Nio (NYSE:NIO) has been unimpressive for the most part of the year. From March 2019 highs of $10.16, the stock slumped by 87% to $1.32 in the beginning of October. In percentage terms, there has been a big relief rally with Nio stock currently higher by about 92%. While Nio has fundamental problems, I believe that the stock can continue to rally in the foreseeable future.
From a macro perspective, the first phase of the trade deal between the United States and China has been reached. This is a key positive trigger as it can boost China’s GDP growth in 2020 and beyond. Weak sales in the broad automotive industry can reverse if GDP growth gains traction. Stronger GDP growth will offset the negative impact of phasing out of subsidies for electric vehicles.
From an industry perspective, China recently raised sales target for electric cars to about 25% by 2025. Currently, electric cars account for just 5% of automotive sales in China. Clearly, the government has set an ambitious target for the next five years. This is likely to benefit Nio, among other players in the industry.
Positive on Third Quarter 2019 Results
Nio will announce 3Q19 results on December 30. I believe that the stock can trend higher when numbers are announced. Nio has reported healthy delivery numbers for 3Q19 with deliveries increasing by 35.1% as compared to 2Q19.
It is also important to note that strong delivery has been reported for October and November. The company expects this positive momentum to sustain. Therefore, the second half of 2019 is likely to be better than the first half.
Gross margins are likely to remain negative in the coming quarters, but sustained volumes growth is critical for cash flows to turn positive. If volume growth is maintained well into 2020, Nio stock is positioned for further upside.
Cash Burn Remains a Concern
Nio has been working on cutting costs and increasing sales volumes to reduce the cash burn. However, I don’t see positive cash flows anytime soon. This is one factor that will worry the markets even as near-term sentiment seems positive.
Nio has ample cash buffer for 2020, but it seems certain that the company will require additional financing beyond the next 12-months. Therefore, dilution worries will impact the long-term trend for the stock.
This is particularly true in a market that has immense growth potential and fierce competition, at the same time. It is worth noting that Tesla (NASDAQ:TSLA) believes that it can fund expansions through internal cash flows.
Nio is far from reaching that point and will have to compete with Tesla and Ford Motor (NYSE:F), among others. These large players have ample cash buffer and positive cash flows to navigate an extended period of cash burn.
It was recently reported that Nio will be launching another SUV in China. This is to compete with the likes of Mercedes-Benz and Tesla. As competition remains intense, there will continue to be investments in R&D and new launches.
As an example, Nio reported R&D expense of $189.4 million, which was 70% higher than 2Q18. The key reason was rigorous testing activities of ES6 before its mass production. Therefore, innovation and competition would imply new model launches and that will impact margins. Overall, turning cash flow positive is a big challenge for Nio and investors will continue to look for answers. Even as the respite rally sustains in the near-term.
My Final Thoughts on Nio Stock
The Nio stock price is significantly higher from all-time-lows and the rally might continue into 2020. However, it is too early to assume that the company is out of the woods. Investors who have bought at lower levels can consider some profit booking after 3Q19 results.
Chinese electric vehicle market has the potential to grow at a healthy pace in the next five years. From that perspective, several players can be absorbed in the market. However, China’s EV market is in a bubble phase and many companies will go bankrupt or will be acquired in the coming years. Nio will need something very special to keep going over the next three to five years.
As of this writing, Faisal Humayun did not hold a position in any of the aforementioned securities.
