Since the last time I covered NIO, much has changed. In my previous article, I rated NIO a hold, mainly due to its steep valuation and competition in its market. However, the picture has improved. The company has earned glowing media coverage. China’s lockdowns have ended. Shanghai has reached zero COVID cases. More importantly, NIO stock has been buoyed by a favourable policy shift in China.
The stock’s most recent dip was caused by a massive lockdown in China that shuttered some of its factories. This month, the lockdown was eased, which led to NIO completely reversing its prior trend overnight. Investors think that the company’s earnings will be better in the future than they were in the past. Even in the first quarter–when the lockdowns were in full swing–NIO managed 25% revenue growth. With lockdowns no longer affecting its production, it looks like NIO could thrive in the quarters ahead.
Indeed, I believe that NIO’s earnings for the upcoming quarters are likely to be good. I believe it strongly enough that I actually bought a small number of NIO shares on the recent dip. The company is a small cap with solid growth and well-reviewed products, so it has promise.
It’s for this reason that I’ve switched my NIO rating to buy. It is promising enough for growth investors that it merits a small weighting in a diversified portfolio. However, there are some caveats to keep in mind. First off, my position in it is miniscule. Second, much of the bull thesis on Chinese equities does not apply to this specific company. People who like Chinese stocks like them because of their high margins, pristine balance sheets, and cheapness. Few of these factors apply to NIO. It isn’t profitable, so the “high margins” thing is out, and 120 price/operating cash flow ratio doesn’t speak to a bargain.
Instead, the NIO thesis mostly revolves around growth potential. Its trailing 12-month revenue growth rate is 66%, and that’s with lockdown-fueled deceleration in the picture. Basically, this is a growth opportunity, not a value play–so it’s different from other Chinese stocks like Alibaba (BABA), which are truly dirt-cheap. In a best-case scenario, NIO stock could rise dramatically. But there are many risks and challenges to be aware of. For this reason, I rate the stock a buy, but not a strong buy. In this article, I'll explain my thesis on the stock, specifically why it merits a small weighting in a growth-oriented portfolio.
To look at NIO objectively, you need to consider the competitive landscape it operates in. NIO operates in China, where there is already one big player–BYD (OTCPK:BYDDY)--and several smaller ones. Tesla (TSLA) is in the Chinese market as well. When compared to some of the bigger names in town, NIO is a bit player in the industry. BYD shipped 593,000 cars last year–about six times NIO’s amount. Further, BYD makes public transportation vehicles, so it can lock in recurring government revenue. NIO, as a maker of sedans, lacks that advantage.
Tesla is another big player in China. In an average non-lockdown month, Tesla makes over 20,000 cars a month in China. They’re not all sold locally but the vast majority are. According to Inside EVs, Tesla sold 104,000 EVs in China in the first quarter of 2022. That’s more than NIO is doing currently. Of course, NIO has a very fast growth rate, so it will gain market share over time. But it’s currently behind two other companies in China.
Next up, we have NIO’s smaller competitors. NIO has a number of smaller competitors in China, including:
Among smaller Chinese EV companies, NIO is in second place. It had 91,000 deliveries in 2021, compared to 98,000 for XPEV and 90,000 for Li Auto. NIO is pretty well-positioned among the smaller players but is still far behind the leaders in China’s EV market.
As for the EV industry as a whole:
It has high growth but is very competitive. It grew quickly in the past and is expected to grow at 19% CAGR in the future. That looks like a positive, but you need to keep in mind the competition in the space. Everybody wants to get in on the EV trend, and that’s leading to a lot of companies entering the market. You can’t just count on any randomly chosen EV company to match the industry’s growth.
To gauge whether NIO can gain market share in the EV industry, we need to look at its products. Plenty of companies are making EVs, not all of them are succeeding. Does NIO have any advantages that could make it a winner?
There appears to be at least one:
According to NIO’s promotional materials, its ET7 has a range of 1,000 kilometers (620 miles). That’s longer than the range of any vehicle offered by Tesla, although some reviewers say that NIO uses the CLTC test cycle, while Tesla uses the NEDC test cycle. So, it’s not exactly an apples-to-apples comparison.
