NIO: Chinese Politics Make This Stock Unattractive To Own


  • NIO faces several challenges that will likely limit its upside in the next few quarters.
  • The lack of a manufacturing plant and the unfavorable geopolitical environment could prevent the company from successfully expanding outside of China in the following years.
  • NIO’s stock has been underperforming since the beginning of the year, and at the current valuation, it still has room to fall.
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NIO has been gaining traction in the last couple of years, as the company has quickly transformed itself from an automotive startup to one of the most popular Chinese electric vehicle brands. As of today, NIO has a market cap of a legacy automaker, it’s aggressively expanding within China, and it has plans of entering the mass market in the following years.

Nevertheless, there’s a risk that in the following quarters the business will start to underperform and lose its aggressive growth rate due to various issues such as the inability to source the necessary materials to meet the growing demand for its vehicles, and the unfavorable geopolitical environment, which will limit its upside and crush its expansion plans. At the same time, the company’s stock trades at a significant premium to its earnings. Considering this, buying NIO’s shares at these levels might not be the best thing to do, as risks slowly begin to materialize.

From Startup to a Mature Business

NIO’s stock has experienced massive growth last year and appreciated by over 1,000% from May 2020 to December 2020. However, as the enthusiasm for electric vehicle stocks started to fade at the beginning of this year, the company has depreciated as well, and currently, its shares are trading close to the YTD lows and have significantly underperformed the market since January.

Despite the decline in share price, NIO as a company has been aggressively growing in recent quarters. As one of the major Chinese electric vehicle brands, which delivers luxury SUVs and sedans, the business has expanded to major Chinese cities and is currently about to expand in Europe as well. In the first half of 2021, NIO already delivered 41,956 vehicles, nearly the same amount that it had delivered in the whole of 2020.

Going forward, there are three major catalysts, which could boost NIO’s business even more and increase the demand for its vehicles in the foreseeable future. The first catalyst is the expansion of its lineup of vehicles. Next year NIO aims to release a premium electric sedan ET7 and two additional unnamed models, which should help it to enter the mass market and expand its presence within China even more.

The second catalyst is the growing infrastructure, which helps NIO to increase its brand awareness and get additional customers. The company’s clubs, power charging stations, and service centers are already in over 100 major Chinese cities, and with each quarter they continue to expand in numbers at an aggressive rate. In addition, NIO also now has close to 400 battery swap stations, which quickly change batteries for NIO owners and give them the ability not to worry about long charging times anymore, as the swap is done in minutes.

The third catalyst is the Chinese electric vehicle market itself, which continues to grow at an aggressive rate and will remain the biggest EV market in the world in the foreseeable future. By some estimates, at least 70% of China’s new car sales will be electric cars by the end of the current decade, so being one of the most popular electric vehicle brands in such a growing market will without a doubt help NIO establish an even stronger presence back at home and drive growth.

Major Risks Ahead

While NIO has without a doubt a lot going for it, it appears that its growth opportunities are overblown, as several risks have started or are about to start materializing in the following quarters. First of all, the company is unsuccessfully managing the chip shortage crisis, which has disrupted the supply chains within the EV sector. In August alone NIO delivered less than 6,000 vehicles, which represents a quarterly decline of deliveries of over 20%, and is now risking missing its Q3 guidance of delivering 23,000 to 25,000 vehicles. In addition, if the crisis is not over by next year, then NIO is also risking postponing the launches of ET7 and two other of its upcoming models.

Another problem of NIO is that it doesn’t have experience in high-volume manufacturing, as it outsources the production of its vehicles to a third party. As a result, the company has no pricing advantage and it can’t fully control its margins in comparison to those who manufacture the cars themselves. While this might be fine for NIO while it competes in the luxurious SUV market, it will become increasingly hard for it to improve its margins when it enters the mass market and starts to sell affordable vehicles. Although NIO plans to tackle this issue by finally building its own vehicle production facility called NeoPark, it will be operational only in late 2022 and will take a few years to reach the forecasted annual capacity of 1 million vehicles.

On the other hand, those companies that spent time and resources in the past building their own plants are already delivering significantly more than NIO and will be able to quickly open additional production lines and expand their capacity. One of NIO’s major competitors XPeng is already on track to deliver 15,000 vehicles per month in Q4, twice as much as NIO does now, all thanks to the expansion of one of its plants in the Guangdong Province.

At the same time, NIO’s other competitor BYD in August alone delivered 60,508 vehicles, up 332% Y/Y, which is close to the same number of vehicles that NIO is going to deliver in the first three quarters of the current year, also thanks to having its own manufacturing plants. Considering this, it becomes obvious that NIO might lose its momentum in China if it’s unable to quickly deal with the chip shortage crisis and build its manufacturing plant on time next year.

Another problem of NIO is that there’s a high risk that all of its expansion efforts might fail in the end. Just this month NIO has officially started its expansion in Europe by delivering the first batch of its electric SUVs ES8 to Norway. It will take time to find out whether the car company will be successful there, but it’s already planning the expansion in the European Union, as recently it has started to hire people in the Netherlands.

