Now that the decade-long bull market has come crashing down, the economic impact of the coronavirus from China is starting to look downright scary. With recession warnings getting louder by the day, companies laden with debt are starting to look very fragile. Such is the case for Chinese automaker Nio (NYSE:NIO), whose finances are in dire straights. Although the firm secured a financing deal that will keep it afloat, NIO stock is one of the riskiest plays in today’s market.
The long-term case for Nio stock isn’t necessarily a bad one — the firm is a play on China’s electric car market, which is seen growing substantially over the next few years. However in the near-term, Nio’s future looks extremely fragile as the firm’s finances may not be able to cope with the economic challenges that lie ahead.
The Corporate Debt Bubble
Now that the coronavirus is threatening to cause a prolonged global economic slowdown, many are starting to worry about the corporate debt bubble that the Federal Reserve has been inflating over the past decade. Cheap loans encouraged irresponsible borrowing, which in turn created a huge proportion of low-quality corporate loans.
According to an estimate by Morgan Stanley’s Ruchi Sharma, one in six firms aren’t generating enough cashflow to pay the interest on their loans. The debt market allowed them to refinance over and over again to keep the lights on.
But that era is over, and debt-strapped companies are going to have to find other ways to cover their bills. Nio is one such firm whose massive debt obligation and unprofitable operations mean it may not make it through near-term turbulence.
Nio Put a Bandaid on a Bullet-Hole
Last week Nio announced that a new deal with the Hefei government in China would ease some of the firm’s cashflow issues. The deal provides Nio with additional funding in order to help the firm grow its operations within the province.
But as Citi analyst Jeff Chung pointed out, the deal doesn’t make Nio’s funding issues disappear. In fact, Chung noted that the deal could actually increase financial pressure on Nio, as it requires the firm to spend money to move its headquarters:
“While the deal will ease [near-term] cash flow pressure on Nio, the collaboration will require Nio to spend a portion of the cash injection on the headquarters move, which may put the company under more pressure in case of prolonged sales weakness.”
Painful Environment for Nio
Prolonged sales weakness is likely for Nio. The firm has established itself as a luxury brand, but economic hardship in China will make it less likely that consumers will be making big-ticket purchases. Plus, weakness in oil prices will probably delay the switch toward electric vehicles — especially as consumers look for ways to save.
“The issue is more likely from demand side. The increased demand for BEV and hybrids are likely going to accrue largely to low-priced vehicles,” said Qian Yang, doctoral student in the Department of Finance at Michigan State, in an email to InvestorPlace. “Though the government has signaled no sharp rollback of tax rebate this year, it will roll back eventually. Data has shown that consumer demands are highly elastic with respect to price of these vehicles.”
Plus, Nio is up against tough competition from Tesla (NASDAQ:TSLA). The electric vehicle giant’ made-in-China Model 3 could further eat away at Nio’s sales, which are already under pressure from coronavirus.
On Tuesday, Bank of America’s Hsun Lee said as much in a note to investors:
“We believe the stock’s fundamentals have bottomed out, but its volume sales are likely to be negatively impacted by the COVID-19 outbreak and the launch of Tesla’s made-in-China Model 3.”
The Bottom Line on Nio Stock
Nio has shown signs of life despite coronavirus’ impact. February deliveries were down nearly 13%, but in comparison to the rest of the market, that’s not terrible. To put that figure into perspective, passenger car sales fell almost 80% in February.
But even if Nio is beating the market, a prolonged period of depressed sales is going to be tough to cope with. Nio is already in a fragile position with a -141 profit margin and return on equity of -430. The firm is carrying around $1 billion in long-term debt. That’s not the kind of company that can weather a storm, especially not a storm of this magnitude.
As an electric-vehicle maker catering to China, Nio has a strong position for future growth. But getting to that future is a concern. If the corporate debt bubble bursts, investors will want to be holding safe, cash-rich companies. Nio isn’t one of those.
As of this writing, Laura Hoy did not hold a position in any of the aforementioned securities.