NIO Inc.: It Is All About Production Capacity

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About: NIO (NIO)
by: Wilsonville Capital

Summary

The company designs, manufactures, and markets electric vehicles to be sold in China.

Tesla investor Baillie Gifford & Co. acquired an 11.4% stake in the company.

Several banks initiated coverage on the stock. Morgan Stanley placed a target price of $8.50, while Goldman and Citi placed the target price of $6.56 and $7.20.

With a large number of facilities and employees, NIO does not seem to be performing the way Tesla did in the past.

With 6,231 employees, the revenues of NIO seem too low. In the first half of 2017, the company reported revenues of only $6.7 million. It seems that the company’s size is huge but the total output is tiny.

With a new investor acquiring a large stake in NIO (NYSE:NIO) and several banks issuing price targets for the company, revisiting this name seems necessary. Most banks are given price targets ranging from $6 to $9.50.

Taking into account the company's current production capacity and the price of the new ES8s model, the stock price seems to be too expensive. Additionally, the company seems to be underperforming compared to its rival, Tesla (NASDAQ:TSLA). NIO has a large number of employees and facilities, and it produces a very small amount of revenues.

Business

Founded in 2014 and headquartered in Shanghai, China, NIO Inc. seems to be the new rival of Tesla in China. The company designs, manufactures, and markets electric vehicles to be sold in China.

(Source: China Daily)

With very ambitious plans and clients having reserved 15,778 ES8s models, many banks and investors were attracted by this business after the IPO went live in September 2018. In addition, many banks have provided target prices for the shares of the company. Understanding the price targets given is interesting. Are they taking into account the production capacity of NIO as of today?

Baillie Gifford & Co. Acquired An 11.4% Stake

Tesla investor Baillie Gifford & Co. acquired an 11.4% stake in the company, which made the market react astonishingly. As the media noted the acquisition, the share price rose by 22% on October 9, 2018. Read the following lines in this regard:

(Source: CNBC)

It is a pity that the filing noting the transaction did not provide the price at which Baillie Gifford & Co. acquired shares. With that, investors should expect the transaction price to be between $6 and $10.50, as the stock traded at this level after the IPO went live. Investors should note that Baillie Gifford & Co. did not have a single share before the IPO went live. Its name is not included in the IPO prospectus. The image below shows the stock chart of NIO:

(Source: YCharts)

The market does not know the price at which Baillie Gifford & Co. acquired shares. However, it does know the intentions of this investor. In the SEC filing, it was noted that Baillie Gifford does not intend to influence the company. Like in the case of Tesla, wherein Baillie Gifford also invested, the investor expects to receive stock returns from the expansion of the electric vehicle. Changing members of the Board of Directors or forcing the company to acquire other competitors will not be Baillie Gifford's style. The image below provides additional details from the filing of Baillie Gifford:

(Source: Filing dated October 9, 2018)

Recommendations From Investment Banks

Knowing the conclusions of big banks as well as number of banks following the stock is interesting. In the case of NIO, several banks initiated coverage on the stock. Morgan Stanley placed a target price of $8.50, while Goldman Sachs and Citi placed the target price of $6.56 and $7.20 respectively.

(Source: Filing dated October 9, 2018)

There is more. Wolf Research also noted a price higher that the trading price as of October 10, 2018. The independent research firm placed its target price at $8.00. According to one of the analysts following NIO in Wolf Research, the company has many long-term positives, and it is the only manufacturer that could design a Tesla-like vehicle. The lines below provide more details:

(Source: Seeking Alpha)

A few weeks later, after the banks released their target prices, they also added that investors will have to wait for profits for long time. Most banks are expecting profitability by FY2020 or FY 2021.

“Wall Street analysts are paying a lot of attention to the path to profitability for NIO. Deutsche Bank (Buy, $9.50 PT) expect NIO to turn a profit in FY20, while Citi (Neutral, $7.20) and Morgan Stanley (Overweight, $8.50 PT) don't expect a profit out of NIO until FY21.”

Source: Seeking Alpha

While the target prices given by banks were debatable, they seem to be right about profitability. An assessment of the current resources of NIO and its expected revenues show that obtaining profits may be difficult.

Number Of Employees Working For NIO And Tesla

As of June 30, 2018, NIO had 6,231 employees. It seems to be the new Chinese Tesla. Let’s see the performance of Tesla and compare it with that of NIO. When Tesla had around 6,000 employees, it was delivering revenue of more than $5 billion. The following graph taken from YCharts shows these stats:

(Source: YCharts)

With 6,231 employees, the revenues of NIO seem too low. In the first half of 2017, the company reported revenues of only $6.7 million. What does this mean? It seems that the company’s size is huge, but the total output is tiny. That’s a serious problem, as it seems to have massive expenses without making a sustainable amount of money.

