NIO Stock Is Undervalued, But Risky

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China’s stocks have struggled tremendously over the past 12 months, as a combination of slowing economic expansion and escalating U.S.-China trade tensions has weighed on profit growth estimates and investor sentiment towards Chinese stocks. That combination has ultimately killed most Chinese stocks. Over the past year, while the S&P 500 is up about 1%, the iShares MSCI China ETF (NYSEARCA:MCHI) is down about 12%.

Why NIO (NIO) Stock Is Undervalued, But Still Very Risky

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Chinese premium electric vehicle maker NIO (NYSE:NIO) has not been spared from this Chinese stock selloff. Often dubbed the Tesla (NASDAQ:TSLA) of China, NIO has actually been a big underperformer over the past 12, months as China’s auto market has dramatically slowed. Since last September, NIO stock price is down about 70%. In 2019, it’s down about 50%.

In other words, there’s no sugarcoating the reality; NIO stock price has been killed over the past 12, eight, and five months.

There’s reason to believe the selloff of NIO stock is overdone. Over the long-term, NIO has a ton of potential in China’s premium EV market. All that long-term potential is arguably being undervalued by the market today. Thus,  one could reasonably argue that NIO stock price can jump  tremendously in the long-run,.

At the same time, one could also reasonably argue that all that  potential is highly speculative, and that NIO hasn’t given investors any reason to bet on NIO stock.

I see both sides of the argument. That’s why I currently look at NIO stock as a potentially undervalued but considerably risky stock. It could turn into a winner in the long-term. But, NIO has to prove that it has what it takes to realize all that long-term potential. As a result, until NIO proves itself, I’ll monitor NIO stock from the sidelines.

NIO Has Tremendous Potential

The long-term bull thesis on NIO stock is pretty simple.

Electric vehicles are the future of the auto market. China is the world’s largest auto market. Electric vehicles (EVs) are also huge in China. Consequently, China is the world’s biggest EV market by a mile. Global EV sales volume hit about 2 million units last year. About half of those EVs were sold in China.

This market is still in the first few innings of its long-term growth. China is aggressively pushing EV adoption through legislation, since it wants to reduce pollution in its cities. As a result, Beijing is targeting a 20% EV penetration rate by 2025. EV penetration was under 5% last year, meaning that this market has plenty of room to expand in the long-run.

The premium end of the EV market, where NIO operates, will grow. The company is a very small player in the total China EV market, as it had a share of less than 1% of that market in 2018.  But NIO has a  formidable presence and meaningful brand strength in the premium Chinese  EV market. Consequently, as the premium EV market expands over the next several years, so should NIO’s volumes, sales, margins, and profits.

The numbers are easy to digest.  Around 30 million vehicles will be sold in China  in 2030. It’s reasonable to assume that 25% of those, or about 7.5 million, will be EVs.

NIO, which presently has an EV share of under 1%, could expand its market share to 2% with new product launches. That implies around 150,000 vehicle sales by 2030. At an average price tag of $50,000, that’s $7.5 million in revenues. NIO’s gross margins will rise towards 20%. Its operating-spending  rate will fall towards 10%, which is average for automakers.

After doing the math on that – and assuming a 20% tax rate – I estimate that NIO has the potential to generate $600 million of net profits by 2030. Based on a  forward price-earnings multiple of 20, which is average for growth companies, that implies a 2029 valuation target for NIO stock of $12 billion. Discounted back by 10% per year, that equates to a 2019 valuation target for NIO stock of about $4.6 billion. That’s 40% higher than today’s market cap.

NIO Hasn’t Proven That It Can Realize Its Long-Term Potential

NIO stock is arguably undervalued by 40% today, and it has a visible pathway to quadruple over the next decade. But NIO stock is undervalued for a reason;  NIO stock is highly speculative, and the company has not given investors enough reason to speculate on its potential.

NIO started selling cars in June 2018. Things started off on the right foot. In the third quarter of 2018, it sold a very respectable total of roughly 3,600 cars. Its operations really accelerated in the fourth quarter of that year, when NIO sold nearly 8,000 cars. That is the sort of growth surge that gets investors to believe in the long-term potential of a company’s business.

Consequently, in early 2019, NIO stock  jumped above $10.

Then, things really started to slow in 2019. In Q1, NIO sold less than 4,000 cars. In Q2, it sold about 3,500 cars. Thus, from late 2018 to mid-2019, NIO has gone from selling 8,000 cars per quarter to 4,000 cars per quarter. That is the sort of growth deceleration that makes investors become increasingly skeptical on the long-term potential of a company.

As long as NIO’s delivery volume trends remain depressed, NIO stock will similarly remain depressed. As long as that remains the case, investors simply won’t have enough conviction in the long-term growth outlook of NIO  to “buy the dip” of NIO stock.

The Bottom Line on NIO Stock

Before NIO stock price rebounds, NIO’s delivery volume trends need to reverse course. That could happen in the back half of 2019. Consumption trends in China are starting to rebound, and NIO just released a new vehicle – the ES6 – which could reinvigorate its sales. Consequently, NIO stock price could rebound by a large amount in the back half of 2019.

But I’m waiting for proof of this delivery-trend reversal before buying NIO stock. The truth is that NIO stock has been beaten up so much that a delivery trend reversal in the second half of 2019 will spark a huge multi-month rally by NIO stock.

By waiting for confirmation of this reversal, investors will miss just one day of the rebound of NIO stock price. But they will simultaneously protect themselves from further declines of NIO stock price in the event the reversal does not materialize.

That seems like the best approach at this point.

As of this writing, Luke Lango was long TSLA.

 


Article printed from InvestorPlace Media, https://investorplace.com/2019/08/nio-stock-is-undervalued-but-risky/.

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