NIO: Can Almost See The Turning Point
Summary
- The new EV subsidy extension is a breeze to NIO.
- The recent earnings call suggests a potential turn with its financial in 2020.
- NIO's service-focused sales strategy will likely be the game-changer in the long term.
Introduction
In Q1 2020, NIO (NYSE:NIO) delivered a total number of 3,838 ES8 and ES6 as the country was heavily impacted by COVID-19. What sparked my interest to write on NIO is their forward guidance and their resistance to get through past challenges. I tend to believe in NIO's future and will turn more bullish if I see confirmation from these areas 1) gross margin improvement 2) mass adoption of the battery as a service 3) continued cultivation of its client base. While many contributors have done quite impressive and in-depth analysis on NIO, I want to write on the aspects I found interesting and, hopefully, provide you with some fresh views on NIO.
Source: NIO Inc.
What is different with this EV subsidy extension?
First of all, for me, it is extremely difficult to believe that China would allow the automotive market to be dominated by a foreign brand - Tesla (TSLA). Not only is the EV market an extremely lucrative market but it also has significant strategic importance for China to boost its high-end manufacturing. Therefore, NIO, as the current leading domestic EV player in China, will be backed by supportive government policies to ensure its survival, unless some other domestic brand proves to be superior.
Such a supportive policy can be shown by the recent changes in subsidies for EVs. Previously, the Chinese government planned to end the new EV subsidy in 2020. Given the economic hurdle caused by the pandemic, the finance ministry announced the tax exemption till 2022 and the new plan to cut subsidies by 20% in 2021 and 30% in 2022. Though this renewed policy provides some breathing room to the EV companies, the subsidies will apply only to cars costing less than 300,000 yuan ($42,376). That is likely to exclude premium electric vehicles (i.e. potential premium EV from BMW or the premium models from Tesla).
What differed this subsidy extension is that this 300,000 yuan threshold does not apply to vehicles equipped with swappable batteries, indicating the government's hope to see swappable batteries develop. Under this new policy, NIO appears to be the biggest beneficiary in this new policy as they are the only premium EV company with battery swap services. All future premium models (price above 300,000 yuan) developed by NIO that come with swappable batteries are still eligible for the subsidy. This shows that the government is siding with NIO, trying to create more favorable conditions for it to thrive and that should be a huge confidence boost for the company today.
The Questionable Battery As A Service ("BAS")
NIO's BAS strategy didn't get the recognition it deserves when this strategy first started years ago. From doing research and reading the reviews online, NIO starts gaining traction and social recognition for the 5-minute battery swap service.
From its latest company report, NIO said they own more than 1,200 battery swap-related patents on the vehicle battery pack, battery swap stations, and cloud service solutions. It also has 131 battery swap stations in 58 cities. Leaving all the bias and brands aside, a 5-minute swap does sound very attractive over a half an hour supercharge. NIO, as of Q1 2020, has completed its 500,000th swap.
Without getting into the details between battery charge and swap, I think there is no right or wrong of which is the best one. Different scenarios have different applications. Charging stations work well in countries with less population density and higher labor cost. In contrast, in countries where high population density is a problem, real estate is expensive and labor is cheap, leasing an 8-vehicle parking lot for charging may not be much cheaper compared to a small battery swap station with a full-time technician.
However, the BAS strategy comes with the risk of adaptation. On the surface, building the battery swap center creates jobs for the community and provides convenience to the clients. Yet, it undoubtedly brings a significant amount of costs (SG&A and R&D) to the shareholders. The lack of adaptation will potentially write off all the investments that have been put towards BAS to date. The only way I see NIO succeeding in this strategy is a mass adaptation to the battery swap concept, tilting its economic scale to the profitable end. (The new subsidy plan signals a willingness of the government to give it a try for the BAS concept.)
It is my understanding that NIO batteries will be a key component of its services - potentially upgradable, leasable, and easily replaceable, lowering the initial purchase price and enabling customers to upgrade based on demand. While this poses a completely different approach compared to Tesla's (i.e. million-mile battery), both strategies aim to preserve the lifetime value for the electric vehicles.
Source: NIO Inc.
The unavoidable financials
It is almost impossible to skip the financial part if one wants to talk about NIO. However, we also need to dive into where the company spent its money, and if they spent it right.
The negative gross margins strike every investor hard, indicating that they lose money selling every single car. The recent earnings do assure me somewhat as they gave positive gross margin guidance for Q2 2020 and a double-digit margin by the end of 2020.
Building an EV company is challenging, not to mention building this from scratch. NIO was founded in 2014 and IPO'd in 2018. Tesla was founded in 2003, approximately 10 years before NIO, and the below free cash flow chart just gave you an idea of how hard it is to run a profitable EV company. Li Bin used the U-shape analogy for its development. He said that, in general, the automobile manufacturing industry follows a typical "U-shaped curve" - 1) investment 2) deep drilling in R&D and sales 3) gaining traction and rebounding after completing the downward curve.
