Is NIO Stock A Buy Or Sell After The Q2 Earnings Report?

Summary

• NIO's second quarter losses continued to narrow as a result of strong vehicle sales and lowered material costs, despite ongoing supply chain disruptions experienced across the industry.
• Overseas expansion efforts are also progressing smoothly, with the rollout of NIO's suite of products and services in Norway to begin in September as planned.
• NIO is also looking to further its market share with the launch of a separate brand that will offer lower-priced EVs and drive greater mass-market appeal.
• The company has also been relentless in improving its technology, with the latest development being the anticipated launch of the 150 kWh solid-state battery pack in Q4 2022, which carries a range capability of up to 620 miles on a single charge.
• Combined with accelerated global EV adoption trends, NIO is well-positioned for further upside ahead. Our outlook on the stock remains bullish, with a 12-month price target set at $59.74.

Michael Vi/iStock Editorial via Getty Images

NIO (NYSE:NIO) continued to narrow its losses with strong vehicle sales volumes and lowered material costs during the second quarter. The results have been a key indicator of the electric vehicle (“EV”) start-up’s strength, as industry rivals mostly warned of further pressure on margins and production levels ahead due to global supply chain disruptions.

Close to 22,000 vehicles were delivered during the second quarter, driving vehicle sales up from RMB 3.5 billion ($540.1 million) in the same period last year, to RMB 7.9 billion ($1.2 billion). NIO’s strength continues to prevail with RMB 8.4 billion ($1.3 billion) in total revenues generated during the second quarter, surpassing consensus estimates of RMB 8.29 billion ($1.28 billion). The EV maker has also made significant progress in growing its market share in China, the world’s largest and fastest-growing EV market – NIO has sold more than 125,500 vehicles in China over a short span of about three years, and currently accounts for more than 50% of the nation’s electric SUV sales within its price segment.

Looking ahead, NIO expects to deliver 23,000 to 25,000 vehicles, and generate sales of RMB 8.91 billion ($1.4 billion) to RMB 9.63 billion ($1.5 billion) in the third quarter, which is in line with our full-year projections and consensus estimates. The company is also on track to making its Norway debut in a few weeks, with its first shipment of the NIO ES8 to the new market currently en route and expected to arrive in late August; the company’s ecosystem of offerings, ranging from its mobile app and NIO House studios to service centers and its proprietary NIO Power battery swap stations will also become available to users in Norway coming September. With the continued rise in demand for EVs in the domestic Chinese market, combined with additional sales in Norway, NIO is expected to realize accelerated sales growth into the end of the year.

2022 is expected to be another year of further growth for the EV maker. During the second quarter earnings call, NIO announced the launch of two new EV models in addition to the previously announced ET7 sedan in 2022; one of which will become NIO’s lowest-priced model, which is expected to compete directly with Tesla’s (TSLA) best-selling Model 3. The EV maker has also unveiled plans for a separate brand that will offer more affordably priced vehicles to drive higher mass-market appeal. Although further details on the separate brand’s launch timeline, product line-up, and available regions have not yet been announced, one thing for certain is that the strategic move will help NIO compete for higher market share, especially in the price segment of Tesla’s Model Y/3 while providing “much better service”.

Our outlook on the stock remains bullish given NIO’s strong performance to date. Combined with its strategic growth initiatives, which include overseas expansion and diversifying its product and price offerings to appeal to the broader market, NIO is well-positioned to capitalize on the global move towards electrification.

Recent Developments Within the Global EV Sector

NIO’s primary market, China, currently leads in global EV sales. According to the China Passenger Car Association, more than 1.23 million EVs were sold in China between January and July, up 210% from the prior year. Total EV sales in the region are expected to reach three million units by the end of the year, approaching the total number of EVs sold globally in 2020. The domestic market trends make strong tailwinds for NIO, whose growth developments continue to challenge its peers in the domestic market. During the month of July, NIO delivered close to 8,000 vehicles, catching up to the supremacy of its American rival, Tesla. The EV maker also saw the highest market penetration in China’s Tier 1 and Tier 2 cities during the first half of the year, with 14% in Shanghai alone; this compares to a penetration rate of 8.4% observed across the broader Chinese EV market, indicating NIO’s outperformance achieved relative to its domestic peers in the first half of 2021. And with the upcoming launch of additional models and a separate brand with diversified and competitively priced models, the rising EV maker is expected to further expand its market share in the world’s largest EV market, especially in China’s smaller Tier 3 cities.

In addition to the domestic Chinese market, global EV sales have also continued to accelerate rapidly at a penetration rate of 7% during the first half of the year, up from 4% in 2020. And in the long run, global EV sales are expected to see a sharp uptick, reaching 14 million units in 2025 and up to 145 million units by the end of the decade. Recall our recent analysis on NIO’s overseas expansion roadmap, which includes Europe in the near term and the U.S. in the long run, the global industry’s growth trends signal significant additional growth opportunities for the EV maker. Being one of the first regions to embrace and promote EV adoption, Europe is currently the world’s second-largest EV market, with Norway currently leading the way to mass-market adoption. The pact’s recent tightening of their emissions standards and emissions reduction targets is also expected to further accelerate mass-market EV adoption across the broader European markets like France and Germany in coming years, making NIO’s upcoming entry to the European market a well-timed move.

