Breakingviews - Buffett-backed BYD could use a battery ram

BYD Co Ltd Chairman and President Wang Chuanfu gestures as he gets out of its hybrid electric car "Qin" at BYD Dreamcast conference in Beijing, China, April 11, 2016. REUTERS/Kim Kyung-Hoon

HONG KONG (Reuters Breakingviews) - BYD’s stock almost doubled this year as China accelerated its electric vehicle drive. Chairman Wang Chuanfu is targeting revenue of 1 trillion by around 2025. Yet earnings at the Warren Buffett-backed carmaker are flagging, and the road looks crowded with rivals. To outpace them, BYD could return to its roots.

BYD is known for electric cars and buses, but the firm started out as a battery factory. Today it is the world’s largest battery maker, according to Bernstein Research, enjoying the lowest production costs in the industry. Controlling this supply chain helped improve margins and build market share for its own-brand autos in China, where BYD made up almost a third of EV sales last year, research by Fitch shows.

Yet BYD is struggling to capitalise on this advantage. Its vertically integrated model means the battery business must grow in sync with EV volumes, a tricky balancing act given volatile car sales. Cuts to subsidies for EVs this year resulted in disappointing earnings – net profit fell by 23.8 percent for the first nine months, compared with a year earlier. At the same time, policies pushing EVs are encouraging rapid market entry.

Doubling down on batteries might be the answer. The company could expand production capacity to sell more of them to other automakers. If China follows through on threats to ban gas guzzlers, there will be guaranteed demand. And providing this particular part may be more profitable than selling the whole. Many electric carmakers struggle to break even, but an operating profit margin of 20 percent is feasible for battery makers, analysts say. The company told Breakingviews that it is exploring this idea, and is even considering the possibility of a spinoff for its battery unit.

There’s no time to lose. Rival battery-maker CATL is plotting aggressive expansion, funded by an upcoming $2 billion listing. Last year CATL tripled production capabilities for lithium-ion car batteries, and it plans capacity of 50 gigawatt hours by 2020, compared with 6.8GWh today.

To compete, BYD will need to find clients quickly and raise more money. Capital expenditure already dwarfs operating cash flows, so free cash flow has been negative since 2013. BYD must race to stay ahead.


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