The phrase “electric cars” is synonymous with Tesla Inc. (TSLA). Considering the success of the company in recent years, this doesn’t come as a surprise. But, there’s a lesser-known company that has been gaining traction in this industry; NIO Limited (NIO). The company primarily operates in China and has been benefiting from the secular growth in demand for premium electric vehicles in China. NIO Limited revenue grew 56% in 2019 to $1.123 billion from $719.8 million in 2018. This growth in revenue is testimony to the massive growth the company is experiencing in China. The performance of NIO shares has been flat in 2020. Even though the share price declined drastically through March 23 along with the broad market decline and the lockdown in China, shares have been quick to recover. One of the primary reasons behind this recovery was the promising March vehicle sales numbers reported by NIO Limited.
Is NIO an attractive investment to play the expected growth in the EV industry? This analysis tries to answer this question.
Why did NIO shares gain 8% yesterday? (April 29)
The Wall Street Journal reported yesterday that NIO has secured funding from Chinese state investors to the tune of $1 billion, in exchange for a 24.1% stake of the company. Investors have been debating about the ability of NIO to survive this recession because of its poor balance sheet. The announcement of this investment helped regain some lost investor sentiment, and this pushed the NIO share price higher yesterday.
At the end of 2019, NIO had $140 million in cash and liquid investments in comparison to a massive debt pile of just over a billion dollars. Many investors continued to be skeptical of NIO’s ability to survive the virus-induced recession because of liquidity concerns, which was one of the reasons for many growth investors to remain on the sidelines. With yesterday’s announcement, many such investors jump on board in hopes the $1 billion investment in NIO Limited will help the company navigate the rough seas and come out stronger.
NIO has consistently failed to convert top-line growth to the bottom-line
True, identifying a company that is reporting eye-popping revenue growth is critical to the success of any growth investor. However, when considered in isolation, this is not a meaningful indicator of whether the shares of such a company is an attractive investment.
NIO Limited benefited from the favorable macroeconomic environment for the electric vehicles industry, but the company has failed to transform this growth in revenue to higher net income.
An investor could argue that this is an inherent feature of many young companies that are trying to optimize their business operations. That, undoubtedly, it true and there’s no arguing about that. However, investors should never forget that many such companies fail to see the light at the end of the tunnel. A prudent investor should conduct industry analysis to evaluate whether NIO would be able to keep its head held high until the company can generate meaningful profits.
The macroeconomic environment is challenging
Almost all automobile manufacturers in the world are searching for some love in China. This is understandable because China is the world’s largest market for vehicles. However, the sales of both commercial and passenger vehicles have declined in the last three years, which is an ominous sign for the industry.
Sales were declining well before the outbreak of Covid-19. The two-month closure of the majority of Chinese manufacturing plants to curb the spread of the virus was not welcome news for the industry. On top of that, it’s evident that the impact of this virus will be felt throughout this year and possibly the next, meaning the purchasing power of Chinese consumers will take a massive hit as a result of Covid-19. This, in return, will lead to a further contraction in total vehicle sales in the country.
Amid this chaos, Tesla is ramping up its manufacturing facilities in China. To make things even worse for NIO Limited, Tesla announced a short while ago that they will be slashing the price of Model 3 cars in China, starting from the next week. Tesla’s gigafactory in Shanghai is helping the company reduce its operating costs as well, which is an ominous sign for other small-scale electric vehicle players such as NIO.
NIO is famous for its seven-seaters. Tesla Cybertruck, which was unveiled in September last year, will carry 6 people. This is a clear indication that Tesla is on a mission to capture the lion’s share of the electric vehicle industry in China.
All the above developments are testimony to the fact that NIO’s competitive landscape will change radically in the next couple of years. The early success the company enjoyed might prove to be difficult to replicate, which should be factored into the analysis of NIO Limited shares.
Takeaway: The recent funding will help NIO survive but the company will find it difficult to keep up the momentum
When it comes to a growth company, there’s nothing an investor does not like more than a decline in revenue and net earnings growth. Let’s leave the latter as NIO Limited does not make any profits yet. The revenue of the company, on the other hand, will come under pressure in the coming quarters as Tesla and other leading automobile manufacturers continue to focus on China. More often than not, when dominant players enter a high-growth industry, small players either cease to exist or become acquisition targets of larger players. The risks of investing in NIO stock are very high and the unfavorable competitive landscape will most likely lead to a dip in revenue.
There’s one other factor that might limit the upside potential of NIO shares as well, which is not even remotely related to the company. The spectacular fallout of Luckin Coffee, the company that was expected to trump Starbucks in China, has given rise to a new wave of pessimism about Chinese companies. NIO stock price might come under pressure as regulators investigate Chinese companies listed on American stock exchanges to prevent accounting malpractices from happening again. This external development might keep NIO shares from delivering stellar returns even if the company comes up with attractive performance figures.
The best way to invest in the expected boom of electric vehicle sales is by investing in Tesla shares. However, Tesla is a tricky company to analyze and invest in as well. You can read what Beat Billions thinks about Tesla here.
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