Kandi Simply Explained, And Its Valuation

SUMMARY

• As the stock price has declined substantially, the business has grown substantially.
  
• The Company is #1 in Pure EV Sales in China for 2014 and 2015 first half.
  
• The Company is a first mover in a rapidly growing sector that will ultimately dominate car and truck sales in China.
  
• The Company beats Tesla ($TSLA) on growth rate, profitability and prospects, and is not yet in the spotlight.
  
• Q2 Company guidance indicates surging sales in the 2015 second half.
  

 Kandi ($KNDI) has been quietly progressing for several years manufacturing a variety of products, now known as its legacy business. During that time, Kandi was developing its Electric Vehicle “EV” technology and production capability as a first mover.  In about 24 months, Kandi has transformed itself into the leading Chinese EV manufacturer it was always intended to be.  Production capacity has grown from 30,000 EVs/year to 330,000 EVs/year. EV sales channels have been created. EV sales are at least doubling annually and are projected to reach 400,000/year by 2020 in the Company’s most recent guidance. Kandi is participating in a disruptive technology that is creating a sea change in personal transportation in China. The stock market is pricing Kandi based on earnings with no growth. The value of Kandi’s growth is several times that of its earnings.

KANDI BUSINESS MODEL

The Kandi EV business model has been evolving and there are now 4 major entities, Kandi, the Kandi JV, ZZY and the Kandi dealership network. The business model was conceived by Mr Xiaoming Hu, Kandi Chairman/CEO and Chairman of the Kandi JV, who manages the overall operation. The 4 entities form a supply chain: Kandi sells parts to the Kandi JV, the Kandi JV sells EVs to ZZY and the Kandi dealerships. ZZY rents or leases EVs to the public and the dealerships sell EVs to the public. The Kandi JV also makes direct sales via other sales channels as shown in the diagram below.

Kandi still operates some more profitable components of its legacy business, manufactures EV parts to supply the ever-growing needs of the Kandi JV, and receives 50% of the Kandi JV profits. Kandi is the brains and management behind the business model operation including hiring, innovation, R&D, government relations and local city government negotiations.

The Kandi JV manufactures and sells EVs. It is a 50/50 partnership with Geely ($0175.HK), the largest auto manufacturer in China and owner of Volvo. The JV Agreement can be found in the 2013Q1 10Q SEC filing. Both Kandi and Geely have transferred manufacturing facilities into the JV and an additional manufacturing facility is currently being commissioned in Jiangsu Province.  Another new production facility is expected to be constructed in Hainan Province by the end of 2016.  Production capacity including the new Jiangsu facility is 330,000 EVs/year with 1 shift, and it will be 430 EVs/year by the end of 2016. Sales can grow unrestricted by production capacity and as they grow efficiencies will increase. The Kandi JV is planning a small IPO on a Chinese stock exchange that will provide cash for expansion and multiply the JV’s value on Kandi’s balance sheet. Due to continuing rapid growth, Kandi’s 50% owned Kandi JV will eventually represent most of Kandi’s value.

ZZY, aka Zhejiang ZuoZhongYou Electric Vehicle Service Co., is 19% owned by the Kandi JV and 81% owned by Jia Xing Jia Le Investment Partnership Enterprise. This gives Kandi a 9.5% interest.  Up until March 2015, ZZY was the sole sales channel in the business model. ZZY purchases only Kandi model EVs, from the Kandi JV. The cost of the EVs, after applying central and local government subsidies, is approximately 30% of full sale price.  ZZY therefore has reduced capital costs and can offer competitive pricing. ZZY has formed partnerships with independent local dealers and property developers to increase market penetration. ZZY raises revenue through 3 programs, collectively called Micro Public Transportation:

1. Car-Share Program which is an extension of the city public transport system, similar to existing bike-share programs. Users rent by the hour from/to multiple locations within the city and the cost is much cheaper than would be taxi.  A scheme is in development whereby renters can reserve and pay via Alibaba’s mobile Alipay with no deposit required. New EV Models will be equipped with Alibaba Yun OS for Internet Plus integration.
   
2. Group Long Term Lease Program which is available for residential communities via their community organization, or business enterprises, or government agencies such as police departments. Leases are normally for 3 years.
   
3. Individual Long Term Lease Program. Leases are for 1, 2 or 3 years and cost is higher than for Group Leasing.
   

The Dealership Network was commenced in 2015 with the first direct sales to the public in April. Kandi has identified 88 cities and districts in which it will enroll independent dealerships. It also has access to the Geely Dealership Network which consists of about 1000 4S stores. As of July 2015 over 30 dealerships had been enrolled.