Source: Macrotrends
The following question an investor may ask is where they spent the money. To start, it simply did not make money to produce cars. This margin problem has not been solved until the recent indication that NIO starts to realize the reduction of the battery pack and other comp costs, optimization of manufacturing expenses, and efficiency.
Moving to the next problem, it is the SG&A expense. Since 2014, NIO has opened 22 NIO Houses and 92 NIO Spaces in 76 cities around China. In addition, NIO spent a lot of money building the online-offline community for the car owners. Instead of saying NIO spent money to sell cars, I would rather say they are spending money to build the brand and the trust in the communities. As we are all aware, the biggest obstacle to start a to-consumer premium EV company is trust. Trust is crucial to get customers comfortable buying the products knowing its quality is superior and the company won't get busted in the long term. As such, NIO's sales strategy turns to monetize its existing customer base and make them be the sales representatives or brand ambassadors within their social circle. Through the use of the internet, NIO is building its own communities with like-minded people, as well as a loyal customer base. This reminds me of the loyal customer base and community for Xiaomi (XI) and Apple (AAPL). As the base enlarges to a sizable magnitude, the so-called word-of-mouth referral becomes the cheapest and most organic way to gain customers. As an example, NIO's orders generated through user referral have reached 69% in early 2020 when the pandemic hit, higher than the 45% average user referral rate in 2019.
In 2019, NIO's deliveries were 20,565 units, while the annual production of battery EV was estimated at 1.21 million units. Further, the EV market share increase as the sales of combustion vehicles decreases (26.82 million in 2018 to 24.56 million in 2019) amid the government's intention to expand on the EV market and grow less dependent on fossil energy. While it is difficult to gauge the stock price valuation given today's negative profitability, I am quite optimistic about the Chinese EV market. I wouldn't be surprised if NIO double its sales units in 2020, delivered a positive margin at the end of 2020 or double its stock price to $8 (still below its all-time high). After all, we are looking at the first market to come out of the pandemic and rebound, alongside with Tesla's entry as a powerful catalyst in the EV sector.
A lot to prove
NIO has a lot to prove in the future. The first and most important thing is to improve margin and increase its scale. As sales develop to a sizable magnitude, they will need to think about their supply chain constraint in terms of the maximum number of vehicles produced per quarter, given that they don't have their own factory. Further, what are the implication of the Hefei partnership and the warranty rights mentioned in the earnings call?
NIO has a lot of questions to answer while some questions can only be answered through actions over time. I view this as extremely high risk and high reward investment. To many people, this is simply too hard to stomach. As I see more bullish evidence to support this company, I believe the turning point is getting close to NIO. Invest with caution and invest in something that you believe in. Thank you for reading.
This article was written by
Analyst’s Disclosure: I am/we are long NIO. 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.
Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.
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Comments (101)
This share has nothing more to do with growth if the operating business is no longer in this share at all. Therefore I recommend to all those who invested here to read the contracts thoroughly.
I have thrown some money on it, like playing in casino. 50 grands, will turn to 0 or half million.
Believe what you want but it’s as sound as any other motor company and supported in China which is the #1 global auto market
But this is good competetion and advertisement of EV cars to Nio.
Nio will be the poormans Tesla.
might be at least 1/4 of Tesla value which is 100-200 ps when sales on EV ramp up. Nio has a battery technology that is worth its competetion. The easy swap of battery is a valuble feature of Nio. The battery life is equal to the life of car.
rapercapital.com/... by @Jeremy Raper after reading above analysis I think that as a car itself NIO could be good but as an investment maybe it is not. to risky to hold a China/Cayman company with a lot of debt, while it transfers some of its assets (but not liabilities) to new NIO China entity and so on. WDT?
Tesla cars are everywhere now, but I never ever saw a Nio car.
I was at the Shanghai Carshow last year and Nio had the biggest booth, the biggest presentation... all other car brands looked like peasants compared to what they had. They also had a bunch of Europeen people "working for the brand" right there on the booth.
I couldn't believe it, and I told myself "when something is too good to be true, it usually isn't".
I don't know much else about this company. All I know is the impression it gives me. They play it like "we are huge, look at us, we are throwing money all over the place". That was also the case for OFO a few years back, and OFO is dead. I would not invest in that brand cause it screams that it is stealing money from investors the good old chinese way. A bit like LeTV did a few years back.
Last thing is, Chinese people don't like chinese brands, especially for cars, so I have no idea who is going to buy these. And if they have the money for one of these cars, they'll just buy a Tesla instead.
Still, in the end, I may be wrong and they might do amazingly well in the future. Just wanted to share my feeling here.
