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Wed, February 8 at 8:00PM ET

Nio Stock Remains a High-Risk, High-Reward Play

In the electric vehicle (EV) world, two pure plays have been on the minds of traders over the past several months — Tesla (NASDAQ:TSLA) and Nio (NYSE:NIO). Tesla is the bigger, more developed, global version of Nio. Likewise, Nio is the smaller, still nascent, China-focused version of Tesla. But Tesla stock is often seen as the safer, more established play, while the less established Nio stock is considered the riskier of the pair.

Nio Stock Remains a High-Risk, High-Reward Play

Source: Shutterstock

You wouldn’t guess that by looking at the Tesla and Nio stock charts over the past month. During that stretch, Tesla stock has dropped 13% on mixed news regarding production and profitability. Meanwhile, Nio stock has rallied 30%, mostly thanks to high-profile and favorable coverage in a 60 Minutes special.

Have times changed? For EV bulls, is it time to ditch Tesla stock, and buy NIO shares?

I don’t think so. Nothing about the fundamentals have changed for NIO over the past several weeks. This remains an early stage, high-end EV manufacturer with limited presence in a Chinese EV market flooded with competition at all price points. There are signs that early demand is strong, and such early demand could lead to huge long-term success. But, given the competitive and saturated EV landscape, extrapolating early demand into long-term success is an unnecessary risk.

As such, until NIO gets bigger and proves itself on a larger scale, Nio Inc stock will remain a high-risk, high-reward play on the Chinese EV market.

There Are Things to Like About NIO

To be sure, there’s plenty to like about NIO. It all starts with the fact that this company could become the Tesla of China. Morphing into “Tesla” would translate into a huge market cap for NIO stock.

Why is that possible? Because NIO is China’s only all-electric luxury car brand today, much like Tesla was America’s only all-electric car brand back in the early 2010’s. The company started with one high-end EV, much like Tesla started with one high-end EV, and that high-end EV has seen robust demand thus far. Plus, NIO has a bunch of status power and brand equity as a futuristic car for China’s wealthy, much like Tesla in the early days had similar clout for the American wealthy.

Thus, there is potential here for NIO to turn into the “Chinese Tesla.” If so, that would imply a huge market cap for NIO stock in the future.

Mostly as a result of population and a recent urbanization trend, China is the world’s largest automobile market by a substantial margin. Further, EV adoption rates in the country have been promising thus far, so China is also the world’s largest EV market by a substantial margin. Even further, China is also the fastest growing EV market in the world, largely thanks to legislation promoting EV adoption in an effort to reduce air pollution.

At scale, the China EV market could comprise upwards of 10 million vehicle sales per year. NIO won’t command a big portion of that market, considering the company makes vehicles catered almost exclusively to the wealthy. But, 1% share seems reasonable given China’s income demographics.

That would imply 100,000 vehicle deliveries. At an average price point of $70,000, that implies revenue of $7 billion. Assuming fairly average 20% operating margins and a 20% tax rate, that could flow into just over $1.1 billion in net profits. Based on a market average 16 multiple, that equates to nearly a $20 billion market cap.

NIO stock has a market cap of $10 billion today. Thus, in an “everything goes right scenario”, Nio Inc stock could roughly double in the long run.

The Risks Cloud the Bull Thesis

Although the bull thesis looks good, it is obstructed at the present moment by some very real and scary competitive risks. Those risks can be segmented into three categories: competition, profitability and valuation.

With respect to competition, the competitive landscape today is very different than the competitive landscape back in the early 2010’s when Tesla went mainstream. Namely, there’s much more competition today, including a global name-brand in the high-end EV market in Tesla. As such, while NIO’s early demand metrics are strong, it is an unnecessary risk to project early demand into long-term success. As NIO grows, it will increasingly rub elbows with both low- and high-end competitors. Any combination of those competitors could derail the company’s growth trajectory.

On the profitability side, NIO’s unattractive gross margin profile implies that this will forever remain a company with niche, high-end demand. Specifically, NIO has negative gross margins. Tesla operates at 20% gross margins. Even at 20% gross margins, the company is having an incredibly difficult time cutting prices and remaining profitable overall. Thus, it will be a long, long time — if ever — before NIO cuts any prices. That means demand will be restricted to the ultra-wealthy for the foreseeable future.

Lastly, on the valuation side, Nio Inc stock could double in the long run. But how far away is the “long run”? China is targeting roughly 2 million EV deliveries in 2020. Thus, 10 million annual deliveries are at least five to ten years away. That’s a pretty long time. NIO stock may not be worth the wait considering the risk.

Also, it’s worth mentioning that Tesla has a market cap about five-fold that of NIO. Yet, Tesla delivered 25-times as many cars in 2018. That comp shines an unfavorable valuation light on the recent run-up in Nio stock.

Bottom Line on Nio Stock

Nio stock remains a high-risk, high-reward play on the EV market. Importantly, the risks outweigh the rewards at the present moment. As such, while the NIO hype machine is operating at full force, now may be a good time to do some profit-taking.

As of this writing, Luke Lango was long TSLA.

Article printed from InvestorPlace Media, https://investorplace.com/2019/03/nio-stock-high-risk-high-reward-play/.

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