Introduction
NIO Inc. (NYSE:NIO) is a Chinese-based EV manufacturer that has been around since late 2014; over its lifetime it has managed to sell close to 200,000 electric vehicles. The company has also been gaining a reputation for its innovative pursuits in battery swapping. In this article, I will attempt to cover some of the pros and cons of pursuing the NIO stock.
Pros Of Buying NIO Stock
Whilst NIO has received praise for its attractive and ever-growing product portfolio, to me, the factor that gives them an edge is their Battery-as-a-Service (BaaS) subscription offering and the NIO Power Swap Station 2.0 For the uninitiated, BaaS enables prospective NIO owners to buy a vehicle and then subscribe to the usage of battery packs separately. This decoupling of battery services from the sale of the car can significantly beef up the affordability quotient of NIO's vehicles thus opening NIO up to a whole new side of the market that otherwise, ordinarily wouldn't be interested (reportedly a BaaS subscription for a 70kWh battery pack for an ES8, ES6, EC6 or ET7 could potentially generate savings of RMB70,000 on the vehicle's purchase price).
Naysayers may question the cost-competitiveness of NIO's battery packs in the current environment where nickel and cobalt prices are putting pressure on EV battery costs, but do consider that quite unlike a lot of other peers that use lithium-ion cells, NIO's battery cathodes use low-cost lithium iron phosphate or LFP.
You also have to consider the growing yet underappreciated benefits of a publicly available battery-swapping station when the level of urbanization in China has been ramping up over time (over the last few years it has typically been around 2.5-3% per year) and the quantum of vertical dwellings is fast gathering pace. As space constraints become even more pronounced in urbanized China, you won't find too many buyers who will have the luxury of installing domestic charging systems; rather what you could see is a predilection toward these highly efficient battery swap stations (a battery in the NIO Power Station can be swapped in just five minutes and each swap station can potentially facilitate 321 swaps per day). NIO's goal over the next three years is to set up 4000 battery swap stations across the world (currently it is less than 900) with a quarter of the new stations to be set up abroad.
If you want to flourish in the EV space, a sustained thrust in R&D activities is a necessity, particularly when you have a rather ambitious goal of launching at least one new model per year (this year alone NIO will launch three new products). In FY22 it plans to double its R&D spend which was already quite high last year ($720m in FY21 representing 85% annual growth and 13% of FY sales.). R&D-related spending in the foreseeable future will focus on boosting the R&D personnel to 9,000 people, tweaking the tech for greater product adoption in the global market, and also investing in some long-term core technologies.
Besides R&D, there will be ongoing construction costs related to setting up NeoPark which looks poised to become the largest smart EV factory in the world (potential peak production capacity of 1.2m units per year). Also consider the additional capital that will be required to support the potential surge in battery swap stations from over 884 at the end of March to 1,300 by the end of FY22.
All these endeavors will call for NIO to have ample financial resources and I believe they are well-positioned on this front. According to their latest balance sheet figures, cash plus short-term investments currently stand at an impressive figure of $8.2bn, this represents a 27% improvement over last year's corresponding figure.
As a company grows in size, you'd expect to see some drop-off in its annual growth trajectory, but even if you account for this, one has to admit that NIO's future growth numbers still look rather promising. YCharts estimates currently point to expected FY22E revenue of $9.89bn and FY23E revenue of $16.68bn; this translates to impressive annual growth rates of 75% and 69% respectively (well over the average monthly sales growth rate of 33% seen over the past four months). Considering this growth cadence, it's fair to say that NIO's stock is significantly undervalued, relative to its own history, as well as other comparable peers in the EV space.
Using the FY22E revenue number, NIO only trades at a lowly multiple of 3.44x, this represents a hefty 66% discount over its trading average of a little over 10x. Then, I've also juxtaposed the NIO numbers against other EV peers (haven't included TSLA in this peer set as it is operating in a different orbit altogether). Note that NIO's expected sales level is well above all these other peers, yet three out of the four peers all trade at pricier forward sales multiples.
When placed against its peers in the green energy space, NIO now appears to offer decent value, something one couldn't state towards the end of 2020.
The first chart shows the relative strength of the stock vs other peers involved in clean-energy tech, as represented by the First Trust NASDAQ Clean Edge Green Energy ETF (QCLN). NIO enjoys a 7% weight in this ETF and is its fourth-largest holding. Currently, this ratio is not only below the average line, but it is also hovering closer to the lower boundary of the descending wedge that has been in place since late 2020. This ratio isn't close to a bottom, but yet still, I think the risk-reward at this juncture looks decent.
Sell-side analysts have their fair share of critics, but it would be foolish to totally dismiss the clout this cohort has in nudging broad market sentiment towards, and against, a particular stock. They may eventually be left with egg on their faces when calling the future direction of a stock, but like it or not, the sell-side brethren just have better information access and are well-positioned to ascertain underlying conditions within a certain market. Fortunately for NIO stockholders, the sell-side sentiment currently appears to be blowing in favor of NIO. Just for some perspective note that out of 26 analysts who cover the stock, 23 of them either have a 'BUY' rating or an" OUTPERFORM" rating, and there are no 'SELL' ratings whatsoever. Crucially the average target price works out to $40.60, which implies potential upside of nearly 100%!
