BYDDY - NIO: A New Year Hit Or Miss?

Summary

• Robust December deliveries that salvaged Q4 performance from the worst-case scenario, and introducing two brand new higher-margin vehicles in a high-demand segment helped NIO shares head into 2023 with a bang.
• Even with solid pre-market gains ahead of 2023's first session, the stock still trades at a mere 1x estimated sales, underperforming both domestic and international peers with similar growth profiles.
• Barring lingering U.S.-China tensions and potential spillover from global recession risks, China's reopening economy could be a key catalyst for the stock's comeback from current levels by the end of 2023.

In our latest coverage on NIO stock ( NIO ), we had taken a step back and delved into the broader picture of how globalization and diversifying end-market penetration will be the next key growth focus for Chinese electric vehicle (“EV”) makers. In the following analysis, we will hone in on recent company-specific developments to NIO’s operating environment and demand outlook – particularly the implications of increasing, though cautious, optimism over China’s re-emergence from COVID Zero and the ensuing economic recovery on the Chinese EV market that continues to favor home-grown brands.

Admittedly, investors’ confidence on the Chinese EV market remains fragile as optimism over the world’s fastest-growing and largest addressable market for the sector continues to be dwarfed by the looming overhang of China’s “messy” exit from COVID Zero and the ensuing economic turmoil expected over coming months, alongside accelerating fears of a global recession. Said economic challenges, paired with rising competitive pressures faced by NIO’s core business in EV sales has created a “perfect storm of skepticism” over the stock’s near-term performance. But despite anticipation for further operating challenges to its near-term fundamental outlook, the NIO stock’s current valuation – which is on par with its estimated forward sales (~1.0x NTM P/S) and at a relative discount to the domestic peer average of 1.5x and broader EV peer average of 2.7x – makes it well-positioned to benefit from a likely recovery in Chinese consumer confidence in the latter parts of 2023 when the local economy normalizes from years of pandemic disruptions.

Deliveries

The market was largely taken back by NIO’s recent decision to slash its fourth quarter delivery guidance at the eleventh hour from the previous 43,000 (+72% y/y; +36% q/q) to 48,000 (+92% y/y; +52% q/q) range to 38,500 (+54% y/y; +22% q/q) to 39,500 (+58% y/y; +25% q/q) range, sending the shares on a persistent decline through year’s end. Though a negative development, we – alongside the broader market – can attest to the fact that this difficult decision was prudent and reasonable given China’s swift transition from harsh COVID lockdowns to an almost-full reopening overnight, which not only exacerbated protracted auto supply chain constraints, but also thwarted vehicle deliveries and productions across the industry and dampened consumer demand due to mobility restrictions.

The final tally ended better-than-expected at 40,052 vehicles (+60% y/y; +27% q/q), with a record push in December that represented almost 40% of fourth quarter deliveries despite acute pandemic challenges in China’s swift COVID pivot. Admittedly, the near-term operating backdrop for NIO will likely remain challenged as recently warned by CEO William Li, as its core Chinese market weathers through a messy reopening that will continue to experience curtailed economic activity within the foreseeable future. The removal of key federal subsidies this year for EV purchases will also compound concerns over dampening consumer demand in the near-term, given the financial incentive was a key complement to favorable policy support from the Chinese government that had played a crucial role in fueling the region’s rapid transition to electric.

Yet, the near-term pains pertaining to China’s swift COVID Zero exit and the local EV industry’s weaning off of years-long subsidies could drive to a new era of longer-term gains ensuing from continued acceleration in EV adoption independent of financial incentives that could potentially coincide with an outpour of record household savings when economic stability returns (more on this in later sections) – or in other words, an intrinsic shift in consumers’ preference supported by innovative battery and in-vehicle technologies and increasing availability of public infrastructure supportive of EV ownership once current macro uncertainties clear up. For now, near-term demand weakness as warned by Li amid China’s uncertain macro picture, which is consistent with struggles recently observed even at key juggernauts like Tesla ( TSLA ) and BYD ([[BYDDF]] / [[BYDDY]]), as well as deceleration in China passenger new electric vehicle sales in 2H22, will likely drive muted TAM expansion in the first half of 2023, as opposed to rapid acceleration observed in previous years. This will not only impact NIO, but also the broader industry of auto OEMs and constituents in the auto supply chain. Yet, NIO’s recent deliveries continue to highlight persistent share gains independent of broader industry headwinds, which also provides a robust set-up for the automaker as it plans to penetrate mass and overseas market opportunities over the longer-term.