Let’s put it this way. Investors are putting a large amount of money in NIO, since it is the new Tesla but in China. They may be thinking that it worked well in the U.S., so it should work in China as well. The only issue is that NIO has not demonstrated anything yet. The company is underperforming compared to Tesla. Thus, it may not trade at the same valuation ratio.

Office And Manufacturing Space

The manufacturing space is another worrying feature of NIO. The image below, taken from Tesla's latest 10-K, shows the total square feet occupied by Tesla: 12.564 million square feet. Take a look:

(Source: Tesla 10-K)

Now, let’s take a look at the amount of space occupied by NIO in China. The prospectus reads that the space occupied by the company in China equals 1,543 million square feet. The image below provides further details:

(Source: Prospectus)

Tesla reports noted $13.68 billion in revenues with 12.564 million square feet. This means the revenue/square feet is $1,088. With this in mind, NIO has 1,543 million square feet, so it should be reporting revenues of $1.678 billion. However, the company is far from that level of revenue.

The following is information provided about the reservations for the company’s new model, ES8s:

“As of August 31, 2018, we had unfulfilled reservations for 15,778 ES8s with deposits. Of these reservations, 9,577 consisted of reservations for which only an initial fully refundable deposit of RMB5,000 had been made. Upon signing of the purchase agreement, which is required prior to a vehicle entering into production, the initial RMB5,000 deposit becomes non-refundable and the user must pay an additional RMB40,000 non-refundable deposit. As of August 31, 2018, we had unfulfilled reservations for 6,201 ES8s, for which non-refundable deposits had been made.”

Source: Prospectus

Let’s be very optimistic and believe that NIO will deliver 15,778 ES8s models. The initial price seems to be around $46,000, thus the total revenues should be equal to $725 million, which is half the amount of revenues that NIO should be making to be comparable to Tesla. Thus, in terms of facilities too, it is underperforming.

(Source: Electrive)

That’s not all. The company has very recently commenced delivering vehicles. The revenues are so low because it delivered only 100 vehicles by June 30, 2018. Read the following lines for further details:

(Source: Prospectus)

The obvious question here is: Why does NIO have such a large number of facilities if it is delivering such few cars? The way the management is organizing the manufacturing process seems a bit problematic here. The company will pay large sums for leasing space and should collect revenues in a few years. As the banks mentioned, the profitability could come, but in a few years. Investors should be aware.

Valuation

As shown in the image below, in the very beginning, when it was not delivering a large number of cars, Tesla traded between 8x and 24x revenues. It seems reasonable to use this range in the case of NIO.

(Source: YCharts)

Assuming forward revenue of $725 million, which seems very optimistic, NIO should have an enterprise value of $5.80-17.4 billion. Adding cash of $670 million and deducting debt of $225.94 million, the market capitalization should be $6.244-17.844 billion. With each ADS representing one ordinary share and assuming 1.026 billion shares, the implied price of each share could be $6-17. The lines below show more details about the number of shares outstanding:

(Source: Prospectus)

Let’s be a bit more conservative now. NIO received reservations for 15,778 ES8s models. However, the company will not deliver them in only 1 year. As of today, the total number of cars produced is lower. The prospectus reads that 1,296 cars were manufactured for the period. Take a look at it in the table below:

(Source: Prospectus)

If the company is able to manufacture and deliver 1,296 cars each year, its revenue would be equal to $59.6 million. With these numbers in mind, the enterprise value should equal $476 million-1.430 billion. Thus, the market capitalization should be equal to $920 million-1.9 billion. Assuming again 1.026 billion shares, the share price could be between $0.92 and $1.9.

What’s the most reasonable valuation? Investors should understand that NIO's total production right now is very low. That said, production capacity should grow in the future. The company will not produce 1,296 cars each year, but it may not be able to produce 15,778 ES8s models per year. Taking into account this rationale, the correct price should be somewhere between $4 and $6, but no more.

There is also another detrimental feature to take into account. NIO is not performing like Tesla. The revenue per employee is low as compared to that of Tesla. Additionally, NIO has many facilities to pay for, and revenues are not shown. Investors should really study this fact. It may not be reasonable to use the EV/Revenues ratio of Tesla if NIO is not performing or growing in the same way as Tesla did. Perhaps 8x-24x revenues is too much for the company.

Conclusion

With a large number of facilities and employees, NIO does not seem performing the way Tesla did in the past. This should be a concern for investors expecting the company to be the next Chinese Tesla. Additionally, with the current production in mind, buying the stock for much more than $4-6 apiece does not seem reasonable. If the company produces more, the price should increase, but as of today, with current information in mind, paying $7, $8, or $9 seems expensive.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.