For months and months, I’ve been saying Nio (NYSE:NIO) stock is a lottery ticket. It’s extremely high-risk and has a massive amount of potential long-term upside. Nio stock has been on fire in recent weeks.
The company is starting to get some love from Wall Street analysts following what I could describe as a mixed earnings report.
The good news for Nio investors is that the company finally seems to be on the right financial trajectory.
While NIO still has a lot to prove before it is a safe investment, the odds of that lottery ticket being a winner seem to be improving by the day.
The Good News for NIO Stock
There are plenty of things to like about Nio’s near-term outlook. Yes, Nio’s revenue was down 16% in the first quarter after a 17% drop in Q4. Nio also reported an operating loss of $221.8 million. But that loss was a significant improvement over the $406 million loss it reported in the previous quarter.
After finishing 2019 with a dangerously low cash balance of just $161.7 million, Nio reported $338.6 million in cash as of the end of March. However, a new cooperation agreement with Hefei City is reportedly worth $1.42 billion. Although the details of the deal aren’t clear, that agreement seemingly eliminates the possibility of a near-term cash crunch for Nio.
But the company’s guidance was the best part of the report. Nio said its deliveries and revenue should more than double in the second quarter as China recovers from the Covid-19 outbreak. Nio reported a record 3,436 vehicle deliveries in May, up 215.5% from a year ago.
Bank of America analyst Ming Hsun Lee was one of the first analysts to recognize the light at the end of the tunnel for Nio. Lee upgraded Nio stock from “neutral” to “buy” following the report.
“We believe NIO’s fundamentals have bottomed out, demonstrated by improving volume sales and margin,” Lee says.
Lee says Nio should take significant steps toward profitability in the second quarter.
“NIO’s vehicle gross margin is likely to reach 5% and overall gross margin should expand to 3% in 2Q20,” he says.
The Problem
The potential problem with NIO stock after its recent rally is that the jackpot on the lottery ticket is no longer as high. NIO stock rallied nearly 20% this week after Goldman Sachs analyst Fei Fang raised his price target to $6.40.
As of Thursday morning, NIO stock was already trading above $6, suggesting limited additional upside. And if investors are expecting Nio to simply grow its way into a higher share price, take a closer look at Goldman’s valuation.
Fang isn’t basing his target on 2020 or 2021 earnings projections. He’s not even using 2023 earnings projections.
“Previously we assigned a 7.7x PE to Nio’s 2023 EPS, but we think it’s more reasonable to apply the multiple for Nio in 2030 when we expect its earnings growth rate to decelerate to 5%, comparable to traditional car OEMs who trade on single digit P/E,” Fang says.
In other words, Goldman is looking 10 years into the future and is valuing the stock today based on those projections. And their price target is still just $6.40.
How to Play NIO Stock
I’ve said repeatedly about Tesla (NASDAQ:TSLA) that valuation matters. You can love a company and you can recognize a major growth source, such as electric vehicles, and still overpay for a stock. I think Nio and Tesla each have incredible long-term growth opportunities ahead, but value matters.
Looking ahead to 2030, NIO stock investors can’t expect a huge premium valuation if revenue growth slows to just 5%. Growth stocks only maintain large valuation premiums when they are still growing at a rapid clip.
Look at Apple (NASDAQ:AAPL). Apple was a growth stock for years and years. But its growth has slowed to an average of 8% the past five years. That’s why its forward earnings multiple is now only 21.9, roughly in-line with the overall S&P 500.
For NIO stock to be a huge home run investment, it will need to do one of two things. Either it will have to maintain double-digit growth for a lot longer than Goldman anticipates, or it will need to be much more profitable than expected.
For now, I believe it’s a worthwhile speculative play, but near-term upside certainly doesn’t look nearly as attractive today as it did two months ago.
Wayne Duggan has been a U.S. News & World Report Investing contributor since 2016 and is a staff writer at Benzinga, where he has written more than 7,000 articles. Mr. Duggan is the author of the book “Beating Wall Street With Common Sense,” which focuses on investing psychology and practical strategies to outperform the stock market. As of this writing, Wayne Duggan does not hold a position in any of the aforementioned securities.
