QuantumScape: A Hero Or Zero

QuantumScape (NYSE:QS) is at the forefront of solid-state lithium-metal battery technology, aiming to revolutionize the automotive industry by offering better range, shorter charge times, improved safety, cost efficiency, and enhanced battery life. As the company moves closer to product qualification and commercialization, there are undoubtedly high expectations for its potential. However, with a lack of profitability and an unclear future, our investment thesis remains neutral on the stock, as we cannot accurately value the company based on future cash flows.

Business Analysis

QuantumScape, established in 2010, has been on a mission to develop substantially better batteries to accelerate the mass market electrification of vehicles. The company believes that to achieve mass market appeal, vehicles need to offer better range, shorter charge times, improved safety, cost efficiency, and enhanced battery life compared to what is currently available. In order to achieve this level of performance, QuantumScape focuses on solid-state lithium-metal chemistry, which they believe is the key to unlocking significantly higher energy density and improved charging times.

As the leaders in commercializing solid-state lithium-metal chemistry for the automotive industry, QuantumScape has demonstrated the performance of its prototypes in various tests. One test, in particular, which the company views as the gold standard for automotive batteries, is charging from 0% to 100% in 1 hour and maintaining 80% capacity after 800 cycles. In December 2010, QuantumScape showcased solid-state lithium-metal chemistry performing to this standard for the first time.

Since going public in 2020, the company has made significant progress by showcasing results from single-layer, 4, 10, 16, and 24-layer cells. The 24-layer cells are especially exciting as they initiate the formal A-sample qualification process for at least one automotive OEM, marking a significant milestone in the company's journey towards product qualification and commercialization.

QuantumScape has established partnerships with six automotive OEMs, with Volkswagen being their most prominent and deeply involved partner. Volkswagen holds two seats on QuantumScape's board, has made multiple investments in the company, and has a joint venture for the first commercialization of the solid-state batteries.

In our analysis, we find that bulls believe that QuantumScape is at a crucial inflection point, with the potential to revolutionize the automotive battery market. The demand for better batteries is immense, given the increasing need for electric vehicles to combat the 30% of global emissions resulting from transportation. In addition to the automotive industry, QuantumScape's solid-state lithium-metal chemistry has potential applications in other sectors that require smaller, lighter, faster-charging, and safer batteries.

However, we believe bulls are not in control here given the stock's over 50% decline over the past year and its rather high 21% short interest.

Concerns

QuantumScape Corporation, a pre-revenue solid-state battery maker, faces several risks and concerns that investors should carefully consider before committing to owning its shares.

Although QuantumScape is riding the massive secular tailwinds of electric vehicle (EV) adoption, with China leading the way and the US in its nascent stage, the company is still far from volume production. We believe there is considerable work needed for QuantumScape to achieve commercial ramp and investors could face potential further dilution in the future. With a projected accumulated free cash flow of -$1.2B through 2024, even before its expected commercial ramp in 2025, it's no wonder that the company remains a favorite for short-sellers.

Another concern for QuantumScape is proving its manufacturing prowess on its nascent technology. The company has identified the opportunity to widen its adoption to consumer electronics, leveraging its solid-state batteries' ability to run with zero externally applied pressure. While this could potentially expand QuantumScape's use cases for its battery technology, management has yet to present the economics of such a breakthrough and commercial ramp to investors.

Moreover, QuantumScape faces competition in the consumer space, with companies like Imprint Energy also working on solid electrolyte for consumer IoT devices. Despite the recent recovery in QS share price, the company's unprofitable business model and distance from profitability make it challenging to model its expected free cash flow through 2025.

Industry Overview

Readers may gain a better understanding of the competitive dynamics discussed earlier with an overview of the industry.

The global transition to electric vehicles (EVs) is driving a surge in demand for batteries, with EVs accounting for 10% of global vehicle sales in 2022 and projected to reach 30% by the end of the decade. This transition is further fueled by climate legislation and policies worldwide, such as bans on gas-powered vehicles and investments in battery manufacturing. In this context, batteries will play a crucial role in the transition to renewable energy, and new developments in the field are expected to have a significant impact on the industry.

