Summary and thesis of the third quarter
I have been writing a series of articles on NIO (New York Stock Exchange:NIO) from May 2022 to warn readers of the many obstacles it faces. I certainly see all the good the bulls like about this Values. However, I see even stronger headwinds. For example, in an article published in August 2022, titled “A simple reality checkI warned readers about its lack of earnings and unsustainable valuation. The stock was still trading at around $21 a share at the time.
Fast forward to now, NIO has just released its Q3 Earnings Report (“ER”). Its third quarter non-GAAP EPS (ie earnings per ADS) was -$0.30 and missed consensus estimates at $0.14. Vehicle margin compressed another 160 basis points to 16.4% compared to 18.0% a year ago. Its share prices fell 12.4% after its Q3 ER in the single digit range ($9.25 at time of writing, before the market opened on Nov 10, 2022).
Now, looking to the future, I maintain my thesis of the bear. And more specifically, in this article, I will argue that NIO stock prices would stay in the single digits in the near term (say the next 1-2 years or so). I acknowledge its long-term headwinds, including China’s secular shift to electric vehicles, its leading brand power, and its aggressive vehicle delivery plans. But I see negative catalysts to have the upper hand in the short term due to a multitude of strong headwinds as detailed below.
Strong delivery and top line growth
To get the full picture, let’s first review the positives before diving into the headwinds. NIO enjoys leading production and delivery scales among China’s domestic electric vehicle players. It has consistently demonstrated a solid increase in production and delivery capacity in the past, as you can see in the graph below. specifically, in his September delivery reportprovided the following update for its Q3 2022 deliveries, with another quarter of the quarterly deliveries and a year-over-year growth rate of almost 30%.
- NIO delivered 10,878 vehicles in September 2022
- NIO delivered 31,607 vehicles in the three months ending September 2022, increasing 29.3% year-over-year and achieving record quarterly deliveries
- Cumulative deliveries of NIO vehicles reached 249,504 as of September 30, 2022
In its Q3 ER, it reported a total vehicle delivery of over 10k for the month of October, which translates to 174.3% YoY (but a slight decrease of 7.5% MOM). And for its Q4 outlook, it is targeting a delivery target in the range of 43k to 48k vehicles, which translates to a growth rate of 71.8% to 91.7% y/y. Total revenue is forecast to grow in tandem from 75.4% to 94.2% year-on-year.
At the same time, its scale helps it maintain healthy operating efficiency, as you can see in the following comparison of its asset utilization (“AU”) versus its domestic peer XPeng (XPEV) and its US peer Ford (F). NIO’s current AU stands at 0.50x, slightly below its long-term average of 0.517x, largely due to lockdowns in China due to recent resurgences of COVID cases. Despite the recent drop in its AU, it is still above XPEV’s 0.47x and comparable to long-term average levels of F.
Margin pressure and lack of profit
However, the business has been suffering from margin pressure on the bottom line and has yet to make a positive profit. As seen, its gross profit margin (“GPM”) peaked at around 18% during the second half of 2021, outperforming Ford. But recently, the GPM has come under pressure and contracted to the current level of 13% by about 500 basis points. Now his GPM is lower than 17.4% F by a good gap (although still better than 10.8% XPEV). In terms of profit margin, as shown in the lower panel, the picture is even more worrying. Its net profit margin has always been negative and is currently -26.7%.
The picture does not improve as we expand the view to include other metrics as seen in the graph below. Its metrics are negative across the board, from EBIT margin, EBITDA margin, and FCF margin.
Looking ahead, I see some key obstacles to keeping earnings negative, in addition to macroeconomic factors such as political uncertainties and government policies. First, I expect capital requirements to continue as he pursues expansion of charging infrastructures. And keep in mind that its cash from operations stood at just $309 million, far from being able to meet such requirements. To meet customer needs, the administration will need to continue spending on both battery swapping stations and charging stations. Second, I expect some of their manufacturing issues to persist and also the global supply chain disruptions. For example, it reported early on an issue related to the low throughput rate of its mega castings with its suppliers. This seemingly arcane issue can actually hamper your production ramp-up and efficiency, and it will take time for NIO to resolve or find alternative suppliers amid supply chain disruptions.
Next, we will see that despite the lack of earnings, the stock is still valued at a high level despite the large price corrections.
Valuation is still too expensive
In terms of valuation, NIO still trades at a huge premium in both absolute and relative terms. Their lack of profit makes the bottom line metric meaningless, as seen in the chart below. Even FY3 PE stands at 163x, compared to around 6~7x for F. Also, due to the many headwinds discussed above and its mixed Q3 results, its earnings outlook is gloomy and highly uncertain, as noted. reflected in the consensus estimates in the second chart below. NIO earnings revisions for the last 3 months show a very pessimistic and uncertain picture. A total of 11 analysts provided EPS forecasts, and a total of 9 analysts revised EPS downward by between 70% and 95% in 2024.
Using top-tier valuation metrics, its P/Sales ratio is still at 2.5x despite price corrections, on par with the S&P 500 Index, roughly 2x higher than XPEV’s 1.3x and 7. 1x more than F’s 0.35x. I found such a valuation unjustifiable given its lack of profit and the many obstacles it faces. And again, its top-line growth is also highly uncertain, as reflected in consensus estimates. A total of 21 analysts presented revenue forecasts and a total of 17 analysts revised earnings downward.
Other risks and final thoughts
To conclude, in the long term, NIO could benefit from China’s secular shift to electric vehicles, its increased capacity, and its strong brand relative to its domestic peers.
However, I see too many powerful forces in the near term to push stock prices into the single digit range. The stock has yet to report positive earnings. Until now, it has been trapped in the dreaded vicious circle: the more vehicles it sells, the more money it loses.
The possibilities of lower government subsidies and policy changes can also drastically change the calculation of risk. The combination of elevated valuation and lack of net earnings would also keep a cap on share prices. China’s Zero Policy on COVID is another uncertainty. NIO had to temporarily suspend production at two of its plants in Hefei during the third quarter due to local COVID control requirements. And it is likely that such suspensions will be repeated in the near future. And finally, the stock may face the risk of obtaining new financing as its high CAPEX requirements persist while its organic earnings remain low or negative.