U.S. investors like to evaluate Chinese stocks by comparing them to their American counterparts. Electric vehicle manufacturer Nio (NYSE:NIO), for instance, is referred to as the Tesla (NASDAQ:TSLA) of China. Alibaba (NYSE:BABA) is the Amazon.com (NASDAQ:AMZN) of China. iQiyi (NASDAQ:IQ) is the Chinese version of Netflix (NASDAQ:NFLX).
There are two problems with the constant need to define Chinese stocks by comparing them to American companies, however. The first is that these comparisons quite often are inaccurate.
iQiyi, for instance, is as much Alphabet ‘s(NASDAQ:GOOG,GOOGL) unit ,YouTube, as it is Netflix. China’s JD.com (NASDAQ:JD), is more like Amazon than Alibaba is. And Nio – despite being an EV pioneer in its country – is no Tesla, for better and for worse.
The second, related problem is that investors making the comparisons tend to see the companies’ end markets and operating models as roughly the same. That’s not the case, so making those comparisons leads to overly simplistic – and potentially dangerous – thinking.
More specifically, if an investor sees Nio Inc stock simply as an early-stage version of Tesla, the opportunity is obvious. After all, TSLA stock rose twenty-fold from its 2010 IPO price of $17. Surely, Nio, with a much larger addressable market, can do the same.
It’s not that simple, however. Nio isn’t the Tesla of China, and it doesn’t have the same opportunity Tesla did. Those distinctions have major implications for NIO stock
The NIO-TSLA Comparison
At the moment, NIO has a market capitalization of about $5 billion. Tesla’s equity – even though it’s near a two-year low – is valued at $42 billion. So the bull case for NIO stock seems pretty clear.
After all, Nio’s market should be larger than Tesla’s, at least initially. The Chinese population is over four times that of the U.S. The Chinese central government is pushing adoption of electric vehicles to address the crippling pollution choking the country’s major cities. Foreign, high-end competitors like BMW (OTCMKTS:BMWYY) and Volkswagen (OTCMKTS:VWAGY) unit Audi don’t have the same presence in China that they do in America.
So Nio Inc stock appears to have a massive opportunity which is larger than that of Tesla. Tesla, when it was still an early-stage EV play, turned out to be one of the best stocks of the decade. It’s now worth $40 billion-plus, more than eight times as much as NIO stock.
That sets up an obvious path for Nio to become an electric-vehicle leader in a larger market than the U.S. If NIO grows roughly as quickly as Tesla did, NIO stock in theory should match the performance of TSLA following the American company’s IPO. Given its larger end market, NIO stock in turn could – and maybe should – be worth more than TSLA.
If that turns out to be the case, NIO stock could soar something like 9,000% from its current levels. That return would make any investor happy, even if it took years to achieve.
Nio Inc Stock Is Not Tesla Stock
But Nio is not Tesla. Tesla faced basically zero competition at the time of its IPO; almost a decade later, rivals still are catching up to TSLA in plug-in electric vehicles. Nio, meanwhile, faces myriad in-country rivals, including BYD, Geely Automotive, and Beijing Electric Vehicle Co. Soon it will be facing off against Tesla itself. At the moment, Nio’s market share is less than 1%.
There’s a second, significant problem with the comparison between NIO stock and Tesla stock. Nio doesn’t manufacture its own cars, and in March, it abandoned its plans to do so. Its gross margins are barely positive at the moment.
Since NIO doesn’t do its own manufacturing, NIO’s ability to expand those margins is limited. Tesla at least can hope to make 25%+ gross margins on its cars, even if bears (myself included) are skeptical on that front. How can Nio generate profits if the company continues giving some, or most, of those margins to its state-owned partner, JAC Motors?
The automotive manufacturing business is brutal. Even Tesla CEO Elon Musk has admitted that. It’s a cyclical, low-margin business. That’s why General Motors (NYSE:GM) and Ford Motor Company (NYSE:F) receive such low valuations. Nio’s margins are going to be even lower as long as it spends its money on Nio Houses and not on improving its manufacturing capabilities.
Nor is being in China necessarily a good thing. Some investors might disagree, seeing greater opportunity in the larger, faster growing Chinese market. But Nio is dependent on government subsidies which can disappear in an instant. It’s competing in some cases against state-owned rivals. And worries about the Chinese economy persist. There are real risks facing NIO stock, and real reasons why the stock is trading near its lows.
NIO Stock Goes in the “Too Hard” Pile
NIO stock can rebound. But the shares are likely to be volatile, and there are reasons to be cautious about NIO stock.
Most notably, Nio probably is going to have to raise cash in the not-too-distant future , and that may well force the company to issue more Nio stock, likely at a discount to its current prices. It’s likely that some of the “smart money” selling of NIO of late is being driven by investors who are looking to get out of NIO Inc stock before the new shares are issued.
Chinese stocks on the whole have to hold up for NIO stock to do well, posing another risk to NIO. 2019 has been a great year for stocks in the region after an ugly 2018. Every one of the top 35 U.S.-listed Chinese stocks by market capitalization has risen so far this year. NIO stock is down 26%. What happens if and when investors start worrying about Asian equities again?
There simply seems to be a lot that can go wrong for NIO stock, both in the near-term and the long-term. A secondary offering to raise capital would likely send Nio Inc stock tumbling. Any weakness in U.S. or Chinese equities would put pressure on NIO stock. NIO’s competition is intense, with Tesla presumably poised to join the Chinese EV market within the next twelve months. The Chinese economy has to cooperate to ensure a steady base of wealthy customers who will buy high-end Nio vehicles.
Nio certainly could navigate through those risks. And NIO stock was at $10 in early March, so a bounce wouldn’t be stunning. But at this point, it’s a tough bet to make.
And if an investor is going to make that bet, his thesis has to be better than “Nio looks a lot like an American automotive stock that was a good buy nine years ago.” Anyone who invests in NIO stock must be a nimble trader with an appetite for risk and the ability to ride out volatility. It seems like there are easier ways to make money.
As of this writing, Vince Martin holds a bearish position in options on Tesla stock. He has no positions in any other securities mentioned.