Still, reviewers seem to be receiving the ET7 well. It scored 4 stars out of 5 in an Autocar review, other reviewers are rating it pretty well too. The Autocar review touted these features:
Dolby Atmos Sound System.
4.3-second acceleration to 62 miles per hour.
Built-in AR and VR features.
The above review is pretty representative of what ET7 reviewers are saying; they generally give it high but not perfect marks. So, NIO seems to have a solid product on its hand.
Having looked at NIO’s competitive position and product quality, we can now turn to its financials. This is one area where the company stands out. NIO already has positive cash from operations and has intermittently positive free cash flow (“FCF”). Its earnings are negative, but the losses are growing smaller as a percentage of revenue.
In the most recent 12-month period, NIO delivered:
$6 billion in revenue.
$1 billion in gross profit.
$-1 billion in operating income.
$-1.186 billion in net income.
$309 million in cash from operations.
In the last 12 months, revenue, CFO, and gross profit increased, although the operating loss worsened from $-707 million.
Generally speaking, NIO’s losses are shrinking as a percentage of revenue. From 2018 to 2021, NIO’s revenue grew from $719 million to $6 billion, while the EBIT loss shrank from $-1.395 billion to $-1 billion. So, the loss as a percentage of revenue shrank by more than the raw percentage change in the loss itself.
That’s a good sign. Shrinking losses speak to the potential for future profit. Also, NIO’s balance sheet is very healthy. It has $1.75 billion in long-term debt, $5.9 billion in equity, $10 billion in current assets, and $5 billion in current liabilities. From this, we get a current ratio of 2 and a debt/equity ratio of 0.29, suggesting high liquidity and solvency.
Armed with NIO’s financials, we can move on to valuation. This is perhaps the biggest challenge to my bullish thesis on the stock. NIO is definitely not cheap. For the trailing 12-month period, it sported the following multiples:
Price/operating cash flow: 120.
These multiples are all fairly high. They’re lower than Tesla’s but definitely more typical of an EV company than your average beaten-down Chinese tech name. Many investors are excited about the “Chinese opportunity,” that is, the opportunity to buy high-quality, profitable tech companies at fire-sale prices. The opportunity is real, but NIO isn’t really part of this specific trade. In terms of valuation, it’s more typical of its sector than its country, and that’s something investors should take into account in today’s value-oriented market.
So far, we’ve seen that NIO is a cash flow-positive company with strong growth and a decent (though not amazing) position in its industry. Given its small market cap, it could rally significantly in a best-case scenario. However, there are significant risks and challenges for investors to watch out for, including:
COVID outbreaks. The recent COVID outbreak in Shanghai and Beijing resulted in NIO’s revenue growth decelerating to 25%. Prior to this, it had been growing revenue at 122% year-over-year. If more COVID outbreaks occur in China, they will likely inspire the government to bring in more lockdowns. If lockdowns occur in areas where NIO manufactures vehicles, then they could take a bite out of the company’s growth.
Competition. Competition in the EV space is fierce. In addition to Tesla and the Chinese competitors mentioned earlier, there’s also Volkswagen (OTCPK:VWAGY), small EV startups, and legacy automakers entering the space. The more competitors enter an industry, the lower the margins tend to be. Traditional gas-powered vehicles aren’t exactly a growth industry right now, and we might someday see EVs arrive at the same place, particularly if competition ramps up.
Dilution. NIO’s stock equity has been diluted in the past. The share count has gone up every single year, with an especially sharp increase occurring in 2019, when the count nearly tripled. In recent years, NIO’s dilution has been much slower. However, it’s still going on, and it creates an expense that offsets the company’s otherwise impressive operating cash flows.
When you put it all together, NIO looks like a worthy addition to a growth-oriented portfolio--albeit at a small weighting. It is suitable for investors with certain needs–say, those wanting a small “high risk/high return” position in a core and satellite portfolio. The best-case scenario with this company is extremely good, so a little exposure might be a good thing. But this isn’t the kind of stock you want to overweight, or “go all in” on. It is genuinely risky, and it is relatively expensive by the standards of Chinese equities these days. So, a portfolio weighting of less than 1% would be appropriate.
This article was written by
Disclosure: I/we have a beneficial long position in the shares of NIO, BABA 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.