Morgan Stanley - CATL (300750 CH) - Is the dip in unit gross margin the new no… · @2030FY_X · TwKit

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Morgan Stanley - CATL (300750 CH) - Is the dip in unit gross margin the new normal? CATL's 3Q26 results significantly missed market consensus, with the core drag being a quarter-on-quarter decline in unit net profit to RMB 0.08/Wh (vs. RMB 0.10/Wh in 1H26). Management attributed this to a product mix shift toward lower-margin products, as well as approximately RMB 1.5 billion in additional costs from a reduction in VAT export rebates and a 2% domestic consumption tax introduced in September. Although net profit attributable to shareholders still reached RMB 21.2 billion (up 15% YoY), the single-quarter gross margin fell 2.5 percentage points QoQ to 20.7%, and earnings came in about 12% below Morgan Stanley's prior model estimates. We expect the market to make significant downward revisions. The current core debate is whether RMB 0.08/Wh has become the new normal, or if it will recover to first-half levels alongside product mix optimization and cost pass-through. Our base case is that the company's quality premium has not collapsed, but intensified price competition in the energy storage system (ESS) track, coupled with the pace of absorbing incremental taxes, will limit the extent of the unit profitability rebound, most likely resulting in a shallow V-shaped recovery rather than a V-shaped reversal. 1. 3Q26 results breakdown: Volume up, profit down, hit by both taxes and product mix - Volume: Quarterly battery sales volume exceeded 260GWh, continuing scale expansion, but the characteristic of trading price for volume was prominent. - Profit: Unit net profit plunged 20% from RMB 0.10/Wh in the first half to RMB 0.08/Wh. Management explicitly guided to two major drags: first, a deteriorating product mix with a rising shipment share of ESS and low-margin EV batteries; second, elevated policy-driven costs, where reduced VAT rebates and the new domestic consumption tax eroded single-quarter profit by about RMB 1.5 billion, equivalent to a unit cost increase of roughly RMB 0.006/Wh. - Gross margin: Total gross profit grew 27% YoY to RMB 34.2 billion, but gross margin dropped 2.5 percentage points QoQ to 20.7%, reflecting short-term pressure on earnings quality amid revenue scale expansion. 2. The new normal debate: Why we judge there is support at the bottom, but a ceiling on the rebound - Quality premium remains, but monetization is harder: CATL's technology iteration, customer stickiness, and recycling system in the EV battery sector form a deep moat. However, in the domestic ESS market, where tolerance for cell cycle life and safety is higher than automotive standards, capacity releases from tier-2 manufacturers are intensifying price competition, making it difficult for the company to fully translate its quality advantage into a premium. - Buffer mechanism for the tax burden: If the new 2% consumption tax and rebate cuts cannot be fully passed on to end-user prices, they will be absorbed by unit gross margin in the short term. However, Morgan Stanley believes that through scale-driven cost reductions (e.g., CTP/CTC structural optimization, in-house mineral production line ramp-ups) and a rebounding share of high-end products like high-nickel/solid-state batteries, the company is expected to gradually offset about half of the tax impact over the next 4-6 quarters, with the remainder constituting a permanent downward step in profit margins. - Our quantitative expectations: We expect 4Q26 unit net profit to recover slightly to RMB 0.085-0.09/Wh. In 2027, driven by ESS overseas expansion (high-margin projects in the US and Europe) and the volume ramp of Shenxing/Condensed batteries, it is expected to return to around RMB 0.10/Wh, though the mid-term average is revised down by about 8%-10% compared to our previous model. 3. Valuation methodology and price target adjustment logic - Valuation anchor: We maintain our A-share target multiple of 13x 2027E EV/EBITDA (implying roughly 20x 2027E P/E), which is 0.5 standard deviations above the three-year historical mean and already prices in the premium of a new product cycle (Condensed batteries, ESS integration). The H-share target multiple is 16x, on par with LG Energy Solution, implying a 20% premium for the H/A price target. - Price target: The A-share price target is RMB 500, offering approximately 93% upside from the current RMB 259.08; this target represents a 35% discount to DCF-based NAV, reflecting valuation discipline. We did not adjust multiples due to single-quarter gross margin volatility and only fine-tuned earnings forecasts, as long-term capacity utilization and free cash flow generation capabilities remain intact. - Financial forecast tweaks: 2026-2028E revenues are RMB 607.7 billion, RMB 717.4 billion, and RMB 873.6 billion (largely unchanged). However, 2026 EPS is slightly revised down from RMB 21.04 to the RMB 20.5 range, and 2027 EPS is revised down from RMB 24.77 to approximately RMB 23.5, implying a 2027E P/E of about 11x, which remains at the lower end of its historical valuation band. 4. Bull/bear factors and risk monitoring - Upside catalysts: A stronger-than-expected rebound in European ESS demand; further declines in lithium prices freeing up cost room; earlier-than-expected mass production of solid-state batteries; overseas localized capacity (Hungary, Indonesia) receiving policy subsidies. - Downside risks: Domestic ESS bidding prices falling below the RMB 0.6/Wh psychological threshold; US IRA exclusivity rules against Chinese capacity proving stricter than expected; lithium carbonate prices rebounding over 30% and eroding processing margins. - Key monitoring metrics: Monthly installation share changes, ESS system gross margin (rather than just cells), changes in unit equipment depreciation, and the actual pass-through rate of the consumption tax. 5. Trading implications Maintain Overweight rating and Top Pick status, believing the market will overreact to single-quarter gross margin volatility while ignoring the company's defensive attributes, including its solid global market share (domestic EV battery share from January to September remained over 45%), strong operating cash flow (over RMB 80 billion in the first half), and a dividend yield expected to rise to 4%-6%. The stock price may face short-term pressure down to the RMB 230-250 range due to earnings downward revisions, but building a long position on pullbacks is a strategy with a favorable risk-reward profile. Relatively speaking, the trading opportunity of the H-share discount narrowing against A-shares is more attractive (the H/A premium has risen to a historical high of approximately 30%).

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