Seeking Alpha • Sep 01
Buy Proterra On Arrival's Downs
Summary
Proterra finally managed to recover after the Q1 profitability miss and is back on track to achieve the 2022 outlook.
Although I expect the business profitability to suffer from short-term headwinds, I believe that the long-term perspectives have recently improved.
The competitive pressure has been alleviated due to challenges by Proterra’s rival, Arrival.
My analysis indicates that these challenges are not fully factored in Proterra’s share price and may be a significant catalyst for the share price acceleration.
Arrival (ARVL) has recently posted its Q2 report. Although I was skeptical about the company’s prospects, I was still surprised by their decision to postpone bus production indefinitely. The main question is what that news can mean for the electric vehicle ("EV") industry as Arrival was perceived as a disrupter in the electric bus field and a strong potential opponent of Proterra Inc. (PTRA).
In my previous articles, I wrote that both of them had flops they were struggling to overcome. However, unlike Arrival, Proterra seems to be recovering after a Q1 profitability miss. Even though it is bound hand and foot by global supply chain constraints, it can still benefit greatly from Arrival’s difficulties. I believe that Arrival’s problems are still not fully factored in Proterra’s share price and may serve as a long-term catalyst for its stock performance. Let's delve deeper into this issue.
Q2 performance update. Proterra is well on track to achieve its 2022 forecast
Revenue
In the second quarter, Proterra managed to achieve solid revenue growth. As promised earlier this year, it alleviated supply issues in the Transit business and produced over 50 buses over the second quarter. I was really glad to hear the roll-out number, as such a fast-paced manufacturing rate shows that Proterra is on track to achieve its 200 bus target over the entire year.
Its second segment, Powered & Energy, achieved a doubled revenue compared with the previous year. However, if I benchmark its performance with the last quarter, I see a lower segment revenue despite an increasing number of batteries sold. At first sight, it may sound alarming because the price per battery went down despite growing prices for raw materials. In reality, price decrease is driven by higher demand in the bus segment, where batteries with lower capacity are required. As the price is set not per battery but per MWh— megawatts per hour— the batteries with lower MHh are cheaper. Thus, Proterra’s battery business continues to gain further traction among customers and is expected to meet full-year targets.
Unfortunately, Proterra did not manage to solve sourcing problems in its Energy (charging infrastructure) business. During the second quarter earnings call, Proterra’s Chief Executive Officer, Karina Padilla, even mentioned worsening supply-side issues:
On top of continued shortages in charging hardware, we are now also coping with the shortages in switchgear 2.
Do I see it as a big problem? Not really, because supply-side issues in the early-stage Energy business have been known for a long time and are already included in the full-year outlook.
Proterra's financial accounts. Prepared by author
Gross margin
As for gross margin, it is back in positive territory in Q2, amounting to approximately $600,000 in the quarter. This is certainly a nice comeback after a negative gross margin rate in Q1, as it confirms that Proterra managed to alleviate its supply issues in the bus business that were quite severe in the first quarter. Those challenges are summarized well in the following paragraph from my previous article “A recession would make Proterra a buy”:
The tight labor market and scarce materials severely impacted gross margins. In Transit, 9% more incremental labor hours were required to complete a bus than in Q1 2022 and 25% more than in Q4 2021. The idle time a bus spent waiting on one component to arrive led to significant inefficiencies across the factory floor.
Despite some profitability increase, I expect weather around the gross margin to remain cloudy until 2023. Proterra is still facing a scarce supply of wiring harnesses and power connectors. Wiring harness production requires a lot of manual operations, and is therefore produced in countries with a cheap labor force such as Ukraine. The ongoing war has dramatically impacted production capacities and prices worldwide. Consequently, I do not see any supply alleviation until the war ends. That is definitely not on the horizon in 2022.
Additionally, ramping up production in a new factory in late 2022 will negatively pressure margins before Proterra achieves a break-even production scale. However, I expect improvement in 2023 as a result of recent pricing initiatives, roll-out scale-up, and an easing of the competitive field where significant positive changes have happened recently. Let me show you in detail what I mean.
