Today I’d like to discuss the outlook for Nio (NYSE:NIO), a closely followed stock in China’s expanding luxury automotive sector. On Sep. 12, 2018, Nio stock went public in the U.S. as an American Depositary Receipt (ADR) at an opening price of $6.
At the time Nio stock was widely touted as the Tesla (NASDAQ:TSLA) of China. After reaching an all-time high of $13.80 in two days following its listing, Nio stock has been on the decline for the past 10 months.
Many of our readers are now wondering whether July may offer a good entry point into NIO shares, which are currently trading around $3.2. Here is a candid look at the the prospects for Nio stock so that potential investors may decide if the shares should belong in their long-term portfolio.
Nio Is a Relatively Young Company
The Shanghai, China-based company develops, manufactures, and sells premium semi-autonomous electric vehicles (EVs) to luxury buyers in China. It was founded in 2014 and currently has office in China as well as the U.S., the U.K. and Germany.
The group initially focused on research and development (R&D) activities, but went into mass manufacturing in March 2017. Its first volume-manufactured seven-seater SUV vehicle — the ES8 — was sold in China in June 2018. At the time it was compared to Tesla’s Model X.
Prior to its IPO, NIO stock reported revenues of only $6.7 million for the six months ended June 30, 2018, and no revenues in 2017. In other words, the car manufacturer was awash in red ink, a fact that would have made the company ineligible to list in a Chinese stock exchange.
As part of rather lengthy and strict listing requirements, Chinese stock exchanges would have required Nio to have been profitable over the three years prior to the proposed IPO date. In other words, Nio could have not listed in China and possibly chose the U.S. due to easier listing requirements for ADRs.
In hindsight, investors who bought Nio stock since its IPO may now be wondering whether the company completed the IPO way too early in its history. Instead should the company have focused on building market share and raising cash through venture capital?
Chinese Booming EV Market Is Evolving
China is now the largest EV market in the world. With a population of 1.4 billion, the country has an important pollution problem in big cities.
As part of its efforts to decrease pollution levels, in 2010, the Chinese government started introducing a range of subsidies to promote the sales of electric cars.
In 2016, Chinese companies manufactured 375,000 electric cars, accounting for a 43% of the global EV market. Q1 2019 numbers from the country showed that the quarterly sales numbers for passenger vehicles reached 254,000 cars, an increase of 118% year-on-year (YoY).
Tax incentives, various fee exemptions and other subsidies granted by the Chinese government have fuelled this market growth that has led to increased consumer demand.
In addition, especially the inexpensive EV models enable Chinese consumers to easily obtain a vehicle plate which is otherwise extremely difficult to get in some cities such as Beijing and Shanghai. It is expected that by 2025 electric cars will have 50% market share in China.
When we look back at the Nio IPO, it is easy to see why many investors would have regarded investing in the NIO stock as also participating in the future growth of the EV market in China.
Let us now fast forward to 2019. As the industry has grown, the landscape in China has also become more competitive. There are currently over 500 Chinese EV manufacturers.
Yet as the Chinese economy cools off especially amid the U.S.-China trade wars, analysts are wondering how many of these companies can actually survive, especially now that governmental subsidies are being cut down considerably.
The government has also announced that foreign manufacturers now will be able to produce cars as wholly-owned foreign entities in China. Therefore companies such as Tesla, Audi, or General Motors (NYSE:GM) will not need to enter into a joint venture with a local manufacturer any more.
Nonetheless, these foreign manufacturers are still likely to rely on the distribution networks of local companies.
As of September 2018, China had 403 million drivers and 322 million motor vehicles in total (including 235 million cars). However, car sales in China declined last year; it was first contraction of the industry in over two decades
In the next few years, hundreds of Chinese EV manufacturers will likely compete aggressively among themselves, possibly pushing profit margins down for all of them, including Nio.
How Nio Stock Makes Money
At present, Nio sells exclusively in China. In addition to the ES8, the company has two other vehicles, the EP9 (two-seater sports car) and the ES6 (five-seater SUV).
