Electric vehicle (EV) investors were greeted with the news that China's automaker and battery giant BYD (BYDD.F -1.10%) surpassed Tesla (TSLA -4.95%) as the world's top seller of EVs during the final months of 2023. Though Tesla still outsold BYD for full-year 2023 (1.81 million deliveries for Tesla versus 1.59 million EVs for BYD), the Chinese company has been growing at a rapid pace and narrowing the gap.
As a result, some investors might be mulling an investment in BYD in 2024. But there's more to consider than just flat-out vehicle sales. Here's one risk to keep an eye on this year.
Automaking is typically a low-margin endeavor
BYD's rapid rise in EV vehicle production (as well as hybrids) has sent revenue sky-high. Revenue was up over 300% in the last five-year stretch, most of those gains coming with the ratchet-up of the EV space since the pandemic.
Data by YCharts.
However, one key item to bear in mind is that, at this point, BYD's operating profit margins still more closely resemble those of a legacy automaker than they do Tesla's.
Data by YCharts.
The EV market is currently in the throes of a price war, one that isn't about market share dominance like it was when Tesla CEO Elon Musk started it in early 2023. Today, after a sharp rise in interest rates that has made financing a new vehicle more costly, EV makers need to drive down the price tag on their models to keep winning over consumers.
These vehicle price cuts tanked what was Tesla's best-in-class profit margins, although it has kept the EV pioneer in overall growth mode. If the price war on EVs continues, lower-margin auto businesses, including BYD, could take a hit. This is a key risk for would-be shareholders to think about before placing that buy order.
BYD's long-term advantage?
That said, BYD has pulled off a stunning rise. Ramping up production like it has is incredibly expensive, and the fact it has done so while generating a profit at all is noteworthy.
At least part of BYD's success has been vertical integration, a strategy pulled from Tesla's playbook. You see, most legacy automakers are more of an assembler of parts (with the exception of maybe the internal combustion engine, which most automakers make themselves). By contrast, Tesla and now BYD have been figuring out how to make many components in-house rather than outsourcing to a parts manufacturer.
Further, some of the most critical pieces to an EV -- the battery and the software that governs the system (including advanced driver-assist features) -- are where most of the production costs occur. BYD started as a phone battery maker and scaled up its expertise to address EVs too. It has partnered with the likes of Nvidia (NVDA -2.09%) for computing system and software development, while Tesla has especially been making a go of the systems software development (like Autopilot and FSD) and battery assembly on its own.
Nevertheless, the point here is that as BYD starts to achieve better efficiencies on a larger scale, perhaps it can unlock more robust operating margins as well. What looks like a weakness right now (low operating margins) could actually flip to a strength.
Buy despite slowing EV demand?
EV demand is slowing, but it's still on the rise overall. If BYD's run higher continues, shares might be cheap at just 18 times trailing-12-month earnings.
There are additional risks to consider, though, like the European Union's investigation into whether subsidies from the Chinese government have unfairly helped giants like BYD earn a big market share foothold (thus harming Europe's own automakers as they race to get more EV models on the roads). Given crosswinds in the EV industry in 2024, I'm not buying BYD stock right now -- though I do get a bit of exposure to it already by owning shares in Warren Buffett's Berkshire Hathaway (BRK.A -0.39%) (BRK.B -0.56%), which counts BYD as one of its holdings in its publicly traded stock portfolio.
