Slowdown Fears Could Be the Last Straw for NIO Stock

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When I last wrote on Nio (NYSE:NIO), I opined that the stock will move higher in the near-term. Since that column, Nio stock is higher by 66% to $4.01.

Slowdown Fears Could Be the Last Straw for NIO Stock

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However, Nio has already corrected by 22% from near-term highs of $5.20. I believe that the downtrend can sustain in the foreseeable future. Renewed fears of economic weakness and potential dilution of equity are key factors for this “bearish” view.

Global equity markets have already been spooked by the spread of coronavirus and its likely impact on the economy. There are strong reasons to be concerned. Estimates suggest that SARS outbreak impacted the Chinese economy by 1.10% to 2.60%.

Shaun Roache, chief economist (Asia Pacific) at S&P believes that China’s GDP growth is likely to be impacted by 1.20% due to corronavirus. China’s consumer confidence remained weak in Q4 2019 and is likely to weaken further in Q1 2020.

As consumption spending takes a hit, Nio’s delivery numbers for the first quarter of 2020 will be impacted. This is likely to take Nio stock lower.

Equity Dilution Likely Soon

When Nio reported Q3 2019 results, the management opined: “The Company’s cash balance is not adequate to provide the required working capital and liquidity for continuous operation in the next 12 months.”

It’s very likely that Nio will announce further cash infusion in Q1 2020.

Clearly, there is a need for funding and with $1.20 billion in debt; I don’t see the company pursuing further leveraging. Issuance of new equity is therefore likely. While cash infusion will provide some relief to the company and investors, dilution is likely to take Nio stock lower.

It is worth noting that for Q1 2019, Nio reported total cash & equivalents of $1.1 billion. This declined to $503 million in Q2 2019 and further to $274 million in Q3 2019. Therefore, the cash burn rate has been rapid.

The point I am trying to make is that Nio would need significant cash infusion to remain afloat for the next 18-24 months. Existing shareholders would feel the impact of a bigger dilution.

Further, Nio used $229 million in cash between Q2 2019 and Q3 2019. Assuming the same amount of cash is used between Q3 2019 and Q4 2019, Nio would be below $100 million in cash. This backs my view that cash infusion will come before March 2020.

Competition Will Continue to Erode Margins

With cash burn a core problem for Nio, there needs to be a clear roadmap on margin expansion and positive cash flows. The likely solutions are delivery volumes growth, cost reduction, lower R&D and marketing expenses.

While the company is already working on cost-cutting, I believe that marketing expenses can remain high. At the same time, margins can remain under pressure due to competition.

To put things into perspective, there are more than 400 companies in China in the business of electric vehicles. Of course, there will be dozens of bankruptcies in the coming years. However, competition is not limited to local players.

Tesla (NASDAQ:TSLA), Ford (NYSE:F) and Volkswagen (OTCMKTS:VWAGY) are just some companies that have big plans for China. This will impact Nio’s ability to expand margins through relatively higher pricing. Further, higher competition would imply more investment in marketing and innovation.

Therefore, even if funding is secured, competitive market conditions will make delivery volumes growth a big challenge.

My Final Thoughts on Nio Stock

In my view, Nio is attractive for trading opportunities, but not for long-term investment. The sharp bounce-back from October lows is a good example of a trading opportunity from oversold levels.

Nio still needs to ramp-up delivery volumes, control cost and turn profitable at EBITDA level for investors to consider long-term exposure. As an example, Tesla stock has been surging higher. A key factor is positive operating cash flows, which will help in funding expansion through internal cash.

Nio is still far from that point and it faces competition from cash rich companies. Nio stock is therefore worth avoiding at current levels.

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

Faisal Humayun is a senior research analyst with 12 years of industry experience in the field of credit research, equity research and financial modeling. Faisal has authored over 1,500 stock specific articles with focus on the technology, energy and commodities sector.


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