Beware of Nio’s Lofty Valuation

After rising more than five-fold from its 52-week lows, Nio (NYSE:NIO) is a favorite name of speculators. But how much of the rally of NIO stock is due to Tesla (NASDAQ:TSLA) stock hitting the magical $1,000 level? Or Nikola (NASDAQ:NKLA) bottoming at around $10 in May before surging to $93.99 by early June?

To answer that question, investors need to dig into Nio’s fundamentals.

Euphoria for Electric Vehicles and Nio Stock

Nio Stock May Actually Be Worth the Gamble This Time

Source: xiaorui /

The frenzied buying of the shares of Tesla and Nikola played a role in the surge of Nio’s shares. As the buying of other EV stocks accelerated, a short squeeze gave Nio stock a lift. The short interest in Nio is now up to 15.56% of its float.

The increases of Nio’s liquidity also hurt short sellers. On June 15, the company announced the completion of its stock sale. Nio sold its American depositary share offering of 72 million units for $5.95 per ADS. The $428 million of cash it raised gave the previously near-bankrupt firm a new lease on life.

Nio “expects…to use the cash investments for research and development of products, services and technology, development of our manufacturing facilities and roll-out of our supply chain, operation and development of our sales and service network and general business support purpose.”

Nio’s R&D Spending  Is Positive

Nio’s ongoing investments in R&D will differentiate its core products – ES6 and ES8 – from those of the competition. And its spending on its supply chain will help cut its costs and improve its efficiency.

Growing Demand for Nio’s Vehicles

Nio posted record deliveries in May, justifying its stock’s recent uptrend.

Nio delivered 3,436 vehicles in May, up an impressive 215.5% versus the same period a year earlier. In 2020, it delivered 10,429 units. Of the vehicles delivered in May, 3,436 were its ES6 SUVs. It delivered 751 of the bigger ES8s.

With China reopening its economy after mostly eradicating the coronavirus, the sales of Nio’s vehicles should continue to climb. The recent coronavirus outbreak in Beijing appears to have been contained. So the combination of investors’ interest in EV stocks, higher liquidity, and higher demand in China should prevent Nio’s stock from falling much again.

Fair Value

Based on its future free cash flow, Nio has a fair value of $7.50. And analysts are negative on Nio. Their average price target is $5.70 (per Tipranks). To figure out what Nio is worth, investors may build a 10-year discounted cash flow model that’s based on EBITDA. This model also utilizes ratios between the  company’s enterprise value and its revenue.

Using these metrics:

Metrics Range Conclusion
Discount Rate 8.5% – 7.5% 8.00%
Terminal EBITDA Multiple 7.3x – 9.3x 8.3x
Fair Value $6.49 – $8.91 $7.65

Data courtesy of finbox

The DCF EBITDA exit model uses an EBITDA exit multiple of about eight times to calculate the value of the stock after ten years. This approach is subjective and generously assumes that Nio will keep posting the same pace of deliveries quarterly. The fair value depends on the discount rate and multiple applied.

Investors may reasonably assume that Nio will sustain revenue growth in the 45% – 70% range in the next three fiscal years. Even if its revenue growth suddenly drops to the single-digit-percentage levels in the seven years after that, the stock is worth $7.65.

Risks and the Bottom Line on NIO Stock

Irrationally high demand for Tesla and Nikola stock lifted Nio’s valuations, too. Though it seems unlikely in the near-term, a dramatic loss in investor interest in EV stocks would pressure Nio stock, too. Investors looking for a better entry point will not likely get to buy Nio’s shares in the $3.00 – $4.00 range for a while. But Nio offers investors exposure to two growth segments: EVs and China’s consumer market.

Chances are good that China’s centrally managed economy will promote the use of EVs in the region. Nio is the leader in this space. Those who can afford it will buy a Nio vehicle. That, in turn, will raise the company’s revenue growth over the next few years.

Since the above model suggests that Nio has a fair value of $7.65, investors should tread carefully. Its EV product lineup is attractive, but what matters is its quarterly unit sales growth . If you think the EV stock buzz will end, wait until after the excitement over the segment cools to lower the risk of buying Nio at its peak.

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

Article printed from InvestorPlace Media,

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