3 Reasons To Avoid Nio Stock Even After Sharp Second-Quarter Correction

NIO's cash burn is a major concern amid China's economic slowdown and negative operating cash flows

It is always tempting to consider exposure to a stock that has been beaten down significantly in anticipation of a bounce back rally. Nio (NYSE:NIO) was trading at $10.16 on March 5. Four months down the line, the stock has slumped by 75% to current levels of $3.49.

Source: Shutterstock

I believe that Nio remains unattractive even after the big decline, basing my thesis on three key factors.

Significant Sales Decline

For the month of May 2018, China posted the worst ever sales decline, slumping by 16.4%. This was the 11th-consecutive monthly decline and underscores the point that an economic slowdown coupled with the U.S.-China trade war has dented consumer sentiment and purchasing power meaningfully.

A more-worrying factor for Nio stock investors is that new electric vehicle segment sales grew by just 1.8% in May 2019 after an 18.1% jump the previous month. Therefore, the decline in sales has been broad based and as economic growth remains sluggish, it is unlikely that sales will gain traction in the foreseeable future.

The decline in auto sales was evident in the Q1 results. ES8 sales for 1Q19 were 3,989 units as compared to 7,980 units in Q4 2018. Further, April 2019 sales were 1,124 units and the decline in units sold was more than anticipated by Nio watchers.

Overall, economic concerns coupled with the trade war have hurt the sector and it’s likely that sluggish sales will sustain in the coming quarters. In other words, there is unlikely to be any positive stock trigger from the perspective of sales growth.

Cash Burn And Equity Dilution

Another major concern for investors is the level of cash burn and its potential impact on the Nio stock price.

Just to put things into perspective, Nio reported negative cash flow from operations for 2017 and 2018. The company also reported negative margin at operating level for Q1 2019 and with weak sales growth, I believe that operating cash flows will remain negative through 2019.

While Nio still has a cash buffer of $1.12 billion as of Q1 end, I believe that cash position will decline or net debt will increase in the coming quarters. It is also likely that the EV maker pursues equity dilution and that can negatively impact the stock price.

From a liquidity perspective, Nio has announced a framework agreement with state-owned fund Beijing E-Town International Investment and Development Company. While further details are awaited, E-Town Capital will invest up to RMB 10 billion ($1.45 billion) in exchange for minority stake.

Clearly, I am not suggesting a funding crisis. The only point from a shares perspective is that equity dilution will translate into NIO stock trending lower.

Negative Impact Of Lower Subsidy And Competition

A third factor that is likely to have an impact on the company’s margin in the coming quarters and years is the gradual phasing out of subsidy for the electric car industry.

The Chinese government plans to gradually reduce subsidy with a target to completely phase out subsidies by 2020. Amid the economic slowdown, the phasing out of subsidies will have a negative impact on sales as electric car manufacturers will have to hike prices or face further cash burn.

It is also worth noting that Nio faces significant competition within the EV industry in China. Just as an example, Tesla (NASDAQ:TSLA) is setting-up a Giga-factory to cater to the demand in China. Similarly, BYD Auto Industries is a much bigger company in this segment with higher financial flexibility and investment in innovation. BIAC Motors also has significantly higher — compared to Nio — sales of electric cars through BAIC BluePark New Energy Technology.

So here we are: Just a few years in the EV business and Nio is challenged by an economic slowdown and increased competition.

Bottom Line on Nio Stock

Even if U.S.-China trade tensions de-escalate, Nio has to cope with other headwinds that include China’s sluggish economic growth, rapid cash burn, gradual phasing out of government subsidy and strong completion within the industry with several established players that can invest more on innovation.

Nio stock remains one to avoid with the immediate concern being potential equity dilution and sustained weakness in sales with depressed margins.

As of this writing, Faisal Humayun did not hold a position in any of the aforementioned securities.

Article printed from InvestorPlace Media, https://investorplace.com/2019/07/3-reasons-to-avoid-nio-stock-even-after-sharp-second-quarter-correction/.

©2019 InvestorPlace Media, LLC