NIO Stock Is Getting Interesting

Summary

  • NIO stock recently fell 7% in one trading day after its Q1 earnings release.
  • Earnings exceeded what analysts expected but were bad in absolute terms, as the net loss widened.
  • I’m more optimistic toward NIO now than I was in the past because its price has come down while its revenue has grown.
  • I still assign it a ‘hold’ rating, though, because I’m not yet ready to recommend it to others due to the high-risk level.

NIO has never been my favorite Chinese stock. I’ve generally rated it a ‘hold’ in my articles, seeing it as a high-growth company with some major financial downsides. NIO grew revenue at 122% in the 12 months before the recent earnings release, which is certainly impressive. However, the company is also rapidly increasing its share count, making every shareholder’s ownership claim smaller over time. NIO isn’t the worst offender on earth when it comes to dilution; its share count popped dramatically in 2019 then slowed down afterward. The share count increase was significant enough to merit a mention though: it grew by 67% CAGR between 2018 and 2022.

For me, this dilution was, until recently, enough of a concern to avoid NIO stock. NIO’s revenue is growing faster than its share count, but the one offsets the other enough that the growth looks less impressive after adjusting for dilution.

That was pretty much the end of the story for me for a long time. As a fan of Chinese tech stocks, I had researched NIO and decided that it didn’t have the financial soundness other Chinese companies have. It’s issuing equity to fuel growth, and it still isn’t profitable. Case closed.

Or so it seemed. While I was content to leave NIO alone for a good while, I started thinking about the success Warren Buffett had with his BYD investment. Buffett bought the stock in 2008 for a mere $232 million, and the position grew to be worth $5.9 billion. I considered buying some BYD, but the stock looked overheated: it was rallying very hard on the day I considered buying it. NIO seemed like a company that could eventually go on to become “the next BYD,” so I snapped up a couple shares. Representing far less than 1% of my portfolio, the shares I bought are almost nothing, but some developments occurred that made me feel that they would be worth a tiny portfolio allocation.

On Thursday, June 9, I noticed NIO stock falling on an earnings beat. That was when I bought. What intrigued me was how much cheaper the stock had gotten due to the combination of a lower price and higher revenue. The combination of these two factors brought NIO’s price/sales ratio down to 5.6, which isn’t exorbitantly high for a company with NIO’s growth track record. In its most recent quarter, the company’s sales grew at 25%, with a massive Chinese lockdown in the picture. If the company can avoid lockdowns and other political headwinds in the next year it should be able to accelerate its revenue growth considerably; a return to 100% growth would make its 5.6 sales multiple appear cheap. This combination of a moderate valuation and growth potential is enticing. Nevertheless, I still rate the stock a hold, as I wouldn’t feel comfortable recommending it to a less risk-tolerant investor, nor would I give it a heavy weighting in my own portfolio.

Competitive Landscape

One of the reasons why I’m maintaining my ‘hold’ rating on NIO is because of the competitive landscape it finds itself in. EV is a very competitive space, with one company – Tesla (TSLA) — having the most brand recognition, and another – BYD – having the biggest market share in China.

NIO, right now, can’t touch the advantages that either of those companies has. It isn’t selling as many cars as either, and it doesn’t have as much name recognition. However, it has the potential to improve. Prior to the Q1 lockdowns, NIO had a 122% revenue growth rate. Even with the lockdowns, it managed 25% growth. The pre-lockdown growth rate was much higher than that of Tesla, yet NIO still has a far lower sales multiple than TSLA does. As a comparative valuation play, NIO looks like it has promise.

The comparison to BYD is less flattering. BYD is growing deliveries by 250% year-over-year, which is a much faster growth rate than NIO. It’s also doing a lot more deliveries to begin with: in 2021, it sold 593,743 cars. Recently, BYD made waves when it was revealed that it was selling batteries to Tesla. That was considered a big deal because it reversed what was once considered Tesla’s big advantage over other EVs: battery production.

NIO is certainly no BYD-tier industry titan. However, it doesn’t compete with BYD head-to-head. NIO mainly sells luxury cars, BYD sells a mix of cars and commercial vehicles. So, there is room for both companies in the Chinese EV market.

Financials

As we’ve seen, NIO has an ‘OK’ competitive position. It’s no BYD or Tesla, but it’s a real company selling ever growing numbers of cars every year. Viewed as a speculative small cap play, it has promise. As for whether NIO is fulfilling its promise, we need to look at the company’s financials to see whether that’s the case.

