflationary pressures on profit margins – especially after Lucid’s price hikes implemented earlier in the summer.
The following analysis will discuss key considerations pertaining to Lucid’s anticipated progress on maintaining demand, ramping up productions, and increasing delivery volumes ahead of its 3Q22 earnings release, and gauge their related implications on the stock’s near-term performance as macro conditions continue to deteriorate.
Demand
Aggressive rate hikes remain the key macro theme over coming months with major central banks fixed on reining in record-high inflation. This has accordingly driven higher borrowing costs that risk stifling growth, causing valuations to contract across the board. Analysts have also flocked to trim earnings estimates due to expectations for a double whammy on margins ahead of anticipations for both growth deceleration and rising input costs.
Despite the growing sound of easing supply chain constraints that have hampered production volumes in the first half of the year, U.S. auto sales are likely to have declined y/y – or at best, flat – during the third quarter. Meanwhile, inventories are being replenished at an accelerating rate over the same period, stripping the weight of previous narratives that the auto industry remains a supply-constrained environment with no signs of demand destruction despite recession risks.
Looking ahead, markets are expecting auto sales to return to growth in the fourth quarter with easing bottlenecks in the supply chain to support the narrative that the auto industry remains resilient; if sales continue on a decline / flat, then chances are, cyclical headwinds are starting to hit the industry. Market forecasts for full year 2022 auto sales have already been revised downward in recent weeks from the previous 14.4 million units to now 13.7 million units in anticipation of a consumer pullback – especially from the middle- to lower-income cohort.
Yet, the premium auto segment which Lucid operates in is expected to be more resilient. With the average EV price now exceeding $67,000 – which effectively prices out close to half of Americans from buying one – due to price hikes favoured by automakers to compensate for inflationary pressures, and aggressive Federal Reserve rate hikes that have dialed up auto financing rates from an average of 4.3% in 2021 to more than 5.7% during 3Q22, the new vehicle market is expected to tilt “further into luxury territory, as high-income buyers are often able to pay cash or secure better loan rates”. This is consistent with the fact that the recently enacted Inflation Reduction Act has no direct incentive for buyers of premium vehicles like the Lucid Air (although Lucid does benefit from a $10/kWh pack assembly credit as a reward for its efforts in bolstering supply on American soil via the LMP-1 unit at its Casa Grande, Arizona facility). Paired with still-robust EV take-rates in the U.S. that have continued to grow while new car sales have remained largely muted, Lucid continues to benefit from favourable market trends in terms of demand.
The anticipated resilience in demand for Lucid’s vehicles, despite a weakening economy, is further corroborated by its substantial order book growth from 30,000 units as of early May to more than 37,000 in early August, without consideration of the 100,000-vehicle reservation from the Government of Saudi Arabia. While the looming economic downturn – current consensus estimates on the probability of a recession in the near term is as high as 98% – introduces risks to auto demand momentum over coming months, we expect Lucid’s demand to remain relatively resilient given its market is positioned primarily in the more premium sector. And Lucid’s ongoing overseas expansion efforts, with its latest store opening to take place in the Middle East before the end of the year, are also expected to broadcast the brand’s awareness and contribute further to continued order book growth, mitigating near-term demand risks.
Production
Production ramp-up remains a key focus area for investors when it comes to EV start-ups that have boasted lofty valuations and aggressive growth promises before unprecedented challenges spanning chip shortages, logistics constraints, and rising raw material costs started to mount. This is further corroborated by the unforgiving selloff after Lucid’s decision to slash guidance for a second time following its 2Q22 earnings release. Production progress matters to investors, primarily because ramping up to scale means improving profit margins, and cars are getting out the door, a critical factor for converting reservations into realized sales.
Despite an eventful 1H22 where Lucid has blamed its production and sales shortfalls on the combination of shortages in glass and carpet supply when the industry was grappling with a shortage of semiconductors, and logistics challenges, we expect the situation to have improved in 3Q22. This is primarily because units that were backlogged as “work in progress” during 2Q22 due to late-quarter enhancements made to Lucid’s production quality processes are likely to have been completed in 3Q22 while easing supply chain constraints observed across the broader auto industry implies positive progress on ramping up its overall output volumes over the same period. Lucid is likely to have benefited from completing its limited run on the Lucid Air Dream Edition as well, dedicating focus on ramping up mass production models like the Air Grand Touring, Air Grand Touring Performance, Air Touring, and Air Pure.
Since Lucid does not separately disclose monthly/quarterly production volumes from delivery volumes, we have done some back-of-the-napkin calculations to gauge its average output run rate. Considering Lucid delivered 360 vehicles in 1Q22, and another 300+ vehicles in April alone, the EV maker has likely produced about 700 vehicles during the first three months of the year. And based on its latest disclosure of 1,405 vehicles produced in 1H22, Lucid has likely maintained a quarterly output run-rate of 700 vehicles, plus a handful that was backlogged as work in progress due to logistics challenges that have hampered parts supply and enhancements made to production quality processes.
This leaves Lucid about 4,595 vehicles out from the lower range of its production target (i.e., 6,000 vehicles) for the year. Taking into consideration the near-finish units that were backlogged as work in progress in 2Q22, which we assume to be in the range of 500 to 600 vehicles based on an estimated average weekly production run-rate in the 100-vehicle range over the same period based on publicly available aerial views of Lucid’s Casa Grande manufacturing facility, Lucid likely started 2H22 with about 4,000 vehicles to go in order to satisfy the lower range of its full year production guidance.
