Why I’m Upgrading NIO Stock (NYSE:NIO)

Introduction

I’ve been writing about NIO Inc. (NYSE:NIO) stock here on Seeking Alpha since November 2022. I have rated the stock a ‘Sell’ from the beginning and have confirmed this again and again, last updating my coverage of the stock in September 2023. So far, my calls have aged well, as far as I can tell.

A few hours ago from the moment I sat down to write today’s article, NIO presented its Q3 FY2023 report and the company’s management commented in detail on the work done and the next plans. So I decided to take another look at NIO to put my old thesis to the assess.

Financials, Developments, And Valuation

In Q3 FY2023, NIO delivered 55,432 vehicles, reflecting a notable 75.4% enhance from Q3 FY2022 and a remarkable 135.7% jump from Q2 FY2023. The substantial growth was driven by the delivery of 37,585 premium smart electric SUVs and 17,847 premium smart electric sedans. Financially, NIO reported a significant enhance in vehicle sales, reaching RMB 17,408.9 million ($2,386.1 million) for Q3 2023, marking a 45.9% rise from the same period in 2022 and an impressive 142.3% surge from the previous quarter. NIO’s vehicle margin fell to 11.0% from 16.4% last year, while the strong gross margin fell to 8.0% from 13.34% in Q3 FY2022.

While experiencing a decrease in gross profit compared to Q3 2022, the third quarter of 2023 saw a substantial enhance of 1,650.9% from Q2 2023, reaching RMB 1,523.3 million ($208.8 million). However, the operating loss was still quite impressive: it fell by 21% quarter-on-quarter, but was 22% higher than in the previous year:

The net loss for Q3 2023 was RMB 4,556.7 million ($624.6 million), marking a 10.8% enhance from Q3 2022, but a substantial 24.8% decrease from Q2 2023. Adjusted for share-based compensation expenses, the non-GAAP adjusted net loss was RMB 3,953.2 million ($541.8 million), indicating a 13.0% enhance from Q3 2022, but a substantial 27.4% decrease from Q2 2023.

In September 2023, NIO launched the All-New EC6, a second-generation mid-sized coupe SUV, completing its product line on the NT2.0 platform. They also introduced China’s first vehicle operating system, SkyOS, and an in-house-developed LiDAR SoC named Yang Jian. In terms of assisted and intelligent driving, NIO released the Power Swap Pilot for Highway beta on November 15th, seamlessly integrating NLP+ and Power Swap for an automated and intelligent highway driving and battery-swapping encounter. Regarding the battery-swapping alliance, NIO announced cooperation agreements with Changan and Geely, emphasizing the network effect and potential for sustainable business models. The company plans to enlarge its power swap network, with potential CapEx and consideration of introducing partners who will hold the battery swap station assets.

As of September 30, 2023, NIO had RMB 45.2 billion ($6.2 billion) in cash and cash equivalents, restricted cash, short-term investment, and long-term time deposits. So NIO may theoretically cover 2 years of operations with its liquidity, which is still not enough for the scaling goals it has set for itself. So in my humble opinion, raising new rounds of investment at the expense of existing shareholders is just a matter of time.

In September and October 2023, the company has already completed an offering of convertible senior notes, raising a total of $1.15 billion. Following the pricing of the new notes, the company used a portion of the net proceeds (approximately US$500 million) to repurchase some of its existing convertible senior notes due in 2026 and 2027 through privately negotiated transactions. The purpose of the repurchase was to retire some of the existing debt using the newly raised funds. The company intends to use the remaining net proceeds (not used for the repurchase) to fortify its balance sheet and for general corporate purposes.

NIO makes attempts to lower its costs. As was mentioned during the Q&A session on the recent earnings call, NIO is set to acquire some production facility assets from JAC, and there will be around a 10% reduction in manufacturing costs when bringing the entire manufacturing process in-house. But this 10% reduction in production costs seems to me appreciate a drop in the bucket compared to the absolute costs that the company still incurs today.

As far as I can see, NIO’s financials have improved in the third quarter compared to the second quarter, but strong competition in the industry will likely continue to limit the company’s pricing flexibility and it will take longer for the company to regain its previous margins. Perhaps the majority of market participants came to the same conclusion by selling shares after the post-earnings rip:

Looking at the latest earnings projections by Wall Street, we see that as of December 6, 2023, EPS estimates for FY2023 and FY2024 are -$1.53 and -$0.84, compared to -$1.44 and -$0.78 on October 16, 2023. That is, after the report was released, the consensus numbers crawled lower, which is an overall negative point. The positive for NIO is that this downward trend only affected 2 forecast years and was not too severe. However, the dynamics of the revenue forecast show significantly worse results:

The company cannot be valued based on FCF, as it is a growth company whose first positive earnings per share are forecasted to appear in 2027. More precisely, it is theoretically possible to build a DCF model, but such calculations have no practical meaning due to their strong sensitivity to a too uncertain future. What we can do is take a look at NIO’s multiples. Seeking Alpha’s Quant System gives NIO a ‘C-‘ Valuation grade, meaning that the stock is no longer as overvalued as it was 3 months ago. However, apart from the sales-related multiples, which are indeed modest, we don’t even have a forward EV/EBITDA. Based on a combination of various SA Quant metrics, the company ranks among the last in its industry.

In my opinion, NIO looks overvalued with a price-to-book ratio of over 6x and an operating loss of over $660M for just one quarter. However, I do not propose selling the stock at its current price levels because a) Q3 results were better than I expected and b) the number of short sellers has increased sharply recently, which may guide to short covering against the backdrop of any minor positive news about the company.

The Bottom Line

As fate would have it, NIO’s expansion took place at a time when competition in the industry was increasing rapidly and consumers were becoming much more selective in the face of the deteriorating economic situation, particularly in China.

I think NIO remains too expensive even after the stock fell 88% off ATH. However, there are already small operational improvements, at least in a QoQ comparison. The company’s margins will continue to be under pressure in my opinion, but they have already started to grow faster than I had previously expected. If management’s cost-cutting strategize bears fruit, a short covering could kick in that could furnish growth of several tens of percent. Even small positive news is enough for such an outcome – we have seen this many times in recent months with various stocks. Given this upside risk, I have decided to upgrade NIO from ‘Sell’ to ‘Hold’. This doesn’t mean I’m recommending you hold NIO stock in your portfolio; I’m just expressing my neutral stance on the stock and suggesting you step aside or think about closing out a short position if you have one.

Thanks for reading!

Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.