"Too much light often blinds gentlemen of this sort. They cannot see the forest for the trees."
-Christopher Martin Wieland (1733-1813), Musarion , Canto II
The above line comes to mind when reading articles debating earnings results, cash position, R&D spend, or prospects of Kandi Technologies Group, Inc. (NASDAQ:KNDI), one of the great emerging growth stock opportunities of our time.
It's my belief KNDI is to personal intracity transportation what Tesla Motors, Inc. (NASDAQ:TSLA) is to the open road. And like TSLA, KNDI is led by a visionary leader pursuing an exceptional, elegant strategy that gives KNDI an edge over its competitors. Unlike TSLA, KNDI's market cap hovers near $800 million, while TSLA boasts a market cap of $32 billion, over 40 times greater than KNDI as of today. Headquartered in Jinhua, Zhejiang Province, China, KNDI has established itself as China's leader and one of the world's largest manufacturers of pure electric vehicles (EVs), and the story is just beginning, or more appropriately ─ the race has just begun.
A question often asked by fellow KNDI shareholders, especially the friends and family variety, is how to value KNDI if not on its earnings potential? I believe valuation begins with a strategic assessment of the market the company serves and the company's strategic positioning.
First the Market
As an early-mover in EVs in China, KNDI's market potential is huge. China's population of approximately 1.36 billion is slightly less than the combined populations of the United States, Europe, and South America. Twenty-two Chinese cities have populations greater than 5 million. Seven have populations greater than 10 million, and three have populations greater than 20 million. The combined metro populations of Shanghai and Beijing, about 42 million, exceed the population of California.
The Peoples Republic of China ("the PRC") set an annual economic growth rate of 7% in its current five-year plan, and a key driver to China's economy is greater consumer mobility. As one would logically expect, China leads the world in the sales of cars.
Smog is a grave personal health issue in China's cities and the internal combustion engine ("ICE") is a major contributor. Images of people wearing breathing masks during the Beijing 2008 Olympics portrayed a continuing everyday reality in China's cities that worsened from 2008 until now. So much so that in March this year, the PRC declared a war on pollution.
The macro issues of smog and oil consumption deny the continuing proliferation of the ICE car in China. Efforts in the war on pollution include controlling the proliferation of ICE cars by limiting the issuance of ICE license plates and restricting the use of ICE cars on certain days of the week. In addition, the PRC recently announced some five million aging ICE cars will be taken off the highways by 2015 and announced additional measures to increase that number to thirteen million.
The Solution - Electric Vehicles
In China today, EVs are the best intracity solution for greater personal consumer mobility, continued economic growth, and fighting pollution. The PRC recently mandated that by 2016 thirty percent of all government procured vehicles must be EVs, all but assuring the PRC will reach its stated goal to have five hundred thousand EVs in use by 2015 and five million by 2020. To drive the adoption of EVs, the PRC provides subsidies and other incentives for buyers of Chinese-manufactured EVs. A recent Seeking Alpha Instablog provides links to current studies by McKinsey and J.P. Morgan citing key China EV market metrics, PRC policy statements, and commitments to spurring EV development and utilization. Today, central and local government subsidies cover as much as eighty percent of the cost of an EV.
In June 2013, KNDI launched Carshare (aka "Micro Bus"), a personal, intracity, EV transportation system that provides EV rental service at a cost less than a taxi, while resolving the issues of range anxiety, ownership, insurance, battery charging, parking or garaging, and environmental disposition of batteries. Carshare provides EV rental at airports, train stations, hotels, business centers, selected residential areas, any place that is the focus of commuter traffic.
Carshare was launched in Hangzhou, the fourth-largest metropolitan area in China with a metro population of 20 million, and since has launched in Shanghai. KNDI is in discussion with Beijing, Chengdu, Zhuhai, Chongqing, Suzhou, Nantong City and other cities about initiating Carshare.
Kandi Long-Term Group Leasing
In June 2014, KNDI launched China's first pure EV pilot communities in the Lake District of Hangzhou, where 700 residents registered for the EV long-term group leasing program and now has over 2,000 EVs leased under the program either to communities or business enterprises. By all measures KNDI leads in the emerging EV market in China, a key strategic attribute for eventual market dominance and higher relative valuations.
Projections and Valuation:
"Simplicity is the ultimate sophistication." ─ Leonardo Da Vinci
The objective of every company is to seek, obtain, and serve customers profitably ─ and this is especially critical for new companies in new industries. How well a company achieves that objective determines its market share relative to its competitors. Companies with the greatest market share in its served market tend to be the most profitable over time.
What typically drives market share is the perceived quality of the company's product and service offerings relative to its competitors. The entire value proposition starts with the customer - if you give customers the value they want they tend to buy more, and if so, the company will almost always increase in value.
By this measure alone, giving customers what they want, KNDI appears to be on the verge of breaking out. Revenues for 2013 increased approximately 50% over 2012 revenues and first half 2014 revenues indicate full year 2014 revenues more than doubling from 2013. Industry conditions, China central government policy, and consumer sentiment have set the stage for KNDI's 2015 revenues to double again, perhaps tripling, or even quadrupling over 2014 revenues. Expectations are high, as they should be.