Nio cars are equipped with a standalone artificial intelligence (“AI”) system called the NOMI. The company also offers various car charging and power solutions.
It is important to highlight that management has been working hard to make the Nio brand more than a car manufacturer, but rather a life-style concept. For example, its showrooms also feature members-only areas, Nio Houses, that act as upscale social clubs. Nio management is aiming to appeal to the changing demographics of the Chinese car buyers who are more tech-savy and want more from the dealership experience.
In addition, the group uses social media actively to engage with current and prospective customers. It also has an app with over 800,000 users as well as a virtual currency.
On May 28, Nio reported Q1 2019 results and Wall Street was not impressed. The manufacturer’s Q1 sales of $228.8 million had dropped 54.6% sequentially from Q4. Its gross margin was negative 13.4%, compared with positive 0.4% in Q4 2018.
Management’s May 2019 monthly delivery update early last month also drove home the concerns for “the challenging macroeconomic and Chinese auto market backdrop.”
And the group’s quarterly cash burn of about $600 million is not likely to decrease in the next quarter. The issue of cash is one of the most important questions regarding Nio’s fundamental story.
Although the car company is going through cash at an alarming rate, Nio posted a smaller-than-expected Q1 loss. Its net loss stood at $373 million vs. what analysts had expected to be $472 million.
On a final note that may excite investors, the ES6, which in effect is a smaller and cheaper version of the ES8, has begun delivery several weeks ago. Could this new vehicle also provide a much-needed sales spark for Nio in the coming months?
So Should You Buy Nio Stock?
Nio’s Chinese name, Weilai, literally means Blue Sky Coming. Yet Nio’s listing at the Big Board has failed to provide excitement and the stock has shed almost its 50% of its value since its September 2018 debut price. Those investors who have bought into NIO shares at about $13 have literally been feeling the blues.
I am of the camp that Nio stock’s price weakness since the IPO is a clear reflection of investor sentiment and major fundamental worries, especially regarding a young company with unproven management completing a rather premature exchange listing in a third country, i.e., the U.S., where it sells no cars.
However, I do not expect that the major investors, such as Tencent, as well as the Chinese government will allow the company to go bust. For example, it is likely that Tencent may have plans to integrate its own voice assistant Xiaowei into Nio cars so that it can offer Tencent services in car displays for shopping or entertainment.
Furthermore, Nio management has recently announced that the group will soon form a joint venture with Beijing E-Town International Investment and Development Co. Ltd which will invest about $1.5 billion in this new entity. Is the Chinese government in effect bailing out Nio?
Although the details of the new JV is not known, I believe that it is an important step to help the company to reach a more viable point in its history.
For example, China is also investing in the development of autonomous, or driverless, vehicles. A report by McKinsey highlights that China will lead the autonomous car market in the years to come. Could the Chinese government be encouraging Nio to develop the AI capabilities in Nio cars to address this market?
In light of the recent cash injection by the Chinese government, it is likely that NIO shares have already seen a low for 2019. Nonetheless, investors should be wary of high expectations for the company.
Daily volatility of Nio stock is high. Any headline news regarding the U.S.-China trade wars as well as sales or earnings figures from Tesla will affect the short-term price in Nio shares, too. In other words what is good for China or Tesla may also be good for Nio and vice versa.
Potential NIO investors may consider hedging their stock purchases with, for example, Nov. 15 ATM covered calls. A similar (and continuous) hedge may also help current Nio shareholders, who do not yet think the Nio stock price will likely improve soon, recover some of their losses over time.
Investors who are interested in buying into Chinese or clear energy companies, but do not want to commit all their capital to a single stock such as Nio may also consider investing in various exchange-traded Funds (ETFs) that have NIO as a holding, including iShares MSCI China ETF (NASDAQ:MCHI), Global X MSCI China Consumer Discretionary ETF (NYSEARCA:CHIQ), Invesco WilderHill Clean Energy ETF (NYSEARCA:PBW), or iShares Core MSCI Emerging Markets ETF (NYSEARCA:IEMG).
As of this writing, the author did not hold a position in any of the aforementioned securities.