Justin Sullivan
The Polestar (NASDAQ:PSNY) stock has lost close to 60% of its value since debuting on the Nasdaq in June. As expected, the stock stormed out of the gate without the lofty valuation premiums that its electric vehicle (“EV”) peers had benefited from during public listings in 2021, while continued deterioration to the broader macroeconomic outlook amid surging inflation, rising interest rates, and a looming recession compounded pains.
Earlier last week, the Polestar stock staged a brief relief rally after reaffirming its full year delivery guidance of 50,000 vehicles despite cautioning continued supply chain snarls and ensuing impacts from COVID lockdowns in China in 2Q22. Yet, the Polestar stock’s momentum failed to sustain, imitating EV peer Rivian’s (RIVN) declines following a similar short-lived rally on reiterated full year guidance. Specifically, the stocks gave up their gains following the release of stronger-than-expected jobs data in the U.S. that reinforced wagers for more aggressive rate hikes by central banks over coming months to cool markets and inflation, which would imply further turmoil on corporate growth, profitability and valuations in the near-term.
The selloff continues to underscore elevated market fragility and sensitivity to uncertainties over the near-term macroeconomic outlook, which bodes unfavourably for stocks like Polestar that remain immediately unprofitable under a market climate where investors’ preferences are shifting from “growth at all costs” to “near-term cash flows”. Despite Polestar’s consistent track record in ramping up production volumes at a pace that outperforms its rival EV start-ups, while boasting robust growth in order volumes that continue to outpace supply availability by wide margins, both inflationary pressures and rising borrowing costs now risk derailing its profitability trajectory, which in our view is likely the biggest overhang on the stock’s near-term performance.
While Polestar remains significantly undervalued on a relative basis to peers based on its performance to date, which makes it a reasonable long-term investment at current levels, we remain cautious of near-term volatility as the risk-off environment in equities – especially unprofitable ones – persists on mounting macroeconomic uncertainties.
Polestar’s Delivery Progress and Implications
Polestar has delivered 21,185 vehicles in 1H22, representing an average weekly run-rate of 820 vehicles (inclusive of weekends/holidays for simpler comparison purposes). During the third quarter, the company reported deliveries of 9,215 vehicles, representing a reduced average weekly run-rate of about 700 vehicles, underscoring the toll of amplified supply chain and logistics snarls experienced at Polestar during the three months through September due to COVID lockdowns and a power crunch across its core Chinese production hubs in Chengdu and Chongqing. For the current quarter, the company remains about 19,600 vehicles out from its reaffirmed full year delivery guidance of 50,000 vehicles, representing a required weekly run-rate of more than 1,490 vehicles, which is close to double of what it was during the third quarter. But based on recent remarks from Polestar CEO Thomas Ingenlath, which suggests that the company has already “doubled output” in the current quarter to catch up on lost output during the monthslong COVID lockdowns earlier this year, reaching its full year delivery target is likely still well within reach.
While Polestar has not separately disclosed its production volumes, we expect the ramp-up rate to have improved significantly over the same period considering deliveries remain a function of output. This is further corroborated by Polestar’s recent disclosure that “the majority of Polestar 2 cars set for delivery in Q4 are ready and making their way to [its] customers”.
While Polestar looks set to deliver on its full year unit sales target, it will likely come at a high cost. The company’s recent remarks suggest similar concerns recently raised by industry peers Tesla (TSLA) and GM (GM), which have both alluded to logistics constraints and an elevation in related costs during the third quarter as downside risks to consider on near-term delivery volumes. Based on Polestar’s recent preliminary disclosure of earnings results in 1H22, the company currently boasts slim gross profits that beat the majority of rival start-ups. Yet, the sustainability of this figure is likely at risk considering the expectation for elevated vehicle delivery costs during “peak logistics weeks” – especially as automakers across the industry rush to get completed vehicles on the production floor, which have benefited from easing supply chain constraints in recent months, to customers and make their respective annual sales targets before the year ends. Protracted port congestions in China due to its on-and-off COVID restrictions also risks derailing Polestar’s risk-reward payoff if it decides to press forward with its full year delivery target at all costs – despite a recent decline in “ocean booking levels” in China due to a slowdown in manufacturing orders in recent weeks, they remain elevated compared to trends observed prior to the pandemic, with export freight rates still at an all-time high, challenging Polestar’s bottom-line given all of its worldwide inventory across 27 markets stem from manufacturing facilities based in China.
