When Nio (NYSE:NIO) went public last year, it had an intriguing story. By buying Nio stock, investors were able to purchase a piece of “the Tesla (NASDAQ:TSLA) of China”. Given that the NIO stock price implied a valuation a fraction of that of Tesla, while the Chinese electric vehicle market was, and could be, far larger than America’s, Nio stock looked attractive.
The problem at the moment is twofold. First, as I wrote last month, that story wasn’t entirely accurate. Like other supposed U.S.-China :twins” – Alibaba (NYSE:BABA) and Amazon.com (NASDAQ:AMZN), along with iQiyi (NASDAQ:IQ) and Netflix (NASDAQ:NFLX) – the difference between NIO and TSLA outweigh their similarities. Secondly, even using that story as a shortcut to understanding Nio, neither side of the story looks attractive. Tesla stock has dropped 50%. And investors again are fleeing from Chinese equities.
In the case of Nio stock, the decision to run looks wise. The Nio stock price, currently below $3, might seem cheap, but it isn’t. And the company has very real difficulties ahead. These problems can get a lot worse, and they could eventually cause the owners of Nio stock to get wiped out.
Nio’s Earnings Show the Shares Can Reach Zero
Nio stock clearly is a long-term play. The company is barely past the start-up stage; it only started delivering vehicles less than a year ago. In that context, it might seem unwise to overreact to a single quarter or to short-term headwinds.
But the company’s recent struggles, which are expected to extend into at least the second quarter, highlight its broader, longer-term risk. Its deliveries in Q1, at just under 4,000, were down nearly 50% from the previous quarter. As management explained in the Q1 earnings release, the decline of Nio’s deliveries was caused by lower subsidies, a slowing economy in China, increased competition, and the impact of the Chinese New Year.
Except for New Year-related seasonality, which of those negative, catalysts will ease? In the current quarter, the company expects “an even more challenging sales environment,” as CFO Louis Hsieh put it. “Competition continues to accelerate,” he added.
These aren’t single-quarter problems. And that is a big problem for NIO.
The negative factors that are weighing on the automaker’s Q1 and Q2 results are unlikely to change. Subsidies are slated to be phased out at the end of next year. That’s a notable problem for Nio, which targets the high end of the market. Tesla has struggled this year because of the decline of its subsidies in the U.S. market. It’s not clear why Nio’s experience in China should be much different. Higher effective prices generally lead to lower demand.
Macroeconomic worries could persist for some time in China. Observers have been waiting for the Chinese economy to cool for years. The trade war shows no sign of ending any time soon. And so NIO will lose subsidies that lower the retail cost of its vehicles just when a higher number of Chinese consumers will likely become more price-conscious.
But competition is the real issue at this point, and that’s the major difference between Tesla and Nio. Tesla, at least, had the U.S. electric-vehicle market to itself. Indeed, the company gets credit (and deservedly so) for helping to ignite the race to develop new electric vehicles.
NIO is not close to having the market to itself in China. The country’s largest EV manufacturer is Beijing Electric Vehicle Co., which delivered 158,000 cars in 2018. Nio is on pace for something like 20,000 this year. In fact, Nio’s market share is minuscule, and that’s before Tesla arrives in China later this year or in 2020.
NIO’s deliveries already are plunging amid factors that could persist for some time. It’s hard to see that as anything other than bearish for NIO stock, even at its lows.
How Nio Stock Price Can Sink to Zero
Adding to the pressure, Nio doesn’t even manufacture its own vehicles ; it outsources production. However, its gross margin was negative in Q1, and the company posted an adjusted operating loss of roughly $360 million.
The company does have over $1 billion in cash, but that may not last more than a couple of quarters. NIO also has $1.35 billion of debt, meaning that even if it eventually licenses or sells its technology to stay afloat, equity holders likely would wind up being wiped out.
Nio isn’t necessarily going bankrupt in three quarters or even three years. But it does not have unlimited time. It’s unlikely to be able to borrow much, given its meager asset base. Selling additional Nio stock will be difficult and would send Nio stock price even lower.
It NIO reports another quarter or two like Q1, investors will start questioning the company’s sustainability. Yet, in that time, Nio has to start beating its rivals and begin narrowing its losses quickly. The company has a new model on the way, but it’s been delayed. And if China’s economy slows further, demand is going to fall sharply for its current vehicle and its upcoming vehicle.
It might seem like these risks are priced into Nio stock. With a market capitalization of $3 billion, however, that’s a tough case to make. NIO stock price still can fall 100%. Even those looking to time the bottom, or those who still believe in the company’s long-term opportunity, need to keep that in mind.
As of this writing, Vince Martin has a hedged bearish option position in TSLA. He has no positions in any other securities mentioned.