Lithium-ion batteries are the dominant technology for EVs today, but there is considerable room for improvement. Researchers are exploring ways to boost capacity, speed charging time, and reduce costs. Concerns about the supply of key battery materials like cobalt and lithium are also pushing the search for alternatives to standard lithium-ion chemistry.

Solid-state batteries are an emerging technology to watch, as they replace the liquid electrolyte in lithium-ion batteries with solid materials like ceramics. This shift could lead to more energy-dense batteries with faster charging times and improved safety. QuantumScape is a leading player in this space, focusing on lithium-metal solid-state batteries and having secured a partnership with Volkswagen to potentially incorporate their batteries into cars by 2025. However, significant challenges remain in terms of degradation and manufacturing, meaning that solid-state batteries will not be widely available in the short term.

Another promising technology is sodium-ion batteries, which use sodium instead of lithium as the main chemical ingredient. While they may not improve performance, they have the potential to reduce costs due to their reliance on cheaper and more abundant materials. Chinese battery giant CATL plans to start mass-producing sodium-ion batteries in 2023, but their suitability for EV applications remains uncertain. As a result, some companies, like US-based Natron, are initially targeting less demanding applications, such as stationary storage or micromobility devices.

Stationary grid storage is a growing market, driven by the increasing deployment of renewable power sources like wind and solar. Lithium-ion batteries are not ideal for this application due to their primary focus on size, weight, and speed. Iron-based batteries are emerging as a strong contender in this space, with companies like Form Energy and ESS making significant progress on their respective technologies.

Lithium-ion batteries will continue to improve in performance and cost, driven by the need to mitigate the price volatility of battery materials. One potential breakthrough is the development of lithium iron phosphate (LFP) as a low-cost cathode material for lithium-ion batteries. This alternative could play a significant role in the industry as researchers look to reduce dependency on expensive materials like nickel, manganese, cobalt, and lithium.

Financial Analysis

Our analysis of QuantumScape reveals a company that is gradually improving its financial performance, as evidenced by the narrowing of operating losses by 7% quarter-over-quarter, from -$121 million in Q3 2022 to -$113 million in Q4 2022. The actual Q4 2022 operating losses came in 3% better than the Wall Street analysts' consensus estimate of -$116 million, according to S&P Capital IQ data. In addition, the company recorded a narrower net loss per share of -$0.25 in Q4 2022, representing an improvement from the Q3 2022 net loss of -$0.27 per share. This recent quarterly bottom line also surpassed the sell-side's consensus EPS projection of -$0.26.

Despite these positive financial results, QuantumScape's stock price fell by 17% from $11.84 on February 15, 2023, to $9.81 on February 16, 2023, following the Q4 2022 results announcement. This suggests that investor sentiment remains cautious, possibly due to concerns about the company's ability to achieve profitability and execute on its growth plans.

QuantumScape's focus on maximizing capital efficiency in its QS-0 pre-pilot line, targeting year-end delivery of equipment needed for early production, indicates a strategic commitment to achieving operational milestones. In our opinion, the company's efforts to improve financial performance, coupled with its emphasis on capital efficiency and operational progress, may bode well for its future growth prospects. However, the market's negative reaction to the Q4 2022 results highlights the need for the company to continue demonstrating progress towards profitability and executing its growth strategy to regain investor confidence.

Conclusion

QuantumScape's ground-breaking technology and partnerships with major automotive OEMs demonstrate its potential to transform the electric vehicle industry. However, the company's current lack of profitability and uncertain future make it difficult to accurately value based on projected cash flows. As a result, our investment thesis remains neutral on QuantumScape's stock. Investors should carefully monitor the company's progress towards profitability and execution of its growth strategy to determine whether the stock becomes a more viable long-term investment.