In addition to the expectation for a logistics cost squeeze at year-end, alongside industry-wide raw material and labour cost increases, Polestar’s margins will likely experience additional pressure stemming from costs of adhering to China’s stringent COVID rules. Just earlier last month, Chengdu became the subject of COVID lockdowns again, forcing Polestar’s parent company Volvo Car (OTCPK:VLVOF / OTCPK:VLVCY) to “suspend work at its factory” in the region. And the recent uptick in infection rates across China on the back of increased mobility during its weeklong National Day holiday risks a repeat of said costly lockdowns – or at the very minimum, expensive operations under a “closed loop” system.
And looking ahead to 2023, Polestar is also expected to experience elevated ramp up costs as it begins volume production on its newest Polestar 3 SUV next year at the Volvo-owned Chengdu and Charleston facilities. With elevated costs stemming from Polestar’s planned growth initiatives now compounded by those stemming from near-term macro headwinds, the company faces risks of a delayed profit timeline that could potentially lead to further volatility in its shares over coming months as market conditions weaken.
Near-Term Catalysts
Recall that profit is a function of both sales and costs. Although costs are expected to remain elevated beyond initial expectations in the near-term at Polestar, its upcoming debut of the Polestar 3 SUV alongside an increasing mix of vehicles sold under its new pricing model introduced in recent months are expected to cushion some of the anticipated pressure on its profit margins.
Polestar is currently preparing for the debut of its flagship SUV, the Polestar 3, on October 12th, at which time it is expected to showcase the vehicle’s performance capabilities as well as pricing. For now, the vehicle is speculated to boast over 370 miles of range on a single charge, with an MSRP at the $70,000-range. The vehicle, which will be Polestar’s first to be built on the “Scalable Product Architecture 2” (“SPA 2”) platform co-developed and shared with Volvo, aims at penetrating the premium SUV segment, with CEO Ingenlath likening its newest model to the Porsche Cayenne.
As mentioned in our previous coverage, the Polestar 3 will open doors for the Swedish EV maker to compete in “one of the highest margin and growth segments across the U.S. and Europe”:
SUVs currently account for about half of new car registrations across Europe and the U.S., two of Polestar’s core operating regions. The Polestar 3’s competitive range capability of 372 miles on a single charge, complemented by advanced autonomous driving and connectivity technologies powered by industry-leading hardware and software from Luminar (LAZR) and Nvidia (NVDA) also makes it an attractive option as EV adoption gains momentum – new EV registrations have continued to expand in strong double-digits, despite a broad-based slowdown in new auto sales this year.
Source: “Is Gores Guggenheim A Buy Ahead Of Its Merger With Polestar?”
And the Polestar 3’s debut comes at an opportune time – not only because it allows Polestar to capitalize on increasing EV adoption momentum across its core operating regions, but also enables the EV maker to additional pricing gains critical to offsetting near-term inflationary pressures. Although the broader auto industry is already starting to see cracks in demand due to a slowdown in big-ticket purchases by consumers amid rising inflation and dwindling budgets – especially as average new vehicle prices surge to a record high of more than $45,000 while the average price tag for EVs surge to $67,000, with car loan interest rates soaring towards 6% – the Polestar 3’s positioning as a premium SUV at average pricing, with performance capabilities and features on par with those at a higher priced segment makes it an attractive option among prospective car buyers within the largest and fastest growing vehicle segment. The vehicle’s higher price tag relative Polestar’s line-up of electric sedans, paired with the new SPA 2 platform that is designed to enable better cost efficiencies and margins are also in the EV maker’s favour for offsetting near-term macro challenges to its fundamental performance. The Polestar 3’s impact on Polestar’s profit margins are expected to become more evident through 2023 once deliveries begin.
Meanwhile, in the immediate term, we expect Polestar’s recently implemented price increases to its Polestar 2 sedans to have a more evident impact on its margins in late 4Q22 through 2023 once vehicles sold under the previous pricing model roll off. The company had earlier announced price increases to two of its three Polestar 2 variants by at least $4,330 over coming months across China to compensate for the “sharp increases in upstream raw materials”. The company had already announced a price hike for its 2023 model Polestar 2 sedans in the U.S. by $2,000 to $2,400, depending on the trim, earlier this year, which we expect provide a cushion for near-term input cost increases and FX headwinds from the surging dollar, and prevent the company from material deviation from its profit realization timeline.
Near-Term Risks to Consider
In addition to production ramp-up and profit margins, investors will also be looking to updates on Polestar’s liquidity position, given its balance sheet and capital structure remains a mystery. Aside from the $1.4 billion in cash and cash equivalents disclosed as of June 30, which is inclusive of proceeds from Polestar’s reverse merger with Gores Guggenheim on June 24th, as well as several credit facilities that provide it with access to about $345 million to support working capital needs, Polestar’s quarterly cash burn rate can only be estimated based on its operating costs disclosed for 1H22. Compared to capital-light peers like Fisker (FSR) and rival EV start-ups like Rivian and Lucid (LCID), which boasts a bigger cheque book and/or have debt/equity financing arrangements in place to fund longer-term capital outlays, Polestar’s liquidity position at the moment is relatively weaker. This is consistent with CEO Ingenlath’s continued evaluation for “funding options including both debt and equity” to fund Polestar’s working capital needs.
