The case for Chinese electrical-vehicle manufacturer Nio (NYSE:NIO) seems appealing. The Nio stock price has come down significantly, and now sits almost 60% below its IPO price. For that cheaper price, investors are getting a company that is backed by government subsidies and that operates in a market with a population of over 1 billion people.
Indeed, since the IPO, Nio has been referred to as “the Tesla (NASDAQ:TSLA) of China.” With Tesla stock falling sharply recently, that story might not seem as attractive. But Tesla stock still has a $40 billion market cap. Nio stock is worth less than $3 billion. Surely, if there’s even a chance that Nio could grow into the next Tesla, Nio stock is undervalued.
But as I wrote last month, that outlook is too simplistic. There are many differences between Nio and Tesla, and those disparities are hugely important. Tesla makes its own cars; Nio doesn’t. Tesla has had the U.S. EV market largely to itself, particularly on the high end. As Bloomberg noted in April, there are 486(!) electric-vehicle manufacturers registered in China.
Nio has a tiny market share, and it’s fighting against larger rivals like BYD (OTCMKTS:BYDDF) and state-owned Beijing Electric Vehicle Co. Alibaba (NYSE:BABA) and Tencent (OTCMKTS:TCEHY) have funded EV startups as well. (Tencent also owns a piece of Nio.)
A reasonably close look at Nio shows its outlook isn’t as simple as many analysts have made it out to be. And its outlook has just gotten worse.
Nio’s Recall
Last week, one of Nio’s vehicles caught fire for the third time since April. The culprit apparently is friction between a module in the battery pack and a voltage sampling cable. In response, Nio is recalling nearly 5,000 cars.
That might not sound like a lot of cars, and perhaps it isn’t. Ford Motor Company (NYSE:F) issued four recalls last month which covered over 1.3 million vehicles. But that’s kind of the point: to Nio, 5,000 cars is a big number.
After all, as of the end of May, per the company’s deliveries update, Nio had only sold 17,550 units in its entire history. So nearly 30% of the vehicles that it has sold have been recalled. None of the vehicles recalled was produced after October, suggesting that the problem isn’t present on Nio’s newer models. Still, for several reasons, the recall creates a significant issue for Nio stock.
The Risk to Nio Stock
Nio can’t afford any extra expenses. The company did close the first quarter with $1.12 billion of cash, restricted cash, and short-term investments. But it posted a Q1 operating loss of $366 million. Cash burn already is an issue, and with Nio stock price plunging, it has become increasingly difficult for the company to raise money by issuing more Nio stock.
Even assuming the recall costs Nio “only” a few million dollars, that is a few million dollars Nio simply can’t afford to waste.
Secondly, the recall represents an early hit to Nio’s brand. Again, there are nearly 500 manufacturers in the Chinese EV market already. Tesla now is one of them (though it had a high-profile fire in Shanghai). Recalling 30% of its fleet and having its name associated with battery fires is not a good look for Nio. That’s particularly true because it’s trying to carve out a niche on the high end of the market.
Finally, the recall adds to the questions that already surround Nio. The company previously delayed the launch of its electric sedan after unveiling a concept version of it. It’s spent much-needed capital on swanky dealerships, which it calls Nio House cafes. There’s an early sense that Nio is better at marketing – and selling Nio stock – than actually designing cars, a sense which is only supported by the recall.
Too Many Pressures on Nio Stock
From a broad standpoint, Nio’s problem is pretty simple: it has to be pretty much perfect. There’s only maybe a year’s worth of cash left on its books. China’s electric-vehicle subsidies are being cut. Nio has hundreds of competitors. Nio somehow has to deliver a car that is the best in the market or at least close to it.
As a result, any error, even a recall of a few thousand vehicles, can be fatal to the outlook of Nio stock. I argued last month that Nio stock price could head to zero, and that’s still the case. The company has a lot of work left to do and not much time in which to do it.
As of this writing, Vince Martin has a bearish options position in Tesla. He has no positions in any other securities mentioned.