The U.S.’ EV sales are also slated to catch up to its Chinese and European peers in the latter half of the decade, which coincides with the timeline of NIO’s anticipated entry to the region after building out its operations in Europe. With the Biden Administration’s recent push for electrification, including capital deployment towards installing public charging stations across the country, consumer rebates for eligible EV sales, and electrifying the government’s fleet, U.S. EV adoption is expected to see accelerated growth at a compounded annual growth rate (“CAGR”) of up to 30% through to the end of the decade. This translates to about 18 million EVs on American roads by the end of the decade, representing approximately 14% of projected global EV sales. The U.S.’ urgency in electrifying its transportation sector to keep its emissions reduction levels at bay is also expected to drive higher commercial fleet conversion rates, which will inadvertently result in heightened demand for fast-charging solutions in which NIO could capitalize on, given its proprietary battery swapping technology.

New Battery Technology Developments

Although NIO has already made groundbreaking battery technology achievements with the development of battery swap stations (“Power Swap”), its recent announcement of the 150 kWh solid-state battery packs is expected to further its competitive edge to higher grounds. NIO currently offers swappable 70 kWh and 100 kWh battery packs, which already enable a range capability of 300 miles and 435 miles on a single charge, respectively. But the newest 150 kWh solid-state battery pack, which is expected to enter commercial use in Q4 2022, will take NIO’s range capability to newer heights. The first-generation ES8 will be able to achieve more than 450 miles of range on a full charge with the new battery pack, while the newer and more efficient models can get a range of up to 620 miles on a single charge. This would top current record-holder Lucid Motors’ (LCID) range capability of 517 miles on a single charge.

With the development of proprietary battery swapping technology that is capable of changing a dead battery out for a fully charged one in under three minutes, and a variety of battery pack options that can deliver an extended range of up to 620 miles on a single charge, NIO has single-handedly provided answers to two of the biggest roadblocks to global EV adoption – range capability and long charge times. And these achievements are expected to translate into higher revenues and boost its valuation within the foreseeable future, as NIO starts to deploy additional Power Swap stations outside of China, and add the new 150 kWh battery pack as a higher-priced option to its “Battery as a Service” (“BaaS”) battery swap subscription service.

Looking Ahead to What is in Store for the Rest of the Year and Beyond

With close to 42,000 vehicles delivered in the first half of the year, and a goal to deliver up to 25,000 vehicles in Q3, NIO is on track to completing more than 88,000 deliveries by the end of the year as we have initially projected in our base case forecasts. This is expected to drive vehicle sales of RMB 32.6 billion ($5.0 billion) by the end of the year based on average vehicle revenue of RMB 367,000 ($56,635), which is consistent with NIO’s sales mix and pricing strategy observed in recent quarters. The projection takes into consideration NIO’s upcoming debut in Norway, which will add to domestic sales growth expectations in the fourth quarter. Meanwhile, some of the incremental upside is expected to be offset by potential impacts from ongoing supply chain disruptions, which has already affected NIO’s productions as management had mentioned during the second quarter earnings call.

And based on NIO’s recent developments with respect to ongoing growth initiatives, which include overseas expansion, technological advancements, and expanding market share as discussed in the foregoing analysis, our base case forecast expects vehicle sales to grow at a CAGR of 30.4% towards RMB 461.4 billion ($71.2 billion) by 2030. Other sales revenues, which are primarily generated from BaaS and “Autonomous Driving as a Service” (“ADaaS”), are also expected to grow at CAGR of 30.0% from projections of RMB 2.3 billion ($352.1 million) by the end of the year to RMB 31.5 billion ($4.9 billion) by 2030; the growth assumption is consistent with the additional value that NIO is expected to benefit from the enhancements made to its battery technology as discussed in earlier sections, as well as the tremendous growth prospects on its autonomous driving technology.

Source: Author, with data from our internal financial forecasts (NIO_-_Forecasted_Financial_Information.pdf).

Combined with NIO’s cost structure, which is expected to improve and drive wider margins within the next five years as vehicle sales volumes continue to ramp up and scale, NIO’s net losses are expected to further narrow towards 2024, with nominal profits of RMB 8.2 billion ($1.3 billion) starting in 2025. The bottom line is forecasted to trend towards RMB 39.3 billion ($6.1 billion) by the end of the decade, representing growth at a CAGR of 36.8% (for a detailed analysis on the projected cost breakdown, please see our detailed analysis on NIO’s 10-year outlook here).

Source: Author, with data from our internal financial forecasts.

