Nio (NYSE:NIO) stock continues its ascent despite the novel coronavirus pandemic. The Chinese EV maker recently recorded a robust second quarter. Even though it did not turn a profit, the company did enough for shares to skyrocket.
And don’t get me wrong, there are several catalysts for Nio stock that investors will be happy with. The Chinese government is hoping that NEVs will represent one-fifth of new auto sales by 2025. As of 2019, electric vehicles accounted for almost 5% of the Chinese vehicle market. Hence the target is ambitious and presents a tremendous opportunity for companies like Nio.
However, much like its counterpart Tesla (NASDAQ:TSLA), shares are highly valued. Nio stock is trading at 11.6x forward enterprise value-sales, while the sector trades at 1x. I fully understand and appreciate the excitement surrounding the EV sector.
However, it’s tough to justify the valuations at which some of the players in the space are trading. Nio has just started to gather steam and there are still several competitors that pose a significant challenge to the long-term progress of the company.
That’s not to say Nio stock is not a good one to have in your portfolio. But I would wait for it to cool off before loading up.
Positive Tailwinds for Nio Stock
As mentioned, things are looking up for Nio. In the second quarter, the company posted its best numbers despite contending with a global pandemic. The numbers are aided by the quicker-than-expected recovery in China. Second-quarter deliveries came to 10,331 vehicles, a 191% jump over 2019. Revenues came in at $526.4 million, beating analyst estimates of $504 million by a handy margin.
Any way you slice it, Q2 was a quarter filled to the brim with milestones. It marked the first time deliveries exceeded 10,000 vehicles, gross margins entered positive territory, and operating cash flow was positive. Long term investors must be smiling from ear to ear, as Nio finally has the figures to back its progress as an early-stage growth company.
Forecasts are for deliveries to rise between 11,000 and 11,500 vehicles in Q3. Third-quarter revenue is projected to fall between 4,047.5 million yuan and 4,212.3 million yuan, handily outpacing the year-ago figure of 1,836.8 million yuan.
The astounding earnings report notwithstanding, other external aspects should instill confidence in Nio investors. The Chinese government is particularly keen on reducing average fuel consumption to 4 liters per 100km. Air quality and pollution are vital issues for Beijing and the government’s actions speak louder than words. Tax breaks on the purchase of NEVs have been extended by two years to 2022, and the Corporate Average Fuel Consumption and New Energy Vehicle credit program, or CAFC/NEV, is upgraded with added incentives for the NEV industry.
What Are the Risks?
With several tailwinds, you would think that there is nothing Nio can do wrong. A long-term growth strategy, government support, and a gargantuan local Chinese market all make for an unbeatable stock. While all correct, it doesn’t justify the premium valuation of at which Nio stock is trading.
XPeng (NYSE:XPEV) recently had an IPO to a lot of fanfare, and Alibaba (NYSE:BABA) built up a sizeable investment of up to 19% in the EV maker. With such a heavy investor backing its activities, XPeng has undoubtedly had a great kickoff, and there’s every likelihood that it will go from strength to strength from here.
No mention of competition in the space would be complete without Tesla. Billionaire Elon Musk’s electric vehicle and clean energy giant will launch its Model Y in China soon. The launch is already a bit delayed by most accounts but will now challenge Nio’s EC6 in September. Although it may look like a very insular market, Nio is competing in a cut-throat sector. Tesla’s scale and size, along with its brand positioning, are already far ahead of Nio. It will be a tough battle moving forward for each percentage point of the sector.
Nio stock is an excellent addition to any portfolio but its trading too hot at the moment. The markets are reacting positively to their growth potential. Investors are also rewarding Nio for their excellent financials and will continue to do so. But shares are overvalued, especially when you consider that Nio stock trades at multiples higher than Tesla.
Refinitiv‘s 12-month price target for Nio stock is $113 a pop, with estimates going as low as $44 per share in a worst-case scenario. Still, even if we take the mean price target, we are left with a stock that is almost 3% overvalued at current prices. In my humble opinion, I would wait for shares to drop by at least 15% before loading up.
On the date of publication, Faizan Farooque did not have (either directly or indirectly) any positions in the securities mentioned in this article.
Faizan Farooque is a contributing author for InvestorPlace.com and numerous other financial sites. He has several years of experience in analyzing the stock market and was a former data journalist at S&P Global Market Intelligence. His passion is to help the average investor make more informed decisions regarding their portfolio.