Since the Holding Foreign Companies Accountable Act was implemented in late 2020, US-listed Chinese stocks such as NIO have come under increased regulatory scrutiny with questions being raised over their accounting transparency. Delisting of these stocks has been mooted as a strong possibility and you would think this facet would put off quite a chunk of prospective investors who would otherwise have considered the NIO stock. Recent reports have now emerged, suggesting that the Chinese regulatory authorities are doing their bit to rectify the compliance gap and are now willing to share the audit reports of most of the US-listed Chinese companies. You would think this would go a long way in reducing the risk of delisting. Could NIO now attract some of those cagey investors who chose to stay on the sidelines on account of this risk?
Besides this, one also ought to welcome NIO's recent decision to also list in Hong Kong, whilst it also has another application under review for listing in Singapore. Diversifying its listing options will help diminish some of the political and regulatory discounts that investors tend to attach to NIO's stock.
Cons Of Buying NIO Stock
The macro-environment in NIO's home turf does not look great with the country's zero-COVID policy putting the brakes on various parts of the economy. Consider the latest industry auto sales numbers which came out earlier this week; this was down 12% in March, the first decline this year, and the Chinese Association of Automobile Manufacturers has stated that this weakness could persist in April as well. Also note that the forward-looking manufacturing PMI there recently contracted for the second time this year (below 50) and incidentally hit its lowest point in over two years!
Growth-chasing investors can often be rather touchy when a company fails to live up to its growth credentials and they wouldn't want to see the declining growth trajectory of NIO's sales. As you can see from the image below, annual sales growth per month has only been around 27% this year, a long shot from what was seen over a year ago. Also, it's been a while since they hit deliveries of over 10,800 units in November last year (In March it was around 9,985 units). Considering the high base effect that will likely persist until July, investors shouldn't be too optimistic about witnessing a drastic pivot in the monthly growth percentage, even though the company has plans to introduce three new products this year. In fact the luxury sedan- ET7 was already launched late in March and I wonder if the latest indefinite production shutdown could dampen conversion for this product in the short term. Admittedly the bookings for the ET7 have been rather heartening, reportedly at over 15,000 units, but even before this latest production shutdown was announced, NIO had stated that ET7 production would be slow to ramp up and would probably only reach normal production levels by Q3. You would think this would now be pushed back even more.
Separately, from next year, investors should also brace themselves for an environment where there won't be any EV subsidies to augment the EV movement in China; this has already been cut by 30% this year and will be entirely abolished by the end of this year. I'm not suggesting that sales will crash, but there's been evidence of how EV sales in markets such as Hong Kong and Denmark have eased off once fiscal incentives for EV ownership were pulled back.
Commodity prices have been on a tear and it is difficult to see this situation easing any time soon given the Russia-Ukraine dynamics. Considering how important Russia is for the palladium market, you would think EVs would find it challenging to source adequate catalytic converters for their vehicles. Then there's the issue of procuring neon (considering that half the supply comes from Ukraine) which is instrumental for chip-making. The chip shortage issue has been a recurring theme for the auto industry for a while now and the likes of BMW and VW think this could persist well into 2023/2024. For NIO this could be a particularly damaging issue as typically each NIO vehicle has around 1,000 chips. All in all, it's worth noting that Chinese manufacturers have been facing a tough time in passing on costs to the end-consumer; this is reflected in the fact that the producer price index in March came in at a whopping 8.3% whilst the CPI there grew by a less pronounced rate of 1.5%.
For a burgeoning EV maker such as NIO to gain more credibility with the investment community it is important to show progress on the gross margin front over time (progress on the operating cost front could be excused for now, given the impetus on R&D activities). In FY21, NIO did well to boost its vehicle gross margin by 740bps to 20.1%, but the outlook for the next year implies a decline to levels of 18-20%. Despite the recent price hikes by NIO, I believe it could be challenging to replicate last year's vehicle gross margin.
2022 has been a dizzy period for global equities and I don't get the sense that risk aversion trends will ease off any time soon with money managers turning increasingly pessimistic about global prospects.
If your risk appetite is on the lower side, you might wonder if there's great merit in loading up on a high-beta play such as NIO at this juncture (the stock's 3-year beta works out to a whopping 2.4x).
Closing Thoughts- Is NIO A Buy, Sell, Or Hold?
There's a lot to like about the NIO story and most of the headwinds appear to be ephemeral in nature and are perhaps more industry-related or macro-related. Besides, given the forward valuations at which the NIO story is on offer, it feels criminal to look away, even though, in the short term, it may not be all smooth sailing for NIO's stock. All things considered, I'd rate NIO as a BUY.