PICTURES

SUBSIDIES

National government subsidies are claimed by the Kandi JV at the end of each quarter and payments were being received about 5-6 months later, however as of August 11 a subsidy payment was received in advance of sales - which is how the subsidy law was originally written . The Kandi JV sells the EVs with the subsidy deducted and, if the government does not pay in advance, the subsidy amount goes into the Kandi JV’s accounts receivable until the subsidy is paid. Local government subsidies are claimed by the buyer.  Local governments have procrastinated, firstly in passing the local subsidy laws and secondly in implementing the administration of subsidy claims. Some local governments are currently paying subsidies and some are still stalling. Since local governments have made commitments to the national government it is certain that the local subsidies will be paid. ZZY has the most EV purchases in Hangzhou who’s government is still stalling but payment is expected by the end of this year. An additional payment for infrastructure grants is expected. In the meantime the subsidy amounts that are due to ZZY go into ZZY’s accounts receivable.

The national government has issued a subsidies schedule extension, defining payments that extend through 2020. 2020 is also the national government’s target for having 5 million NEVs on the roads. NEVs “New Energy Vehicles” include Hybrid EVs and Pure EVs. Since 5 million will be only 1/50 of the cars and trucks currently on the road, expect the subsidies to be extended in some form beyond 2020. Eventually subsidies will no longer be needed because the market will be huge and mass production costs will be much lower, and battery technology much improved at much lower costs.

The national government has proposed a system of carbon credits to commence in 2016 which would provide an additional form of subsidy to EV manufacturers. EV manufactures will earn green credits for each EV and polluters, such as ICE vehicle manufactures, will need to buy those green credits.

MARKET FORCES

The China Central Government and Local Governments have declared war on the internal combustion engine [ICE] vehicles. Government is compelled to do this due to deadly pollution levels and to protect their economy from future astronomic increases in oil imports. They are additionally developing a strong EV manufacturing base that can dominate world trade as ICE vehicles gradually become extinct. Government has introduced many deterrents to ICE vehicle ownership and obstructions to their operation. At the same time they have introduced incentives to ownership of EVs and benefits to their operation. Inevitably, public demand is moving from ICEs to EVs.

China has a population of 1.368 Billion. In 2014, annual car and truck sales , almost all ICE powered, reached 23.5 million units. At a 9% annual growth rate 2020 car and truck sales will reach 39.4 million units - a huge and still growing market. What percentage of this market will be buying an NEV in 2020 after 5 more years of government pressure and technological development?  In 2014 the China NEV sales annual growth rate was 324%. Pause and think about the magnitude of these numbers - it is worth giving this paragraph a 2nd read.

GROWTH

Kandi’s FY 2014 showed that Kandi has returned to profitability. This is nice but the real key to Kandi’s value is GROWTH. For 2014 over 2013 Kandi's income statement top line appears to show growth of 1.8x; however, that would be an incorrect assumption because it excludes Kandi's primary business, EV manufacturing. Kandi reported the Kandi JV top line which appears to show growth of 14.2x. This is also misleading because EV manufacturing operations were transferred from Kandi’s financials to the Kandi JV’s financials in 2014. True growth rate cannot be determined without looking at both sets of financials.  Kandi’s earnings PR failed to even mention growth rate, leaving investors to figure it out for themselves. Since Kandi owns 50% of the Kandi JV:
Revenue = 100% Kandi Revenue + 50% Kandi JV Revenue
2014: $170,229,006 + $107,768,602 = $277,997,608
2013: $94,536,045 + $7,606,174 = $102,142,219
Kandi's complete business GROWTH was 2.7x

In 2013 Kandi sold 4,694 EVs, of which 3,463 went into the ZZY Micro Public Transportation program. In 2014, the new Kandi JV sold 10,935 EVs, all of which went into the ZZY Micro Public Transportation program. The Micro Public Transportation unit sales increased 3.2x. ZZY purchases enabled the Kandi JV to be the top Pure EV seller in China in 2014 and ranked 4th in World Pure EV Sales - and Kandi is only selling in China.  Note: the referenced sources include Hybrids that need to be removed to reveal Pure EV rankings.

At the end of 2014Q4 Kandi had expanded EV sales to 9 cities , mainly provincial capitals: Hangzhou, Shanghai, Chengdu, Nanjing, Guangzhou, Wuhan, Changsha, Changzhou and Rugao. The total EVs in Micro Public Transportation was 14,398, up from 3,463 one year earlier, up 4.2x. Most Chinese cities have a population of several million and Shanghai has 22 million. Hangzhou has a population of 6 million and the original estimate of Micro Public Transportation EVs required was 100,000. The 2014Q4 total of 14,398 is therefore just the beginning.

