The 22% Rally in Xpeng Stock Only Highlights the Risks

I’ll admit it: I’ve been wrong about Xpeng (NYSE:XPEV) so far. After last year’s initial public offering, I remained a skeptic. Yet XPEV stock has soared.

Indeed, XPEV stock now has rallied over 350% from its initial public offering price of $15 per ADR (American Depositary Receipt). It’s more than doubled since I called it an IPO to avoid in October.

Of course, this is not an uncommon story. Growth stocks of all stripes have generally rallied despite skeptics like me pointing to underlying concerns. For Xpeng, those concerns include significant competition and a questionable valuation.

It’s possible that skepticism at some point will be vindicated, both for XPEV stock and for the market as a whole. It’s equally possible that growth investors have it right: that the focus on long-term potential should outweigh any near-term concerns about valuation. For now, I’m sticking to my skepticism, with Tuesday’s move in XPEV stock a big reason why.

The New Credit Line

On Monday evening, Xpeng announced that it had signed a “strategic cooperation agreement” with a number of Chinese banks.

Based on the release, that appears to be a fancy term for a revolving credit facility. Xpeng secured a credit line of 12.8 billion RMB, or just under $2 billion.

To be clear, the agreement is good news. The company is facing a number of deep-pocketed competitors in China. Both Nio (NYSE:NIO) and Tesla (NASDAQ:TSLA) continue to raise capital by the billions.

For those companies (as well as Xpeng), higher share prices even have been referred to as a “virtuous circle.” A higher share price means the ability to raise more capital, which creates higher growth expectations, which means a higher share price, etc. etc.

In this instance, Xpeng — which sold $2.5 billion in ADRs in December — is raising capital without diluting shareholders. Some optimism is warranted.

XPEV Stock Rises 22.4%

But “some optimism” isn’t what greeted XPEV stock on Tuesday. The stock rallied 22.4% on the news.

Obviously, that’s a huge move. There’s another way to look at it which shows how sharp the reaction was. Xpeng added over $7.7 billion in market value on Tuesday. That’s nearly four times the capital raised.

To be fair, comparing the $1.9 billion raised to the $7.7 billion in market value gained isn’t exactly apples to apples. Assuming that capital will provide a positive return on investment (which likely is true), Xpeng’s market value gain perhaps should have outpaced the amount of capital raised.

And, again, shareholders aren’t being diluted by this agreement the way they were in December. It’s also possible, perhaps, to see the agreement as a sign of faith from the Chinese central government, given that Xpeng is competing against state-owned companies (including JAC Motors, which manufactures Nio vehicles).

All that said, the size of the move certainly looks questionable. It’s not as if the capital wasn’t available to Xpeng. The company raised $2.5 billion just weeks ago. It could easily have moved to sell another $2 billion in stock at some point in the coming months. Yes, shareholders are avoiding dilution, but proceeds from an equity offering don’t incur interest and, of course, don’t have to be paid back.

This is not a rally that makes any fundamental sense. The question, of course, is if, or when, that matters.

An EV Bubble?

From here, the electric vehicle sector looks an awful lot like a bubble. To be clear, I don’t think XPEV stock is quite to the level of other names. We’ve seen battery maker QuantumScape (NYSE:QS) soar sevenfold in a matter of weeks, and companies like Electrameccanica Vehicles (NASDAQ:SOLO) skyrocket on the backs of questionable business models.

But XPEV stock definitely is riding the wave. Indeed, sector-wide optimism likely contributed to Tuesday’s rally.

And bubbles aren’t just about valuation. They’re about the breadth as well. What we saw in the late 1990s was massive rallies in every stock even tangentially related to the internet (or the telecom industry). We’re seeing the same thing once again in EVs.

Every stock seems priced for ultimate success. Yet there are going to be losers. There will be companies that don’t meet the massive expectations being embedded in their share prices.

Xpeng isn’t going to go bust. It’s not a scam. Unit sales in 2020 certainly were impressive, and the company has plenty of growth in front of it.

But it also has no shortage of rivals in the way, and a market capitalization that’s now back above that of Ford Motor Company (NYSE:F). At the least, an awful lot of success already looks priced in. Even more is priced in after Tuesday’s rally.

On the date of publication, Vince Martin did not have (either directly or indirectly) any positions in the securities mentioned in this article.

After spending time at a retail brokerage, Vince Martin has covered the financial industry for close to a decade for InvestorPlace.com and other outlets.