Did Buffett and Munger see the one wrinkle in BYD’s stellar performance?

After years of sitting on an over 20 per cent stake in China’s BYD Co, Warren Buffett’s Berkshire Hathaway may be mulling an exit. A similarly-sized position showed up in Hong Kong’s clearing system last week, fueling worries that the Sage of Omaha was over the hot Chinese electric vehicle and battery maker.

It sure seemed like odd timing: BYD has risen to the top of global electric vehicle maker rankings. It’s closing in on Tesla Inc. while forging a clear path ahead on batteries and, somehow, circumventing severe supply chain snarls. The firm has done all the right things. On Thursday, the Hong Kong-listed company said it expects preliminary net income in the first half to jump 207 per cent.

The question is, if the stake in the clearing house is Berkshire-related, what risk do Buffett and his vice chairman Charlie Munger see that others don’t? Could it be a judicious call, much like the one that led them to take a stake in BYD to begin with?

Also Read: Warren Buffett’s Berkshire Hathaway buys more Occidental Petroleum shares

Beneath BYD’s stellar performance, a wrinkle is emerging: lithium supply. While it’s been well-telegraphed that a raw material shortage looms as prices surge, the company has so far circumvented those cost pressures. It’s been pushing a vertically integrated model: eyeing mines across the world, boosting production, making better batteries and keeping a tight hold on its supply chain. Among all those factors, its grip on lithium production has been the most uncertain. High material prices have been hitting China’s industrial firms so hard that Beijing called for capping the rising lithium price and is planning policies to help downstream firms.

BYD has been on a mission to get its hands on lithium mines and resources this year. The firm is connected with Youngy Co, one of China’s first spodumene, or raw lithium compound, miners. In March, it participated in a private placement in another miner, Chengxin Lithium Group. As part of this, the firm will get discounted lithium compounds in the future. While both are likely to continue buying more mines in the Sichuan region, it isn’t going to lead to immediate or guaranteed supply: Most of the quarries have future — not existing — ore production capacity and Chengxin doesn’t have full access to supplies in some of them.

Even if BYD were to take all the output from two of the mines, it would only get an equivalent of 80 gigawatt hours by 2025, according to Daiwa Capital Markets analysts. Across the top nine Chinese battery companies, around 27 gigawatt hours of batteries were installed in June — and BYD added just over 5 Gwh. Clearly, the supply deficit is here to stay.

Meanwhile, the types of batteries the firm makes — mostly lithium iron phosphate — are now gaining traction outside of China as key patents that restricted production to the country get closer to expiring. That means there will be even more demand to pressure supply.

There are other, less-appreciated issues. For instance, analysts are counting on more lithium-bearing minerals and ores from Sichuan, but it could be lower than expected because the terrain is difficult, which affects how long mines can operate. There are also escalating environmental issues in the region.

These pressures led BYD to look at Chile, where it won a contract for lithium extraction. It was hindered again when some of those contracts were suspended by the South American country’s top court. It’s now looking for mines in Africa, but no clear deals have emerged.

The firm bet on EVs after announcing it wouldn’t make any more traditional cars. Still, it isn’t clear how it will churn out its lithium-heavy top-of-the-line batteries, or the estimated 1.5 million EVs this year that will need those powerpacks, without tied up supply contracts.

Whether it’s Buffet’s stake or someone else’s, investors are skittish around raw material supplies and costs, no matter how vertically-integrated a company is, or how good sales forecasts look.

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