To The Moon

Although NIO$NIO Inc.(NIO)$ $NIO Inc.(NIO.SI)$ $NIO-SW(09866)$ 's Q4 earnings fell short of expectations, as net losses widened while revenues missed the mark, the EV manufacturer's early 2023 numbers suggest that delivery growth is still intact. Although a major decline in gross margin was touted as a top area of concern from NIO's results, margin improvement is likely through the year. February deliveries showed a sign of strength, growing +98% y/y to over 12,000 vehicles, setting the stage for at least 50% growth potential in FY23, assuming no major production hiccups, offering solid upside potential. Starting off - deliveries for Q4 rose approximately +26.7% q/q and +60% y/y to 40,052 units. Vehicle revenues rose 23.7% q/q, suggesting that pricing mix trended somewhat negatively q/q, possibly from a higher sedan mix in Q4 relative to Q3 and the ET5's base price of RMB328,000 compared to SUV's average price of RMB426,000. Cost of sales showed substantial y/y growth as NIO recorded just under RMB1 billion ofimpactsfrom "inventory provisions, accelerated depreciation on production facilities, and losses on purchase commitments." That sum adversely impacted vehicle margin by 6.7 percentage points - excluding the impact, NIO would have recorded vehicle margin of 13.5%; this would still represent a somewhat substantial y/y and q/q decline, but given the fact that most of these headwinds are expected to ease by Q2, margins have room to run higher. Driving that RMB 1 billion in negative impacts was a platform shift in the ES6, ES8, and EC6 models - NIO is bringing these recently launched models to its NT2.0 platform, incurring costs related to retooling and leading to higher vehicle costs persisting through Q1. From a margin standpoint, these pressures are expected to ease beginning in Q2, once the new generation models have been launched, allowing a freer trajectory for margin expansion as raw material and battery costs cool significantly. A driving factor behind Q4's steep decline in net loss was a +117.7% jump in R&D expenses - NIO spent RMB2.1 billion more than last Q4 on R&D. For the full year, NIO spent an additional RMB6.2 billion on R&D, contributing significantly to its RMB14.4 billion net loss for the year. R&D is essential for NIO's development of its NT2.0 tech platform, the transition of its three models to the platform, and the development of itsfiveupcoming models. That's a pretty substantial product pipeline, so it's not necessarily concerning that R&D expenses have surged, but those expenses will have to be managed more tightly in 2023. Q1 Delivery Outlook & 2023 Volume Ramp NIO released delivery numbers for February alongside its Q4 results, showing a surge in m/m deliveries as sedan sales picked up steam. January'sdeliveriesdipped quite heavily from December's tally, likely primarily due to the transition of the SUV line to the NT2.0 platform, considering SUV deliveries took a larger hit. Growth returned pretty quickly in February, following the end of the Lunar New Year, with SUV growth bouncing back - up +130% m/m - while sedan growth increased about +12.7%.Moving through 2023, NIO is expected to generate a substantial amount of its delivery growth via its sedan line, which is demonstrating an ability to scale quite rapidly relative to choppy SUV volumes. Although NIO declined to provide single-vehicle statistics, it's likely that the ET5 remains a main driver of deliveries - from December, the ET5 generated 48% of total deliveries. NIO showed a major reliance on the ET5 and ES7 (EL7) in December, with the two accounting for 74% of deliveries - any production impact on those two models, or any shift in demand could dent deliveries; however, that is not expected given the strong demand exhibited so far. For 2023, NIO is expecting deliveries between 31,000 and 33,000 units for Q1, marking an approximate -20% q/q decline. However, deliveries are projected to be much stronger in the second half of the year, following the launch of two new models in May and June combined with management's confidence that a 30,000 delivery monthly rate run is achievable by year's end.As seen in the graph above, quarterly deliveries are projected to ramp substantially in Q3 and Q4 '23. This view is supported by production capacity, which can support at least 25,000 to 35,000 vehicles monthly by mid-summer, along with more model launches and limited production headwinds. A bull forecast for 2023 places deliveries at a projected ~200,000 unit level, approximately +63% y/y, with monthly deliveries averaging ~20% shy ofmanagement's 30,000 unit target. A more conservative forecast assumes NIO falls far short of management's targeted volumes, coming in at about 20,000 units on average by Q4, predicting difficulties launching multiple models across multiple geographic regions as well as factoring in macroeconomic impacts from potential inflation re-acceleration. Even if NIO struggles to scale towards that 30k/month delivery target, the conservative forecast still points to about +45% growth to 178k units. Shares A Steal At $8.50 Using Covered Calls We remain optimistic that NIO can exceed an initial>50% growth projectionfor 2023, reaffirmed by February's strong results - in what typically is NIO's weakest month for deliveries, it managed to deliver in excess of 12,000 units, implying a quick return to a 15,000/month run rate. This reaffirms our view that 200,000 deliveries are feasible, considering management's commentary and belief in reaching 30,000 deliveries per month and 250,000 deliveries for the year. Management's outlook would require average quarterly volumes in excess of 70,000 units, which may not arise until Q3 at the earliest in our view. With an upbeat view on deliveries - +63% growth towards 200,000 for the full year - the next catalyst looks to stem from gross margin improvement. As NIO's NT2.0 platform shift completes and CATL's battery discount takes effect, along with decreasing raw materials costs, NIO could see a path back to 18% vehicle margin by the end of the year, taking full year vehicle margin back towards the 14% range. At an initial revenue projection of ~RMB80B/US$11.6B, based on RMB68B in vehicle sales and RMB12B in other revenues, NIO trades at a relatively attractive 1.1x EV/revenue multiple. A return to a ~14% vehicle margin should put gross margin around 12%, or gross profit of RMB9.6B/US$1.4B. However, given NIO's spending profile and the need for R&D to continue in the early half of the year, NIO could book a net loss of approximately RMB10B/US$1.45B, or about ($0.90) per share. We believe that peak pessimism has hit NIO's shares in the near term, with Q1's weak delivery guidance and Q4's margin declines overshadowing the potential to scale significantly higher in the back half of the year. We see shares as particularly attractive at an $8.50 cost basis when paired with aJan 2024 $15 call, offering about 70% capped upside and the chance to own shares at a 12.5% discount. With the potential for margin weakness in the first half of the year, the ability to purchase shares at a discount offers an extra bit of downside protection - while there is the chance that money could be left on the table should shares advance past $15, the risk-reward here looks quite favorable.