The last couple of weeks has been rough on Chinese electric-carmaker Nio (NYSE:NIO) and Chinese stocks more broadly. Nio stock shed 14% of its value on July 17. Although it has since recovered those losses, escalating tensions between China and the U.S. continue to take a toll.
But a few things have helped Nio get back on track despite the trade war headwinds.
For example, Nio averted a potential disaster with the help of a bailout package from the Chinese government. Moreover, CEO William Li is confident that the company can turnaround its profitability in the second quarter with stronger deliveries.
However, the trade dispute with the U.S. still looms as a possible threat.
Weakening U.S.-China Ties
The growing divide between the U.S. and China continues to spook businesses operating in both countries. Recent tensions involve claims by the U.S. government that two Chinese hackers were targeting American companies to steal valuable information and compromise their security infrastructure on behalf of the Chinese government. Subsequently, the U.S. ordered the closure of China’s Houston consulate, and China followed suit by closing the U.S. consulate in Chengdu.
The most natural thing for any investor is to assess how stock returns have changed in the past week since these tensions have escalated. I looked at the 1-week returns relative to the S&P 500 to the 30-day returns relative to the S&P 500 for 461 stocks of companies headquartered in China and listed on the New York Stock Exchange. The results showed that, on average, there was an 8.5% drop in returns in the past week, which clearly illustrates the pejorative effect of the increasing U.S.-China tensions.
These tensions will naturally result in higher tariffs, company bans and ultimately impact many stocks’ valuation. Since July 17, Nio stock has been on a rocky road. It appears that at least in the near-term, the trend will continue.
Is Nio Stock Overvalued?
Nio stock’s valuation is as clear as mud for most industry experts. Few prominent analysts such as Fei Fang, working with Goldman Sachs, feel that the stock is overvalued by roughly 42% compared to its current price of $12. The primary reason for the downgrade is the lack of profitability.
From the table above, we can observe that Nio has the worst profitability figures out of its peers. Its net margin and earning per share are significantly lower than the peer averages. However, it is important to note that the company was only formed in 2014, and may need a lot more time to turn a profit.
On the flip side, its competitor Tesla (NASDAQ:TSLA) was formed in 2003 and took 16 years to generate a positive operating margin. Moreover, the company’s valuation was approximately $52 billion when it posted its most substantial loss in the past 10 years. Therefore, the $14 billion valuation for Nio doesn’t seem like much of an aberration.
Additionally, Nio also has the backing of Beijing, which bailed it out with a $1.4 billion investment in its first quarter. Chinese-American relations are weighing it down, but the colossal Chinese market allows for ample room for growth.
The $1.4 billion bail-out package for Nio has effectively removed any bankruptcy risks that the company was facing. Unit sales fell late last year, and the company was short of cash due to its aggressive strategy towards expanding its service network. After receiving a lot of flak for his decision-making, it seems CEO Li has more foresight than others.
Nio posted solid second-quarter deliveries in June, and its deliveries grew by a remarkable 179.1% year over year. In the second quarter, it delivered 10,331 units, which is 190.8% higher than last year’s levels.
During a recent earnings call, the CEO said that the company is confident in reducing its losses to achieve a gross margin of 5% by the conclusion of the second quarter. “We maintain the guidance of double-digit profit margins by year-end and so far we are confident to achieve it,” Li said. He added that the company’s cost control measures were improving operating efficiency and the cost of car parts. Things should be clearer once we have the second-quarter results, which are due later this month.
The Final Word on Nio
It’s difficult to invest in Nio stock at this point. The heated political climate is one thing, but the impact of the novel coronavirus cannot be ignored either. However, the news regarding the company’s second-quarter performance is promising so far.
Once the results come in, we can better assess Nio’s overall positioning. Until then, it would be best to hold on to the stock
Muslim Farooque is a keen investor and an optimist at heart. A life-long gamer and tech enthusiast, he has a particular affinity for analyzing technology stocks. Muslim holds a bachelor’s of science degree in applied accounting from Oxford Brookes University. He does not directly own the securities mentioned above.