In 2015Q1 the Kandi JV sold 1,670 EVs, up 37% from 2014Q1, in what is typically a slow quarter. It is perceived that ZZY EV purchases could be expanding less than the expected 2x growth rate due to local governments delaying subsidy payments. In Q1 Kandi was also preparing the launch of direct sales to the public by starting enrollment of dealerships in 88 cities and districts and developing new styling for its existing K10 and K11 models. Kandi is able to enroll dealerships from Geely’s network of 1,000 4S stores.

In 2015Q2 the Kandi JV sold 4,446 EVs, a big increase from Q1 and perceived to be part of a continuing ramp up through Q3 and Q4. The Kandi JV sold 6,116 EVs in 2015H1 which, although less than investors expected, enabled the Kandi JV to be the top Pure EV seller in China in the first half of 2015. From the China media the nearest competitor was BAIC with 5,803 EVs sold. The first direct sales via dealerships occurred in April.

The growth of Kandi EV unit sales over a 4 year period is shown in the following chart:

        Source: The Company’s Form 10Q and 10K filings at sec.gov and 2015Q2 Earnings Report

FUTURE PROSPECTS

Kandi provided guidance for at least 20,000 - 25,000 EV sales in 2015 and in the Q2 CC confirmed that it will not be at the lower end. The guidance for Q3 is 5,500 - 6,500 EV sales. That leaves the expectation of about 10,400 EV sales in Q4. The guidance provides the expectation of more than 2x growth rate for 2015 over 2014. Long term guidance for 2020 is at least 400,000 EV sales. Since Kandi’s new IR firm is focused on institutional investors, it is hoped that the guidance is given on the basis of under promise and over deliver. Sales will be helped by the ramp up of the nationwide dealership network which currently has over 30 enrolled. Sales should also be helped by cities and provinces moving to meet their 2015 target commitments to the central government which total 500,000 NEVs .

Many more cities are interested in Micro Public Transportation and have been in negotiations with Kandi and ZZY, and Kandi has projected that the number of cities will increase from 9 to 15 in 2015.  

In 2015 Kandi will release 3 new technologically advanced models, first the K17 Cyclone [sedan], then the K30 [luxury sedan] , and the K12 City Beauty [mini] by year end.  The K13 City Cowboy [mini] has been slipped to early 2016. The K17 Cyclone sedan has already been launched in Beijing and Shanghai, 2 huge cities that severely limit ICE vehicle use and pay local subsidies. The K30 luxury sedan will target government and enterprise fleet sales. Central and local governments are mandated to have 30% NEVs by 2016 and this percentage will be increased beyond 2016. Confirmation of the above is on the following links: 2015Q2 earnings PR , transcript of the 2015Q2 Conference Call , 2015Q2 10Q SEC filing .

VALUATION - Based on TTM Sales

A) Method:

Slow-growth and no-growth businesses can be evaluated based on earnings, preferably adjusted earnings, and therefore their P/E ratio can be used for valuation. It is patently wrong to value a growth stock based on earnings. Kandi has solid earnings, unlike fellow EV manufacturer Tesla, but at this stage of growth those earnings are not representative of Kandi’s true value, just like Tesla’s huge losses are not representative of Tesla’s true value. For both companies their growth represents far greater value than their current earnings

P/S ratio is a valuation method used in start-up/high growth stages of a business when growth represents far greater value than the current earnings. Businesses in this category can support high P/S ratios, e.g. Baidu ($BIDU) 6, Twitter ($TWTR) 11, Google ($GOOG) 7, LinkedIn ($LNKD) 10, Alibaba ($BABA) 15, Tesla ($TSLA) 9, Kandi ($KNDI) 1.7 GAAP / 1.0 non-GAAP .

Tesla supports a P/S of 9 whilst operating with a massive loss, massive negative cash flow, no prospects for profit, and analyst’s estimated 2015 growth of 1.5x. In contrast, Kandi is profitable with a P/E of 12 and has provided guidance of 2x growth. This could warrant Kandi having a P/S ratio of 21, as explained in FAQ #3. However, to be ultra conservative, we will use P/S = 6.   If P/S = 6, P = S x 6.