This accordingly translates to a required average weekly production run-rate of about 152 vehicles over 3Q22 and 4Q22, which we view as achievable given easing supply chain snarls -a key “gating factor” on production volumes at Lucid during 1H22 as discussed in the earlier section. The required production run rate is also relatively modest when compared to peers like Rivian, especially considering Lucid has taken immediate actions in mitigating production challenges by bringing “logistics operations entirely in-house” and enhancing production quality processes on the manufacturing floor, which point to an even higher exit production ramp-up rate in 3Q22 that is expected to maintain momentum into 4Q22.
Although Lucid’s slashed guidance in 2Q22 has done a degree of damage to its credibility, we believe it has dialed down its execution risks for the remainder of the year when compared to peers. The reasonably conservative narrative taken by management might have been a prescient move, considering supply chain challenges remain a fluid situation, despite early signs of easing over the past several months (e.g., rising auto inventory levels; improved 3Q22 auto production levels). Any further setback to estimated forward production volumes paired with the dire market climate today would be detrimental to valuations. While Lucid’s 3Q22 production progress will remain a mystery until its earnings release in November, it appears that sufficient internal action has been taken to remedy the early-year stall in output volumes, with easing supply chain constraints playing to its favour over coming months.
Deliveries
Production ramp-up has historically taken precedence over delivery volumes when it comes to key focus areas for investors in the EV sector, given the former translates into more direct cost and profit implications. But given the near-term expectation for weakening macro conditions, investors are now paying more attention to delivery volumes as well. Recall that reservations and completed vehicles (i.e., production volumes) do not translate to revenues until they have been delivered. And with rising inflationary pressures eating into margins, automakers across all price and vehicle segments, including Lucid, have implemented price hikes. But again, these price hikes do not impact profit margins until vehicles ordered at the new price have been produced – and delivered. So delivery volumes are becoming just as important to investors as production volumes, given their increasingly critical role in alleviating cost pressures on profit margins. This is consistent with the Tesla stock selloff earlier in the week when its deliveries missed consensus estimates due to logistics challenges.
Turning to Lucid, it has had its fair share of logistics challenges this year too. But instead of last-mile logistics challenges in getting cars to customers’ hands – the type experienced by Tesla in 3Q22 – Lucid had logistics headaches when it came to getting supplies to its production line which hampered volumes in 2Q22. Considering Lucid has taken immediate actions to remedy the situation by taking its logistics operations “entirely in-house”, the company has likely addressed lengthy lead times in 3Q22, which benefits production volumes as discussed in the earlier section, while also making favourable contributions to profit margins by “reducing various costs” as a result of the newly implemented strategy.
Now, turning to last-mile logistics constraints that have been chimed by auto peers like Tesla and GM (GM). Both have alluded to “logistical issues” for its softer-than-expected delivery volumes over the past quarter, with Tesla citing challenges to securing sufficient “vehicle transportation capacity and at a reasonable cost” during peak delivery season at quarter-end, and GM pointing to most completed vehicles still being in transit to dealerships/customers.
Considering Lucid had volumes that were near completion in 2Q22, the company was likely able to get some units out the door at a spread-out timeline throughout 3Q22 to prevent a logistics bottleneck at quarter-end like those experienced by peers. This should complement anticipated improvements to its production volumes – or in the bear case, compensate for any shortfalls in production volumes to expectations. From a longer-view perspective, we expect the favourable margin impact from price increases implemented by Lucid to be more evident in volumes produced and delivered in 4Q22 through 2023 as it rolls off from deliveries of the low-trim models under the original pricing model.
Final Thoughts
We expect the broader EV sector to remain volatile over the coming months given their elevated valuation premiums to the broader auto industry still, especially considering most remain unprofitable which does not bode well with increasing investors’ preference for near-term cash flows and profitable growth to compensate for elevated risks in equity investments under a constrained economy. In the near-term, production ramp-up and delivery volumes will remain key focus areas for EV investors – not so much demand since it still outpaces supply by wide margins – as the two factors directly impact profit margins and imply whether a specific company can remain resilient amid a rapidly deteriorating macro backdrop.
For Lucid, although we expect things to have improved in 3Q22 based on near-completion work in progress that has been rolled over from 2Q22 and easing supply chain constraints observed across the industry, production ramp-up remains a weak link for the stock. While we believe the slashed production guidance has played a critical role in reducing Lucid’s execution risks relative to peers for the remainder of the year, its exposure to said risk remains elevated nonetheless, given industry-wide supply chain constraints ranging from material shortages to logistics bottlenecks continue to evolve.
Looking ahead, investors will have to wait until November to know Lucid’s actual 3Q22 results and commentary on its forward guidance. In the meantime, we expect the stock to move in tandem with its EV peers and the broader market, which will likely be volatile given tightening monetary policies that have heightened recession risks, compounded by growing pains of an auto sales slowdown as consumer sentiment wanes.
While Lucid’s longer-term growth prospects remain intact given its continued focus on getting different variants of the Lucid Air off the production line, alongside overseas expansion to grow its global footprint and market share within the burgeoning EV sector, we caution near-term risks that will continue to weigh on the stock before its upsides (PT $29) can prevail. The stock could very well stay rangebound in the teens for longer – even if it reiterates its full year production guidance and/or shows significant ramp-up progress, given related gains may not be able to sustain amid a market-wide sell sentiment, as recession risks, inflation, and Fed monetary policy tightening remain fluid factors.
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