The problem is that it’s likely that NIO will fail in Europe for two major reasons. First of all, it will be significantly hard for the company to penetrate the European market due to the presence of legacy automakers such as BMW, Daimler, Volkswagen, and others, all of which started to aggressively expand their EV capabilities and began delivering their first electric vehicles there.

Without having its own manufacturing plant in the region and a wide network of dealerships, shipping cars from China might not be worth it in the end, especially if NIO wants to attract new customers by offering them affordable cars in the end. That’s the main reason why Tesla has been building its Gigafactory in Berlin, as there’s no other way for it to compete on price with local manufacturers, all of whom have operational plants in the region.

In addition, China and the European Union failed to sign a free trade agreement called Comprehensive Agreement on Investment this year, and there’s a risk that it won’t be signed at all anytime soon due to the increased hostility between the two parties. As a result, being a Chinese manufacturer in this instance is a downside for NIO, since the lack of a free trade agreement will make it harder to compete with local brands due to the need to pay additional tariffs to ship the cars to Europe.

The same is true when it comes to the US market. NIO likely has very little chance of succeeding in the US, if it decides to enter that market at all. As legacy manufacturers such as Ford, and General Motors along with new entrants such as Rivian, and Lucid, are expanding and starting to electrify American roads, it will become harder to compete there for a relatively unknown outside of China auto brand. In addition, geopolitics is also likely to negatively affect NIO as well. We’ve already seen a few years ago how a trade war between China and the United States could disrupt whole industries and destroy supply chains when sanctions and tariffs are imposed.

A possible new trade war in the future or the increase of hostilities between the two biggest economies of the world will nevertheless have negative consequences for NIO since it still trades on US exchanges. In July, the presidential executive order already prohibited US investors from investing in 59 Chinese entities, and there’s a risk that NIO might be added there as well if trade tensions start to boil over time.

More Troubles At Home

There’s also a systemic risk of investing in any Chinese asset at this stage due to the increased presence of the Chinese Communist Party in the lives of fast-growing companies that raise funds abroad. Earlier this year the Chinese regulator already fined the biggest e-commerce company in the world Alibaba for $2.8 billion and clamped down on firms such as DiDi, which recently executed a public offering on US exchanges. If NIO becomes too big too fast, then there’s a risk that Beijing will take a closer look at the company as well. NIO already trades at a market cap of a legacy automaker, so it’s likely a matter of time until the Chinese government starts to interfere in its affairs, especially since there are already reasons to believe that that is what’s going to happen soon.

Just earlier this month the Chinese minister for industry and information technology said that the consolidation of the EV sector within the country is inevitable, as there are too many EV makers in China. By giving such a statement, Beijing is likely hinting at the fact that the EV space is going to be more regulated soon. If that’s going to be the case, then it might negatively affect NIO the worst among the big brands. Let’s not forget that the company doesn’t have its own production plant, it struggles to deal with the chip shortage crisis, and it doesn’t even fully own its battery swap business, which is shared between NIO, CATL, and two major Chinese players in fields such as banking and industrial park development.

On top of all of this, the worst downside of NIO is that just as it’s the case with a lot of other Chinese stocks, the company is not offering its shares directly on US exchanges. Right now China doesn’t allow direct foreign investments in certain industries, so companies use a variable interest entity structure, or VIE for short, in which a Chinese business creates an offshore shell company in places such as the Cayman Islands that can indirectly issue ADRs to foreign investors.

The problem with this is that it carries too many risks for investors who invest in such structures. In its effort to strictly control companies that raise funds abroad Beijing recently has adopted new rules in which if the company wants to go public on foreign exchanges through a variable interest entity, it needs to get approval from the regulator first, which wasn’t the case a year ago. As a result, some companies decided to abandon their plans to raise funds abroad, and now there’s a risk that the companies such as NIO, which went public on US exchanges through a VIE structure, could be more regulated as well, which could negatively affect those who invest in such companies.

The Bottom Line

When an investor considers all of those risks, the growth opportunities of investing in NIO don’t look so attractive anymore. In addition, if we look at the company’s current valuation, we could conclude that even after declining more than 20% since the beginning of the year NIO’s shares could still depreciate further. At a market cap of around $60 billion, NIO trades as a legacy automaker, even though it doesn’t deliver as many vehicles as big manufacturers at this time. In addition, its current growth rate is not enough to justify its current multiples and valuation.

In Q2, the company generated only $1.3 billion in revenues, while its EPS was -$0.06. In Q3, analysts expect the company to generate only $1.45 billion in revenues, while its EPS is forecasted to decrease Q/Q to -$0.10. NIO is also expected to be unprofitable this and next fiscal year at the very least, so investing in it could be considered a very risky endeavor at the current price, especially since it trades at 10 times its sales.

While NIO was a great stock to own last year, it’s not going to be the case this year, as there are too many risks that are associated with it. Therefore, it’s safe to say that its future growth is already priced in and the upside appears to be limited. The stock already trades close to its local technical support level of ~$30 per share, and the breach of that level could lead to further depreciation in the following months. Considering that NIO has a bearish quant rating from Seeking Alpha, I believe that it’s not worth it to purchase the company’s shares at this time, as there are better EV alternatives out there.

NIO stock Quant Rating and Factor Grade

Source: Seeking Alpha

Author: Bohdan Kucheriavyi, Seeking Aplpha

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