Kandi's financial reporting accounts for its interest in the Kandi JV and ZZY by using the equity method, and therefore does not consolidate the Kandi JV and ZZY revenues into its financials. The reported revenue excludes Kandi’s primary business, EV manufacturing, and tertiary business, EV rental/leasing.  A proportion of the Kandi JV and ZZY sales revenues are attributable to Kandi using non-GAAP accounting methods. For business valuation purposes, it is appropriate to combine sales revenues from all parts of Kandi’s business over the trailing twelve months.
i.e. Sales = 100% Kandi Sales + 50% Kandi JV Sales + 9.5% ZZY Sales.
Since ZZY Sales have not been disclosed, I will conservatively exclude ZZY from the calculation:
Sales = 100% Kandi Sales + 50% Kandi JV Sales.

B) Calculation:

All values are taken from 2014Q3 10Q , 2014Q4 10K , 2015Q1 10Q and 2015Q2 10Q
Q2+Q3+Q4+Q1 Sales = (100% x $188,842,193) + (50% x $235,138,309) = $306,411,347
Weighted Average Diluted Number of Shares = 46,896,809
Sales Per Share = $306,411,347 / 46,896,809 = $6.53
Price Per Share = S x 6 = $6.53 x 6 = $39.20
Share Value as of June 30 2015 = $39.20

The above is a trailing valuation, not a forward valuation.
Trailing valuations are based on hard facts whereas forward valuations are based on informed guesses.
The Kandi JV sold 10,935 EVs in 2014.
Kandi’s current official guidance is for at least 20,000 - 25,000 EV sales in 2015 and not at the low end.
Therefore it is reasonable to use 22,500 EVs which gives a growth rate of 2.05x
My conservative guess is that in the next 4 quarters, Sales Per Share will at least double to $13.06
Forward Price Per Share = $13.06 x 6 = $78.36
Forward Share Value for June 30 2016 = $78.36

PPS ANALYSIS

Why is the current share price, around $7 , severely lagging the trailing valuation?
Four reasons...

1.       Poor investor relations. Lack of communication. Communication with understatement, brevity and poor word choice and no concept of Wall Street marketing. Kandi’s hiring well known US PR firm, TPG, has resulted in no benefit because they only do discrete marketing to institutional investors. Management in China will likely continue being sparing with information. Kandi also fails to release full monthly EV sales numbers to the Chinese media which results in permanent incorrect Kandi data on almost all EV sales websites. Investors only learn Kandi’s true ranking among EV manufacturers after quarterly earnings are reported, and by that time EV sales websites have stopped updating their reports. The Company’s website is not used effectively. The veil of secrecy may be a deliberate strategy to keep ahead of the competition.

2.        Stock price manipulation is claimed by many investors based on witnessing trading patterns that repeat on different days and employ strategies like blocking offers and bid attacks that a long investor would not do. There is one master strategy, operated by 1 computer controlled set of algorithms that are indicative of a short hedge fund operation. The short has recently been able to reduce a major loss, but is trapped, pays average of 30% APR to borrow shares, and incurs additional losses to control the trend. Short interest was at 6.9 million on 7/31 . This is like a coiled spring under the stock price.  Kandi will produce a steady stream of good news as the business expands, eventually triggering a release of the energy stored in the spring. The result will be a short squeeze or a series of mini short squeezes.

3.       Many investors do not do serious due diligence on any of their investments and their perception of value is based on the current stock price and recent trend. This enables the hedge fund short to control the trend - until it can’t.

4.       It is normal for share prices to be either much lower or much higher than reasonable valuation for micro and small cap stocks. When a business is succeeding, the transition from much lower to much higher can happen rapidly.

FREQUENTLY ASKED QUESTIONS

1. Are you recognizing Kandi sales to the Kandi JV twice?

• No, but at first glance, it appears so.
  
• Only profit is of value, not sales. However, P/S ratio is the valuation method used in start-up/high growth stages of a business where growth represents far greater value than the current earnings. Currently both Kandi and the Kandi JV profits cannot be considered as a basis for valuation. For sales based valuation, the sales used have to be indicative of future profit as the business matures.
  
• The Kandi JV will buy parts from various parts manufacturers including Kandi. Kandi sells parts at market price.  Buying from Kandi is a legitimate "cost of sales" because it does not reduce the Kandi JV gross margin and indication of future profit. Therefore, 50% of the Kandi JV sales are attributable to Kandi for P/S valuation purposes. It is immaterial that Kandi is one of the parts manufacturers.
  
• Parts is one of Kandi's new high growth revenue channels and it makes little difference whether it sells parts to the Kandi JV or any other EV manufacturer because Kandi sells the parts at market price.  Therefore parts sales to the Kandi JV does not reduce the gross margin and indication of future profit.
  
• On this basis both sets of sales are indicative of separate future profits and can legitimately be attributed to Kandi for P/S valuation purposes.
  