Competitive field
Proterra’s main competitor was BYD Company Limited (BYDDF, BYDDY), a Chinese manufacturer of electric vehicles. Although the quality of BYD buses is sometimes debatable, its cost advantages, strong presence in the EV sector, and efficient supply chain management allowed BYD to get a significant market share. Therefore, the decision made by the U.S. government to deprive BYD of its customer base by excluding Chinese producers from federal subsidies was highly beneficial for Proterra.
Another rival of Proterra’s is the NFI Group Inc. (NFYEF), a Canadian bus manufacturer. Though they have recently entered the EV and batteries market, they mainly specialize in combustion-engine buses. Zero-emission buses represent about 17% of their portfolio, primarily consisting of hybrid buses rather than battery-electric ones. Despite its efforts in the EV transition, the NFI group is not perceived as an EV player by the market. Its low price/sales multiple of 0.3x is evidence that the company is considered a traditional car player.
An additional competitor for Proterra is the British EV manufacturer Arrival specializing in electric buses and vans. The start-up had ambitious development plans, leveraging on placing its microfactories near its customers’ locations. That strategy was focused on decreasing production costs via an innovative production concept and capturing demand based on the proximity of its microfactories to the customers. However, Arrival has recently faced significant implementation problems. I believe that its downs can serve as a long-term catalyst for Proterra’s performance.
Arrival - on the other side
Vehicle producers primarily achieve profitability by extracting savings from economies of scale. However, the demand for buses is relatively limited and insufficient for significant economy-of-scale synergies. Therefore, producers have to either expand their product range beyond the buses or devise alternative production methods.
Proterra opted for the former approach of expanding in the battery business, selling to commercial vehicle producers with insufficient money and expertise for EV transformation. At the same time, Arrival placed its bet on a unique production method via the microfactory concept. It promised to decrease total costs of bus ownership by 50% vs. competitors and achieve 2.2x lower production costs while keeping profitability. These savings should have come from three factors: high vertical integration with vehicles built from scratch, the significant economy of scale as bus and van parts are interchangeable, and lightweight composite materials.
Additionally, the characteristic uniqueness of the microfactory concept lies in its proximity to customers. Both labor and supply chain issues can be diminished through such an approach, not to mention strengthening the regional economy. A proposition to order buses by a company-manufacturer located nearby in the county is significant for local authorities, the main customers in the bus market.
To illustrate some of these local customers, let’s go through the primary beneficiaries of federal funds under the Bipartisan Infrastructure Law in 2022. The agencies involved are the New York Metropolitan Transportation Authority, Los Angeles County Metropolitan Transportation Authority, Memphis Area Transit Authority, and Colorado Department of Transportation. They are all public departments or public benefit corporations responsible for public transportation in a particular area. While it’s probably not a high priority to attract an automotive employer to the state when the unemployment rate is so low as it is now, the innovative workplace is appreciated by the voters in the next elections.
The microfactory strategy was perceived as an extremely promising idea, and was appreciated by investors valuing Arrival at $13 billion when it got listed last year via SPAC. Initially, Arrival planned to produce around 11k buses worldwide in 2024. However, despite its many promises to investors, Arrival faced significant issues I described in my May article “Avoid Arrival - management needs to show some execution”.
I doubted the management’s credibility and was inclined to think that Arrival had serious production issues leading to financial distress by the end of the year. Unfortunately, my Cassandra's view turned out to be correct. Recently, Arrival announced its restructuring plans to preserve cash and decided to focus on the vans while simultaneously abandoning the projected bus roll-out. Giving a commentary about their plans, Arrival said that their main bus client, First Bus, was still committed to restarting the trials when Arrival has a new road map for the platform.
From my perspective, “a new road map for the platform” sounds quite far-fetched as Arrival has both serious cash issues and plans to raise a part of a new equity round later this year, even before the first vehicle roll-out. It’s a sign that the management is not confident in its manufacturing capabilities. Otherwise, why not issue equity after a successful launch benefiting from a higher share price? I will soon publish an article where I will focus on the topic in more detail. Currently, it is essential that Arrival is off the bus route for an uncertain period. I summarize these developments in the chart below.