Kerrisdale Capital returned -3.2% net for the second quarter, compared to 4.3% for the S&P 500 and 1% for the Barclay Hedge Fund Index. Year to date, the firm's Kerrisdale Partners fund is up 4.3%, versus the S&P's 15.2% return and the Barclay index's 5.4% gain.
Since its inception, Kerrisdale Partners has gained 3,365.2% net, versus the S&P 500's 693.2% gain and the Barclay Hedge Fund Index's 130.5% return over the same time frame.
Long on Hong Kong-listed Chinese auto dealers
In their second-quarter letter to investors, which was obtained by Hedge Fund Alpha, the Kerrisdale Capital team said they are long on Chinese auto dealers listed on the Hong Kong Stock Exchange. They noted that dealers are similar to publicly listed auto dealers in the U.S. like Lithia, Asbury and others sell new and used cars and perform service and maintenance on passenger vehicles.
The Kerrisdale team said China's auto landscape has gone through a revolution in recent years, with new-energy vehicles, including hybrids and electric vehicles, jumping from 6% of all the vehicles sold in the country in 2020 to over 35% in the first half of this year.
BYD, Li Auto, Nio and others have taken some market share from foreign automakers. However, publicly listed Chinese auto dealers mostly sell luxury brands from foreign companies like BMW or Mercedes, which has hurt their sales due to the rise of domestic EVs.
Why Yongda stock plummeted
The Kerrisdale team noted that shares of China Yongda Automobiles Services Holdings (HKG:3669) have tanked 91% from their peak in July 2021, its stock chart since then being "one of endless declines and despair." However, the company's sales have only fallen 7% and are expected to be flat this year with a return to growth in 2025.
Yongda's profitability has also plummeted, as evidenced by the 58% plunge in its EBITDA between 2021 and 2023. Meanwhile, the company's net income has tumbled 78% over the same time frame, with more declines expected this year due to profit margins on new cars.
The Kerrisdale team added that the Chinese automaker has become "flooded with cars," many of which are "sold by perpetually unprofitable players like Nio and Xpeng." As a result, the market has been undergoing a massive pricing war, with all automakers seeing their prices and margins crushed. Most foreign automakers are also seeing their unit volumes tumble.
The long thesis for Yongda
However, the Kerrisdale team likes Yongda because of its after-sales parts and services, which they called "the real cash cow," with used-car sales being cash generators to a lesser extent. As a percent of the company's total gross profit, after-sales parts and services accounted for 65.9% in 2023, while commission income accounted for 25.6%.
In fact, plummeting gross profits on new vehicles have accounted for 83% of Yongda's profit declines over the last two years. However, the Kerrisdale team believes gross margins on new vehicles are reaching their trough, falling to the lowest level it has ever been at in the history of Chinese auto dealers.
Ultimately, they think this margin must rebound, benefiting Yongda over the long term as after-sales parts and services and commission income grow at healthy margins.
Attractive valuation amid positive long-term trends
Yongda trades at a price-to-earnings (P/E) ratio and a price-to-free-cash-flow (P/FCF) ratio of 5x despite having a net cash position, which gives it an enterprise-value-to EBITDA ratio of 0.4x. The Kerrisdale team explained that if that cash "is real," investors are getting the entire company nearly for free, supporting the long-term investment thesis.
Additionally, Yongda has been aggressively repurchasing shares and is targeting a 50% dividend payout ratio. The founder CEO actually owns 31% of the company's shares, ensuring alignment with shareholders.
Despite the decline in new-vehicle sales, the Kerrisdale team believes Chinese consumers will continue to have a healthy appetite for luxury European auto brands, similar to their appetite for luxury European clothing and jewelry brands.
They expect new-energy vehicles to ultimately take sizable market share from mass-market foreign automakers on a permanent basis. However, the Kerrisdale team also expects luxury automakers to catch up in EV technology in the coming years.
Additionally, they said it's relatively easy for Yongda and other Chinese auto dealers to switch brands. In fact, Yongda has been working with many new-energy vehicle brands to open pilot dealerships.
Over the long term, the Kerrisdale team expects the company to eventually get through the current industry storm and continue being profitable and growing, selling and servicing vehicles over the long term. They also feel Yongda's entry price is currently "dirt cheap" and an "attractive entry point for brave investors" willing to buy shares "during the eye of the storm."
Nonetheless, Kerrisdale also thinks all Chinese auto dealers make attractive investments at current levels.
Short of Riot Platforms
On the other hand, the Kerrisdale team is bearish on bitcoin miners, having published a short report on Riot Platforms (NASDAQ:RIOT) in early June. Riot operates two "giant facilities with tens of thousands of computers that utilize exorbitant amounts of energy" in mining bitcoin.
They described bitcoin mining as a "terrible business model" and "the most competitive commodity industry" they've ever come across. The Kerrisdale team added that any company globally with access to "cheap power" can buy computers and mine bitcoin, noting that U.S. miners won't end up being the lowest-cost producers.
Further, they believe the companies that do end up being the lowest cost "will still make de minimus returns." Although this is the primary reason Kerrisdale is short Riot Platforms, the firm also pointed to several more reasons for their thesis.
The April bitcoin halving slashed the yield miners have been receiving in half again. Meanwhile, miners around the globe have just ordered loads of new computers using fresh capital received on the back of the latest euphoria surrounding the recent surge in bitcoin prices.
The Kerrisdale team also warned that regulators may end up levying heavy taxes on miners due to the massive amounts of energy Kerrisdale accuses them of wasting. In Texas, which has been suffering repeated energy crises, they think the general view of miners may turn more negative.
The Kerrisdale team also cited "never-ending dilution" that weighs on Riot shares and those of most miners. Notable, the firm has hedged this short by being long bitcoin via exchange-traded funds.
Pivot to AI data centers
However, as Kerrisdale published its short thesis, some miners started talking about how they could repurpose their facilities and turn them into data centers for artificial intelligence. Core Scientific struck a deal to provide high-performance computing to Coreweave, which offered to buy all of Core Scientific at a healthy premium to its trading price.
Recalling Intelsat in 2017, the Kerrisdale team said it operated a "terrible," "highly levered and operationally doomed" satellite business. As 5G technology evolved, cellular providers suddenly displayed strong demand for the wireless spectrum Intelsat was using for its linear TV services.
As a result, the company was sitting on a gold mine, and Kerrisdale built a sizable position in the stock. Currently, the firm is conducting research on the potential for bitcoin miners to convert their facilities to high-performance computing usage and will decide how best to position their portfolio for this twist.
Kerrisdale did cut its short exposure to bitcoin miners due to this new development, although the firm remains net short on miners. The firm concluded that bitcoin miners "may remain zeros and attractive shorts," adding that it may publish again on Riot or another miner at some point.
However, that report is expected to focus more on the high-performance computing conversions rather than the "terribleness" of bitcoin mining.