2. Is Kandi selling to itself?

• Not under GAAP rules which Kandi follows. Yes in lay terms because we can say that the Kandi JV is 50% self and ZZY is 9.5% self, however it would be better for investors if each was 100% self.
  
• If Kandi owned 100% of the Kandi JV and 100% of ZZY it would be better for Kandi investors because they would get all the profit from all 3 stages of the supply chain. Of course, if this was the case, Kandi would be following GAAP rules and restructuring its financials differently.
  
• Shorts tell lies via distortion and innuendo and have been blurring the distinctions in GAAP reporting rules by saying Kandi is selling to itself and inferring that this is both fraudulent and bad for investors. Tell that to an oil company that owns a supply chain comprising production, refining and marketing of product.
  

3. How can you justify valuation with a P/S of 6 when Ford ($F) has a P/S of 0.41?

• Growth rate and future growth rate are the primary justification.
  
• Ford is a lumbering giant, not a growth stock, and its valuation is largely based on earnings. Modest growth over 3 years is likely to have less affect on earnings than other factors. Investors are pricing the company for low/no growth, which causes the P/S to be very low.
  
• In contrast, Tesla has a P/S of 9 with no earnings and no prospect of significant earnings for 5 years. Current earnings are not of prime importance to growth investors.   Investors are pricing the company based on growth and growth prospects, and they presume that after significant growth, earnings will come. Analysts are predicting a Tesla growth rate of about 1.5x this year.
  
• Kandi is already growing its earnings and has a P/E of about 12. In 2014/2013, Kandi’s attributable revenue growth was 2.7x, and this is at the same time as transitioning EV manufacturing operations from Kandi to the Kandi JV. EV unit sales growth was 2.3x but due to unit price increases, EV $ sales growth was 4.6x. EV unit sales into ZZY Micro Public Transportation growth was 3.2x. The market forces in 2015 are greater than in 2014. I therefore expect Kandi’s future growth rate could be greater than 2x although current guidance is about 2x.
  
• Take a 3 year period: Tesla is expected to grow about 1.5x per year, so compounded growth is 3.4x and this warrants a P/S of about 9. If Kandi grows 2x per year, compounded growth is 8x and this warrants a P/S of 8/3.4 x 9 = 21. A Kandi P/S of 21 is obviously too high for most people’s comfort, so we won’t use it. To be conservative let’s just say Kandi warrants a higher P/S than Tesla and to be ultra conservative, I choose a lower P/S than Tesla, i.e. 6.
  

4. Will Kandi face competition?

• Yes. The growth prospects are irresistible but Kandi is a 1st mover, and was 2014 EV sales leader and 2015H1 EV sales leader.
  

5. Why is air pollution in China a major force for change?

• Watch the brilliant, moving, explicit Chinese documentary “ Under the Dome .”
  

6. Is the Chinese Economy in Trouble?

• No. The media use the words “slow down” without providing context. There is concern that growth may slow down from 7% GDP growth. If it slipped to say 6.8%, the economy would still be growing 6.8% per year, which by world standards is rampant growth.
  
• The Chinese stock market has been having an overdue correction. It still has stellar performance. The Shanghai Composite is currently up 57% over 12 months.
  
• The Chinese Currency, the Renminbe, has just had a small devaluation due to a strong USD. This is a blip in an uptrend. Since 2005, the Renminbe has appreciated about 30% compared to a basket of currencies.
  

7. Who is Mr Xiaoming Hu?

• An engineer and entrepreneur with strong business and political associations, who is well respected within the PRC and frequently honored.
  
• From Bloomberg: Mr. Xiaoming Hu has been Chief Executive Officer and President of Kandi Technologies Group, Inc. since June 29, 2007.  From October 2003 to April 2005, Mr. Hu served as the Project Manager and Chief Scientist in the PRC Pure Electric Vehicle Development Project.  From October 1984 to March 2003, he served as a Factory Director in Yongkang Instrument Factory, Factory Director in Yongkang Mini Car Factory, Chairman and General Manager in Yongkang Vehicle Company, General Manager in Wan Xiang Electric Vehicle Developing Center, and General Manager in Wan Xiang Battery Company.  He owns 3 Invention patents, 5 utility model patents, over 10 appearance design patents.
  

CONCLUSION

Conclusions are best drawn by the reader. All I will say is: Kandi is no falling knife, it is a swinging pendulum that has reached a ridiculous extreme. Please verify my facts via authentic sources, not comments and tweets by "shorts" who will say anything to stop you investing, and usually concealing their real name. The short's motive is not to protect you - it is fear that new investors will drive up the share price. Authentic information will be found at Globe Newswire, the SEC website and in the IR section of the Company website.