Though expectations are high, KNDI is a relatively new company serving a new industry with high-growth potential. Accordingly, of the generally accepted valuation methodologies ─ revenue, earnings, cash flow, or equity; revenue-based is the methodology most appropriate and useful for valuing KNDI. When seeking a quote on Yahoo! Finance the PSR (P/S-TTM) is presented under the Key Statistics section on the right hand side in the middle of the page. The price to sales ratio is calculated by dividing the market capitalization by the trailing twelve months (TTM) revenue. The market capitalization is calculated by multiplying the outstanding common shares by the current price quoted for the stock, also found on the Yahoo! Finance page when seeking a quote. Any full quotation service provides this same information.
During the early stage of rapid market expansion and related high sales growth it's expected KNDI will make infrastructure investments in capacity and people that can negatively skew earnings and cash flow. Additionally, necessary growth-related financing activities typically have costs that skew earnings even though the costs may be non-cash. For the foreseeable future a revenue-based valuation is appropriate for valuing KNDI.
Ultimately earnings and cash flow-based valuation methodologies will be useful to augment a revenue-based valuation of KNDI. But that will come later when earnings and cash flows are more reliable and therefore more predictable, thus enabling more meaningful analysis and projections.
Price to Sales Valuation
KNDI has approximately forty-four million shares outstanding but I also use fifty-four million shares outstanding in the valuation model. Filing a $300 million mixed securities S-3 shelf registration affirms KNDI's intent to raise capital within the foreseeable future. Effectiveness of the S-3 shelf registration was issued August 6, 2014, which has the added benefit of quieting any concerns about an SEC investigation or any accounting issues regarding KNDI that have been raised in recent Seeking Alpha and other published articles.
What I find particularly remarkable is that sales of 70,000 units will generate over $1 billion in revenues, less than a quarter of KNDI's current manufacturing capacity. The above revenue projections are used to determine the projected market capitalization and resulting projected price-per-share assuming a price to sales ratio or multiple consistent with comparative valuations.
In the valuation model I use a price to sales ratio of 4. At the close of the market on Yahoo! Finance on August 11, 2014 you would have found a price to sales ratio of 6.30 for KNDI. You will find comparative price to sales ratios of 12.65 for TSLA, 18.97 for Facebook, Inc. (NASDAQ:FB), 13.85 for LinkedIn Corporation (NYSE:LNKD), 29.45 for SolarCity Corporation (NASDAQ:SCTY), and 5.48 for Netflix, Inc. (NASDAQ:NFLX). Personally I believe a price to sales ratio of 6 appears to be a conservative ratio for KNDI. Comparative price to sales ratios (new industries/services, early market-movers, emerging market leaders) demonstrate the ratio could easily be increased 50% to 100% for determining KNDI's value for valuation analysis.
Comparative valuation exercises are useful to help determine whether a stock would be considered cheap, fairly-priced, or overpriced. Today KNDI certainly appears cheap relative to future revenue potential considering the time element required to saturate the China market KNDI serves, and relative to comparative valuations. For example, Pacific Crest analyst Brad Erickson thinks TSLA is "attractively valued" when looking at the TSLA's growth trajectory setting a price target of $316 based on a valuation of 4X projected EV/2016 revenue.
Determining KNDI's near-term value on the same basis Brad Erickson used to value TSLA, I would project KNDI's 2016 revenues in the range of $1 to $1.5 billion and using a price to sales ratio of 6, a price target of $117 to $167 would appear reasonable assuming 54 million shares outstanding. With 44 million shares outstanding the price target would be $143 to $205.
Based on KNDI's current market capitalization, early stage of market development, and comparative price to sales ratios, it could easily be argued KNDI could be valued with a price to sales ratio 50% to 100% greater than four which would yield price targets 50% to 100% higher. Ultimately "the market" will determine price to sales ratio deemed most appropriate based on KNDI's emerging fundamentals. For now I opt for the conservative price to sales ratio of 6.
Beyond China, the question is "then what?" It's certainly a question worth considering at some point in time. For now there is more than sufficient market potential to serve in KNDI's home market to satisfy potential investor's consideration of KNDI.
KNDI has the capacity to produce 300,000 EVs annually, with the capability to expand to 500,000 in the relative short term. KNDI has strategic relationships with State Grid, the largest electric utility in the world supplying electricity to over 1.2 billion Chinese citizens, a joint venture with Geely, the largest independent automobile manufacturer in China, and Wanxiang Group Corporation, the largest China-based automotive components company measured by revenues and a company committed to developing EV batteries and becoming a larger player in the worldwide EV market. These key strategic relationships and other strategic relationships are critical if KNDI realizes a sharp increase in demand such as expected for 5,000 and then 10,000+ units per month.
With the second half of 2014 underway and a record first half 2014; KNDI has just crossed the starting line in its race to serve the world's largest automobile market the most elegant, personal, intracity transportation system until someday, "Beam me up, Scotty."
In my opinion, modest expectations for 2015 would be a doubling of EV shipments and revenues, and increasing profitability and positive cash flows. KNDI should then be on course to achieve the billion dollar sales threshold in 2016.
Disclosure: The author is long KNDI. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.