In its most recent quarter, NIO delivered:

  • $1.56 billion in revenue, up 24.2%.
  • $228 million in gross profit, down 6.9%.
  • A $345 million operating loss, worsened by 640%.
  • A $281 million net loss, worsened by 295%.

As you can see, most of the profit metrics got worse. Revenue grew, although it decelerated from previous quarters. It’s not hard to see why NIO sold off after reporting these widening losses. When a company’s losses increase in magnitude, it becomes worth less, assuming it was valued accurately prior to the losses. With that said, NIO’s release beat on not only the top line but also the bottom line, so it’s not clear why it sold off after earnings. It suggests that analysts covering the stock were not very confident in the appraisal of fair value they held prior to the release.

To be perfectly honest, even the fact that NIO had a strong top line showing was impressive. Lockdowns were in effect in much of China in the quarter just reported, and NIO factories were known to have been affected by them. Given the headwinds present at the time, the earnings release was relatively strong, although the possibility of future lockdowns certainly merits caution.

Balance Sheet

Having looked at NIO’s most recent quarter, we can now turn to its balance sheet. According to Seeking Alpha Quant, NIO boasts the following balance sheet metrics:

  • Assets: $13.7 billion.
  • Liabilities: $7.8 billion.
  • Equity: $5.3 billion.
  • Debt: $1.7 billion.
  • Current assets: $10 billion.
  • Current liabilities: $5 billion.
  • Cash: $2.5 billion.
  • Cash + short term securities: $7.7 billion

From the figures above, we can calculate:

  • A current ratio of 2, suggesting excellent liquidity.
  • A cash ratio of 1.54, again suggesting excellent liquidity.
  • A debt/equity ratio of 0.32, suggesting strong solvency.

Put simply, NIO’s balance sheet is very good. It scores well on both liquidity and solvency, and has enough cash to pay off ALL of its debt! The only caveat I’d mention here is that much of this was achieved by selling equity instead of borrowing. In today’s market conditions NIO won’t be able to raise as much money by selling stock compared to what it was able to sell in the past, so it may have to borrow more in the future.

The Bullish Case

So far we’ve seen that NIO recently delivered lackluster earnings, but has a strong balance sheet. Pretty mixed signals on the financials front. However, there is a bullish case to be made here. Assuming that we can avoid truly severe lockdowns in China over the next few years, then NIO should be able to ramp up its revenue growth considerably. Remember that the company was growing sales at 122% before the lockdown-induced deceleration to 25%. If operations at NIO’s factories get back to normal, then it could experience revenue acceleration. If it can get back to 100% growth, then some of its valuation multiples will begin to look low. NIO currently trades at 5.6 times sales, 5.7 times book value, and 100 times operating cash flow. These multiples definitely look steep, but with sales growing at 100% year-over-year, they aren’t impossible to justify. Notably, the sales multiple is far lower than Tesla’s, and NIO’s pre-Q1 growth was far higher than that company’s. So there is significant potential here.

Risks & Challenges

As we’ve seen, NIO is a very fast growing company with a strong balance sheet. If it can get over its current COVID-induced woes, it may become a winner. However, there are many risks and challenges to be aware of here. Enough that I’m still rating it a ‘hold’ even though I did pick up a few shares myself. These risks and challenges include:

  • Equity sales and debt issuance. NIO’s share count grew at 67% CAGR between 2018 and 2022. It still has more share sales planned. If its stock keeps going down then it may have to borrow to finance operations, which will take a bite out of the healthy balance sheet metrics I mentioned earlier. To be frank, NIO really needs the COVID situation in China to moderate before it can truly take off. If that doesn’t happen then dilution and/or borrowing will become necessary.
  • Competition. Competition in the EV sector is fierce, and NIO is not China’s market leader. It is far behind BYD on deliveries, and also on revenue. There are smaller competitors to contend with as well. NIO is a much smaller cap company than BYD is, so it has more potential to really soar in a best-case scenario. But it is definitely an underdog.
  • Regulatory issues. Chinese stocks are currently facing regulatory pressure from the United States. The U.S. wants more ability to do on-site auditing before it will give Chinese companies the go-ahead to remain listed on the NYSE. NIO is one of the companies that has been identified as not meeting U.S. auditing requirements. If NIO has to list exclusively in Hong Kong, then U.S. investors may find it not worth the hassle to invest in. Potentially it could underperform relative to a U.S. company with identical fundamentals.

These risks are very real. Real enough that I’m not actively recommending NIO to anybody else for the time being. I did buy a few shares for my own account, but I’m not prepared to tell anybody that this is ‘a buy.’ There is potential with NIO, for sure, but also a lot of risk.

Author: Growth at a Good Price, Seeking Alpha

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