Shares of Nio (NYSE:NIO) gained 18.6% after the company reported revenues for June and its second quarter that exceeded analyst expectations. It said it delivered 3,740 vehicles in June — up 179% from its year-ago performance. Nio stock is up essentially 100% for the month and is trading at a 316% discount, according to consensus estimates.
“In June, we achieved a historical high of monthly deliveries, contributing to our best quarterly performance. We appreciate the continuous support from our growing and loyal user community,” stated CEO William Li.
The company has also benefited from the continued support provided by the Chinese government in extending cash subsidies for new energy vehicles (NEV) until the end of 2022.
The government push along with its growing customer base is powering Nio stock to new heights. Let’s look at some of these reasons in more detail.
The Chinese Government Is on Nio’s Side
Nio is currently the leading domestic player in the Chinese EV market, and it’s being supported by the government in its efforts to break through. It’s difficult to imagine that China would allow a foreign player such as Tesla (NASDAQ:TSLA). But the market is extremely lucrative and is expected to hit $803 billion by 2027.
Moreover, it is also of pivotal importance for China’s move into high-end manufacturing.
The government had initially planned to end the NEV subsidy by 2020, but the economic pressures brought on by the novel coronavirus compelled the government to extend the subsidy until 2022. However, the policy applies to cars that cost less than $42,376. This is likely to exclude many of the foreign players, including Tesla. Additionally, the threshold does not apply to cars with swappable batteries.
Nio has an excellent battery-swapping network which includes battery upgrades, exchange and leasing options. Its battery swapping strategy has long been criticized for its adaptation risks and significant costs. However, in this case, it is a blessing in disguise as it enables the company to get the full government subsidy regardless of the price of its cars.
Nio Has Negative Gross Margins
One of the striking elements of Nio’s financials is its gross margin. Nio’s gross margins for its latest quarter are -7%, down considerably from last year’s -15.3%. The company’s management believes that gross margins can be over 5% mainly due to a series of efficiency improvement and cost control measures.
Gross margins are tough to maintain, especially for an EV company. Tesla was founded 11 years before Nio and its free cash flows have been in the negative until last year.
A large part of the problem for most EV companies is building trust and brand identity. This involves significant selling, general and administrative expenses. Since its inception, Nio has opened up 92 spaces in 76 cities across China along with 22 of its Nio Houses. Moreover, it has also spent tons of money on building its presence in different online and offline communities. It has been successful in building strong communities that value its product offerings and are providing it with organic traffic.
For instance, its user referral rates were at 69% in early 2020. The healthy rise in deliveries for May and June will help push margins higher. But ultimately, the company needs to be more efficient in managing its expenses and capital expenditures.
Moving Forward
Nio has a lot on its plate as we enter into the latter half of the year. The most obvious aspect for it to work on is its gross margins, specifically in increasing its scale and controlling costs. The company is witnessing a strong increase in revenues in the past few months and it needs to think about its supply chain constraints.
Additionally, it also needs to worry about its free cash flows and its financial flexibility.
Thankfully, its funding needs would largely be taken care of until 2021. Several strategic investors including Hefei City Construction and Investment Holding, CMG-SDIC Capital and Anhui Provincial Emerging Industry Investment will invest 7 billion yuan in a new Nio China entity. Additionally, the company will invest 4.3 billion yuan (2.4 billion yuan from its internal reserves and the rest from fundraising) along with core assets in the new entity. Nio will have a 75.9% stake in the new entity.
My Final Word on Nio Stock
Nio has a lot of things going for it at this time. Its revenues are up by a staggering amount, it has secured sufficient funding to cover its liquidity requirements until 2021 and it has the government’s support.
However, it needs to focus on getting its margins up and increasing its scale. Analysts have a median price target for Nio stock at $35, which is roughly 316% of its current stock price. Therefore, it’s the ideal time for investors to grab the stock at a massive discount.
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.
