To The Moon

Summary

• I see NIO stock as a “hold” under its current conditions despite the recent large price movements.
• Its stock price has more than halved YTD and its valuation is at a historical low.
• Looking forward, it enjoys several strategical long-term assets: China’s determination to expand EV deployment, its branding power, and scale.
• However, I am yet to see it translating its expanding scale to a reduction in its unit cost and a boost in cash flow.

Thesis

The stock price for $NIO Inc.(NIO)$ in China suffered a 56% price decline YTD, underperforming the Shanghai Composite by almost 40%. Such a large price correction has brought the NIO stock price (together with otherEV players such as Li Auto (LI) and XPeng (XPEV)) to a multiyear low as you can see from the following chart. NIO’s price to sales ratio is about 4.6 only as of this writing, compared to a peak value above 16 early this year.

Looking forward, we see a promising future for NIO in the long term with its leading position, brand awareness, and also China's secular support. However, in the short term, we see large probabilities for the stock valuation to further contract for a range of near-term catalysts. NIO has not been able to leverage the scale of production thus far to reduce its unit cost. NIO is facing pressures from delivery uncertainties due to factory shutdowns, supply chain shortages, and rising inflation costs. Our final verdict is a “hold” rating considering the potentials and risks.

Chart 1 – healthy growth and China support

The most positive factor for NIO is its healthy growth in the biggest EV market in the world.

NIO just reported its March 2022 deliveries on April 1. It delivered a total of 9,985 electric vehicles delivered, up 37.6% year over year. For the first quarter of 2022, it produced a total of 25,768 vehicles, a rise of 28.5% year over year. This is the eighth consecutive quarter, a quite impressive streak, of rapid growth. Expanding the time horizon a little bit broader, it delivered 4,799 vehicles in the third quarter of 2019. As a result, in the past two and half years, its deliveries have grown at a spectacular 96% CAGR per year.

Looking forward, the company is well-positioned to capitalize on the EV market in China. China’s “new-energy cars” only accounted for about 5% of all new automobile sales in 2019. The percentage is mandated to rise to a target of 50% according to the government roadmap. And out of all the “new energy cars”, more than 95% will be EVs or hybrids. As reported by Nikkei Asia(and the highlights were added by me),

China plans to  make all new vehicles sold in 2035 "eco-friendly," part of a goal that promises to give a tailwind to Japanese automakers like Toyota Motor, which specializes in hybrid engines. Of all new vehicles sold that year in the world's most populous nation,  50% are to be "new-energy" vehicles -- electric, plug-in hybrid or fuel cell-powered . The other half are to be hybrids. The country's organization of automobile experts on Tuesday announced its road map for new-energy vehicles. The report is created under the guidance of the Ministry of Industry and Information Technology and will serve as the basis for China's rules and policies for automobiles.

Chart 2 – pricing power

Even though the competition in the EV space is heating, NIO has demonstrated the pricing power. NIO’s closest competitors are XPeng and Li Auto. In March, XPeng delivered more electric automobiles than the other two. Guangzhou-based XPeng delivered a total of 15,414 vehicles. In contrast, NIO delivered a total of 9,985 in March, about 50% less than XPeng.

However, NIO enjoys healthy brand awareness and its smart EVs have been in high demand. It has been able to maintain its pricing power in the past as shown in the following chart. Its average unit sale price was $53,553 per vehicle about two and half years ago in 2019 Q3. And the average sale price has reached $62,231 per vehicle now, a total of 16% or about 6.2% on a CAGR basis.

Looking forward, I see its pricing power to maintain given its brand awareness and high backlog. As an XPeng spokespersontold CNBC recently(emphases were added by me),

“The company attributes its robust Q1 delivery results to growing brand awareness and higher demand for its Smart EV products as well as  accelerated delivery of its large order backlog from 2021 and new orders received in 2022  after it completed technology upgrades for its Zhaoqing plant in February,”

I even see a few signs of further strengthening of its pricing position in the near future. As an example, it has announced a 10% retail price hike recently to offset higher raw materials. This could of course be interpreted as a reaction to offset raw materials and component costs. But at the same time, it is also a demonstration of its strong market position. Moreover, its anticipated release of new models (such as ES8, ES6, EC6, and also its new SUV) can also add to the higher price and higher margin. As announced in itslatest earnings release,

In late May 2022, the Company plans to unveil the 2022 NIO ES8, ES6 and EC6 with the latest digital cockpit hardware, and to launch the digital cockpit upgrade plan for existing users. In the meantime, NIO ES7, the Company’s new mid-to-large five-seater SUV equipped with NIO Technology 2.0 (NT2), will also make its debut.

Chart 3 – revenue reasonably valued but cash flow expensive

As a for ementioned, the recent large price corrections have brought the valuation of all major EV players to a multi-year low. NIO’s price to sales ratio is about 4.6 only as of this writing, compared to a peak value above 16 early this year. And compared to about 4.3x to 5.9x for Li Auto and XPeng, NIO’s sales are valued at on par to these peers. To put things in a broader perspective, TSLA’s price to sales ratio is about 12.3x and the overall S&P 500 price to sales ratio is about 3x. When leverage is considered, the EV to sales TTM is only 2.1x on an FW basis and 3.4x on a TTM basis, also either on par or at a discount compared to its peers.

However, the company is not profitable yet in terms of net profit. It has been generating a small positive operating cash flow (“CFO”) and its current price to cash flow multiple is about 88x as you can see from the chart below. It is substantially higher than Li Auto (about 16x) and also even higher than Tesla (about 57x), which leads to our biggest concern as shown in the 4thchart below.

Chart 4 - NIO has not passed the breakeven point

The following chart clearly shows NIO’s average cost of revenues per vehicle in recent quarters. As seen, even though the business was able to grow its deliveries at superb rates (by about 96% CAGR as aforementioned) and also at the same time increase its unit sales price (by about 6.2% CAGR), its average revenues cost per vehicle also increased at a rapid pace, about 90% CAGR. The average cost of revenue was $324k per vehicle in 2019 Q3, and it is $1,618k now.

Production costs come in two varieties, fixed costs and variable costs. For a production-oriented business like NIO, it has to first pass a breakeven point to recuperate all the fixed costs and start making a profit. After that critical point, the fixed costs get to be diluted on more and more units and the average revenue cost per unit would gradually decrease. However, this is not the trend that I am seeing so far for NIO as the chart shows. This is my biggest concern for NIO at this time, which has resulted in its low operating cash flow and the high price/CFO multiples seen above.

Final thoughts and other risks

An almost 50% price decline YTD brought NIO stock price sales ratio to about 4.6x, an attractive in both relative and absolute terms considering the growth potential, brand awareness, and also the secular support in the world’s largest EV market. However, we also see large probabilities for the stock valuation to further contract. NIO has not been able to translate its expanding scale to reduce its unit cost so far, resulting in low operating cash flow and also high price/cash flow multiples (even higher than Tesla).

Besides the risks mentioned above, investments in NIO also involve a few other risks. NIO is facing pressures from delivery uncertainties due to factory shutdowns caused by the COVID pandemic, supply chain shortages, and rising inflation costs. NIO had to halt its production and delay deliveries as China forced key cities into lockdown mode. Its supply partners in Jilin, Shanghai, Jiangsu, and other regions are disrupted and yet to recover.

source: seekingalpha