Considering the anticipated near-term macro headwinds facing Polestar’s margins, paired with the intensive capital outlay required to fund its longer-term growth initiatives – including new model roll-outs like the Polestar 4 premium SUV, Polestar 5 premium 4-door GT, and recently announced Polestar 6 electric Roadster, as well as continued global commercial expansion – the Swedish EV maker likely faces the need for additional fundraising within the foreseeable future. And this would not be an ideal undertaking under the current market climate, considering elevated borrowing costs that could potentially further weigh on Polestar’s margins, and a broad-based slowdown in the corporate bond and equity markets that would make any securities issuance difficult the in the near term. However, the support that Polestar benefits from parents Volvo and Geely (OTCPK:GELYF / OTCPK:GELYY) – from both an operational (e.g. platform sharing; manufacturing support; etc.) and funding perspective (Volvo alone holds close to 50% equity interest in Polestar) – is expected to offset any near-term liquidity risks.
On a side note though, Polestar’s upcoming 3Q22 earnings release is as much a risk as it is a positive catalyst to the stock. Under the current market where there is no bottom in sight for stocks of high growth, yet unprofitable, businesses like Polestar, the disclosure of its balance sheet would shed light on its book value and potentially result in greater visibility to where the stock might arrest its recent declines, and improve investors’ confidence.
Another near-term risk facing Polestar is its potential loss of market share at a meaningful time for EV adoption in the U.S. Investors are starting to raise concerns over whether Polestar’s lack of production capabilities in the U.S., which would potentially preclude it from some of the financial incentives stemming from the recently enacted Inflation Reduction Act (“IRA”), and dilute its appeal to prospective car buyers. The IRA currently extends a $7,500 tax credit to buyers with individual annual gross income of under $150,000 (or $300,000 for joint filers) on eligible EVs priced at under $55,000 for passenger vehicles and under $80,000 for pickups/SUVs/vans that are assembled in North America. For now, Polestar is not on the eligibility list given all of its vehicles are manufactured in China. However, beginning next year, when the IRA extends 1) $3,500 tax credit for EVs fitted with a battery pack that is assembled in North America, and 2) another $3,500 tax credit for EVs fitted with “battery materials sourced and/or processed in the U.S. or a free trade agreement country”, the Polestar 3 just might be able to make it on one part of the list.
Recall from earlier sections that the Polestar 3 SUV, priced at under $80,000, will begin volume productions at Volvo’s Charleston facility beginning 2023, which will likely meet the “domestic assembly” criteria and put the vehicle on the eligibility list for $3,500 in tax credits for buyers. However, it is currently uncertain whether the Polestar 3’s battery cells will meet the America (or free trade agreement country) cell composition threshold (minimum 40%) to extend buyers with the second $3,500 increment in tax credits, given China’s CATL is currently one of its key suppliers, second to LG Chem (OTCPK:LGCLF). Ineligibility would likely dull Polestar’s allure in the American EV market when compared to rivals like the Tesla Model 3/Y and offerings by legacy automakers at a time when domestic demand is expected to reach an inflection point. However, considering Polestar continues to sell every car it makes, with “strong momentum in [its] global order take” and robust delivery growth, the EV maker likely already benefits from growing brand traction across its global operations, and establishing share gains in other fast-growing markets – namely, China and Europe – to compensate for any potential weakness in the U.S. market over coming years.
Final Thoughts
While Polestar continues to outperform peers in terms of ramping up output volumes, thanks to its competitive advantage stemming from platform-sharing and manufacturing support from parent companies Volvo and Geely, it remains victim to market’s unforgiving hand over unprofitable, long-duration stocks. With the Federal Reserve still fixed on an aggressive monetary policy tightening trajectory that risks stifling growth in consumer end-markets like auto, coupled with protracted inflationary pressures that are poised to impact industry-wide profit margins in the near-term, the Polestar stock will likely remain an underperformer in public markets and trade at the sub-$10 level.
We believe the stock remains a favourable investment from a long-view perspective considering its gradual market share gains and proven competitive advantage in operating a capital light business model that also benefits from additional cost efficiencies stemming from operational overlaps with parent companies Volvo and Geely, which is further corroborated by its positive, albeit slim, auto gross margins to date – a rare find across EV pureplays. But until there is greater visibility into its capital structure and alleviation in monetary policy tightening, the Polestar stock will likely be subject to further volatility that can unleash a lower drop.
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