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Should You Buy the Dip in QuantumScape (QS) or Avoid Exposure?

·6 min read

The automotive industry is fast changing gears to electric. While electric vehicles (EVs) are the future of transportation, it may take quite a few years before the mass adoption of green vehicles becomes feasible. With EV competition getting rife with each passing day, battery stocks are becoming all the more attractive. Batteries, being the heart and soul of eco-friendly vehicles, will play the most important role in accelerating the EV revolution.

In this write-up, we shall focus on EV battery maker, QuantumScape QS, which made its NYSE debut on Nov 27, 2020 through a reverse merger with Kensington Capital Acquisition. For a brief period of time, the company even surpassed the market valuation of U.S. auto giants, Ford F and General Motors GM. However, like many other high-fliers in the red-hot EV and battery landscape, shares of QuantumScape have been badly hit, as investors started taking notice of the stock’s fundamentals.  The company is currently trading at around $27 a share, down around 80% from its all-time high of $132.73 attained on Dec 22. The stock has plummeted 68% on a year-to-date basis. Does the sharp plunge call for a buying opportunity?

What Do We Like About QS?

QuantumScape’s next-generation cutting-edge batteries are set to revolutionize the e-mobility landscape. The Bill Gates-backed EV battery supplier is developing the next generation of batteries utilizing lithium metal, which has a significantly higher energy density than lithium ion. 

Set to disrupt the world of batteries, QuantumScape claims that its batteries are designed to offer up to 50% longer range than the existing lithium-ion batteries and will also make the cars safer. Per the company, its batteries would charge up a vehicle to 80% of its full capacity in around 15 minutes. Leveraging lithium-metal technology, QuantumScape hopes to achieve a range of 300 miles or more, hyper-fast charging (less than 15 minutes), cheap vehicles (less than $30k), and extended battery life (more than 150,000 miles), thereby accelerating the race to mass EV adoption.

Automotive giant Volkswagen VWAGY is the key shareholder in the company, inspiring investors’ confidence in the business' legitimacy. QuantumScape’s association with this Germany-based auto biggie dates back to 2012. In 2018, both the firms established a joint venture for the mass production of solid-state batteries. Volkswagen has invested $300 million in QuantumScape and intends to deploy the latter’s batteries in its vehicles.

But the Stock Has Lots to Prove

There is an enormous amount of uncertainty surrounding this next-generation battery enterprise, considering it is just in the product development stage. According to QuantumScape's eight-year plan, it doesn't expect to generate revenues until 2024 and won't be able to drive positive free cash flows until 2028. The firm anticipates to post revenues of just $14 million and $39 million in 2024 and 2025, respectively. It targets to scale up to $275 million and $3,210 million in 2026 and 2027, respectively. While that may sound good, it's quite far out in the future. 

The stock does possess a high short interest (more than 21% of float has been sold short). In fact, a short-seller Scorpion Capital accused QuantumScape as a "pump and dump SPAC" scam in its report dated Apr 15. The report stated, “Our research leads us to conclude that the company is no different than other recently exposed SPAC promotions and EV frauds.” The report cited that Volkswagen’s employees hinted that engineers and battery experts were highly skeptical of QuantumScape’s claims.

Retorting to Scorpion Capital, QuantumScape made a statement on Twitter, “QS stands by its data, which speaks for itself. We have provided higher transparency than any other solid-state battery effort we are aware of, with details on current density, temp, cycle life, cathode thickness, depth of discharge, cell area, pressure."

While QuantumScape says so, the company is still viewed as highly secretive with lack of transparency regarding its technology. In the absence of anything concrete so far to be shown to the public, it is difficult for investors to believe the company’s claims. And how much would an average consumer would be able to understand about the intricacies of battery tech anyway? Its indeed hard to test the claims of the company; and even if the claims are true, the execution risk is quite high. Even if the company comes up with the solid-state battery as promised, it has to pass the test of achieving industrial-scale in order to meet mounting demand once EVs get mainstream.

High capex and R&D expenses will remain a headwind for this pre-revenue company. During its last quarterly release, the company raised its 2021 spending forecast to $260-$320 million. While the company is setting its first factory in California, mounting capex and uncertainties related to production ramp-up raise concern.

Further, competition has been rising in the battery tech space. QuantumScape is not the only company with solid-state battery technology. Japan-based auto giant Toyota is set to debut its first functional prototype solid-state battery this year. Sila Nanotechnologies, which is expected to become a publicly traded company this year, is also new in the field of solid-state battery technology. Not to forget, General Motors’ collaboration with Massachusetts-based SolidEnergy Systems to build a solid-state battery. Meanwhile, Ford and BMW AG have boosted investment in SolidPower to develop solid-state batteries. Daimler AG has also partnered with Blue Solutions on solid-state technology. Competition in solid-state battery application in EVs will be another concern for QuantumScape, which anyway has lots to prove.

Word of Caution

Indeed, QuantumScape’s battery technology holds promise but the investment potential in this stock is still questionable. Amid the various red flags, it seems investors might have bet on Volkswagen and Bill Gates’ stakes in the company during the initial few months after its IPO. However, with the commercial production of its batteries still three to four years away, we don’t advise to buy the recent dip as the stock seems more of a speculative bet now. With the company still years away from scaling up; high short interest and tough competition, we prefer to adopt a wait-and-see approach, all the more because it is yet to deliver on its claims.

QuantumScape currently carries a Zacks Rank #3 (Hold). While it's recommended not to buy the stock until we get more clarity, it might also not be the opportune time to sell given the sharp drop in stock price of late. You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

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