NIO Stock Valuation

Source: Author, with data from our internal financial forecasts.

Taking into consideration NIO’s stellar financial performance in Q2 and upcoming growth developments as discussed in earlier sections, our outlook on the stock remains bullish with a 12-month price target of $59.74 based on an equity value of $7.97 billion. This represents upside potential of 57.0% based on the last traded share price of $38.05 on August 27^th.

The 12-month price target is derived from a discounted cash flow ("DCF") analysis over a five-year discrete period in conjunction with the financial projections for NIO as discussed above. We have used projected free cash flows up to 2025 to compute our 12-month price target to reflect the valuation expectations on the EV maker's near-term growth initiatives. A cost of equity of 11.9% is applied to discount NIO's projected free cash flows in our near-term valuation analysis, which is consistent with the company's current risk profile, taking into consideration its highly leveraged balance sheet and recent volatility in its price performance given uncertainties over the Chinese regulatory landscape. Our analysis also assumes a 90.6x EV/EBITDA multiple, which is derived based on NIO's current size of operations, growth initiatives, and business outlook. This compares to the EV/EBITDA range of 70.9x to 112.2x observed across its industry peers.

Recent Developments to China’s Evolving Regulatory Landscape

While China has continued to place a heavy hand on tightening its regulation of businesses across a variety of industries, ranging from tech to baby formula, the EV sector has yet to experience significant adverse repercussions as it continues to play a critical role in China’s journey towards becoming carbon neutral by 2060. In fact, China’s EV sales have continued to accelerate at an unprecedented rate, thanks to the Chinese government’s intervention through generous consumer rebates on eligible EV purchases. The Chinese government’s support for the nation’s EV sector is also officialized through the five-year State Development Plan for the New Energy Automobile Industry, which plans to have EVs account for 20% of total vehicle sales by 2025 and become the mainstream choice by 2035 to ensure China’s continued dominance in the global EV market.

The Chinese EV sector has also seen a “greater tolerance for higher valuations” amidst the ongoing sell-off of Chinese stocks, underscoring the market’s confidence in China’s booming EV market. Even institutional investors like Goldman Sachs have recently increased their fund’s position in NIO to 21.44 million shares following the release of the EV maker’s Q2 results, further corroborating the market’s positive view on China’s fast-growing EV sector.

And out of all other domestic EV makers, NIO may be in the most favorable position amid China’s evolving regulatory landscape for the following reasons:

• NIO is 9.64% state-owned – Based on recent developments, regulators have signaled preference for state control through either direct ownership interest or a seat on the board as a solution to the ongoing regulatory woes experienced by data-heavy tech companies. And given NIO’s ties to the Chinese government through its organizational structure, it just might provide an additional level of safeguard for the EV maker against the ongoing regulatory crackdowns. In February 2020, NIO entered into an agreement with the municipal government of Hefei to create “NIO China”. The arrangement involved a cash injection of RMB 7 billion ($1.1 billion) by the state-controlled investor consortium known as “Hefei Strategic Investors” while NIO contributed all of their research, supply chain, and sales valued at RMB 17.8 billion ($2.7 billion); as of December 31, 2020, NIO held a 90.36% controlling interest in NIO China (2020 10-K, page 77).
• NIO’s strategic partnership with state-backed oil giant, Sinopec – NIO has recently entered into a strategic partnership with Sinopec to deploy an additional 5,000 battery charging and swapping stations over the next five years, and cooperate in the development of new materials and smart EV technology. The strategic partnership further bolsters the support that NIO has been receiving from the Chinese government to facilitate its continued growth within the domestic EV market.
• Favorable policy support – The Chinese government currently offers a consumer rebate of up to RMB 13,000 ($2,000) for eligible EV purchases, which must satisfy one of the following two criteria: 1) the purchased EV is priced under RMB 300,000 ($46,000); or 2) the purchased EV is compatible with battery-swapping technology. NIO’s vehicles do not satisfy the first requirement, given its lowest-priced vehicle currently starts at RMB 350,000 ($54,000). However, the second requirement is a testament to how Chinese policy has favored NIO. Because NIO is the only EV maker in China with models compatible with battery-swapping technology, it continues to be a significant beneficiary of the Chinese government’s EV purchase subsidy program.

Conclusion

NIO’s stellar financial results reported in the second quarter is a testament to its strength and resilience in navigating through industry headwinds related to China’s unstable regulatory environment and ongoing supply chain disruptions. Combined with the recent developments made to its ongoing growth initiatives, which include overseas expansion, technological advancements, and expanding market share as discussed in the foregoing analysis, NIO is well-positioned for further upside ahead. Accelerated global EV adoption trends will also remain as strong tailwinds for NIO – as long as the EV maker continues to execute the growth initiatives according to its business plan, the profits will follow and be reflected in its price performance.

Disclosure: I/we have a beneficial long position in the shares of NIO either through stock ownership, options, or other derivatives. 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.