I’ve been bearish on Nio (NYSE:NIO) stock for most of my tenure as an InvestorPlace contributor, but my narrative’s changed due to an abrupt shift in market forces. China’s recent monetary policy U-turn has prompted me to look at NIO stock from a bird’s nest view for once.
It has occurred to me that we may experience a multi-year consumer spending surge in China, which could come during a period of proxy seeking in the financial markets. By “proxy seeking,” I simply mean that investors are currently stuck in overvalued financial markets with underlying entities operating in inflationary environments. However, China could be a proxy now that systemic risk has stabilized, and Nio could be one of the breadwinners.
Here’s why.
Promising Earnings Outlook
The Chinese electric vehicle maker released its fourth-quarter earnings report earlier this year and beat revenue expectations by $20 million while narrowly missing out on earnings estimates by 16 cents per share.
However, the past is the past, and I prefer looking into the future.
Nio’s management has provided positive guidance and anticipates a robust first quarter in 2022. The consensus is that Nio’s deliveries will increase by up to 29.6% year-over-year, in turn increasing total quarterly revenue by 25.1% YoY.
I firmly believe in Nio’s ability to scale in this first quarter.
China’s consumer discretionary space holds a significant advantage at the moment and is aligned for a cyclical upturn. The nation’s inflation rate of 0.90% is considered very low relative to the global economic sphere, which means that Nio can deliver fairly priced vehicles to the market. In addition, by cutting interest rates to 3.7% in January, China has been one of the only notable nations to recently engage in expansionary monetary policy instead of contractionary monetary policy. The effect of this could be a surge in economic activity and vehicle financing, thus adding to Nio’s topline growth.
NIO Stock: Valuation and Stock Price Prospects
After capitulating and losing nearly half of its market capitalization during the past six months, NIO stock looks investable again, with its price to sales ratio trading at a 50% discount relative to its 5-year average. An additional attraction to the stock is that Nio’s stacked up a significant amount of cash lately. The company holds $8.24 billion of cash on its balance sheet with a current ratio of 2.18x, suggesting that it’s a liquid enterprise that could provide plenty of future residual to its shareholders.
NIO stock holds much promise from a pricing vantage point. I always try to ensure that a stock’s fundamental valuation multiples and its pricing metrics align to provide more substance to my analysis. The Capital Asset Pricing Model (CAPM) is a linear regression that factors in the stock’s sensitivity to the broader index (beta), the stock market’s risk-premia (equity risk premium), and the U.S. 10-year Treasury yield (risk-free rate) to justify a baseline price target for the stock.
I calculated Nio’s CAPM at 17.06%, suggesting that the stock provides attractive return prospects relative to the broader market. However, it should be worth noting that the expected return is based on an efficient market and doesn’t account for event-driven market movements.
Source: Author’s calculations with data from Gufrufocus
What About the Geopolitical Risk?
First things first, much of the excess return on Chinese stocks is attributed to geopolitical risk. There’s a risk-return tradeoff in the financial markets, resulting in an equilibrium tradeoff between an investor’s risk-return prospects.
It’s evident that the Chinese Communist Party (CCP) has altered its narrative quite a few times over the past few decades. However, it seems as though the economy and the financial markets are of priority again to the CCP after the central committee stated in March that it must: “implement the decisions and arrangements of the CPC Central Committee, effectively invigorate the economy in the first quarter, proactively respond to monetary policy, and maintain moderate growth in new loans.”
NIO stock will undoubtedly be sensitive to geopolitical risk. However, I believe that the tides have turned, for now at least. And global investors will likely feel more comfortable with exposure to Chinese stocks for the foreseeable future.
On the date of publication, Steve Booyens did not hold any position (either directly or indirectly) in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