Specifically, on the delivery front, NIO’s ability to outperform the upper range of its adjusted guidance with record monthly deliveries achieved in December’s tough operating conditions underscores robust share gains still within the increasingly competitive Chinese EV market consisting of legacy automakers, EV pureplay start-ups, and “mainstream JV brands”. The achievement also implies NIO’s improving brand and product appeal within the increasingly saturated market, underscoring favorable take-rates for its continued commitment to innovation and ecosystem-building business strategy.

Meanwhile, on the production front, NIO has demonstrated consistent resilience in overcoming unprecedented supply chain constraints in the auto manufacturing industry in recent years. This is corroborated by NIO’s resilient bounce-back observed in June, with record-setting output volumes following muted performance during the sprawling COVID lockdowns across key auto and supply manufacturing hubs in China during the second quarter of 2022:

NIO delivered 25,059 vehicles in the second quarter (+14% y/y; -3% q/q), underscoring reaccelerated growth as China re-emerges from the worst of supply and logistics constraints following recent COVID restrictions. Similar to its American EV peers, NIO delivered record-setting volumes in June. Specifically, productions of the newest ET7 sedan, which began in March, grew by more than 40x from 163 units in the first quarter to 6,749 in the second quarter, which highlighted NIO's strength in re-ramping productions following heightened supply chain bottlenecks.

Source: “ EV Roundup: Everything From Tesla To NIO, U.S. To China ”

And this time around, China’s abrupt COVID Zero exit is undoubtedly going to introduce renewed adversities to already-fragile auto supply chains. All things considered, NIO did stage a pretty strong and impressive exit in December, but challenges will likely worsen before becoming structurally better heading into 2023. Specifically, the severe outbreak in China following its pivot from COVID Zero in recent months has already dampened economic activity in the country (more in later sections). And coinciding with “a likely travel rush during the upcoming Lunar New Year holiday” – one of China’s biggest festive celebrations after National Day – infection counts are likely to surge further before stabilizing. This means the delivery and production challenges NIO faced during the fourth quarter will remain a fluid situation into the first quarter of 2023 at the minimum, hindering both the supply and demand ends of the company’s near-term fundamental prospects. But with the COVID overhang inevitably easing in the latter half of the year, NIO is likely to demonstrate its strength in re-ramping productions again – and this time with added capacity running at NeoPark – to capture the anticipated return in demand.

New SUVs

NIO’s annual keynote event last month was characterized by the introduction of two new models for its flagship premium brand.

The ES8 – NIO’s flagship SUV – has been revamped with the latest technologies and exterior appeal that the Chinese EV maker had to offer. The usual in-vehicle “ NOMI ” AI which boasts compatibility with 5G connectivity, and the “ AQUILA ” suite of cameras and sensors powering NIO Pilot ADAS features alongside other multimedia capabilities is now powered by the “ Banyan ” operating system to enable a “second-generation digital cockpit”. The redesigned full-size six-seater boasts as much as 900km in range per charge (previous standard range was 580km) on a 150-kWh battery pack, starting at RMB 528,000 ($76,500) with customer deliveries to commence around mid-year.

The company also unveiled a “new pure electric coupe”, the EC7 . With an exterior that fits the bill of well-liked premium luxury coupes like the Mercedes GLE ([[MBGAF]] / [[MBGYY]]) and rival Tesla’s Model X, the EC7 combines performance with a progressive silhouette that will continue to improve NIO’s appeal to preferences in overseas markets over the longer-term. Boasting a range of up to 940km on a single charge, the EC7 is offered at a starting price of RMB 488,000 (~$70,000), which is relatively modest compared to counterparts offering similar performance and specs.

Both newly introduced SUVs are built on the NT 2.0 platform, which currently drives NIO’s range of ET7 and ET5 sedans that began deliveries in 2022. NIO’s continued transition of its model line-up to the updated platform will play a critical role in ushering current vehicle gross margins in the mid-teens to 25% over the long-run to bolster competitiveness with more mature peers in the industry, and support its planned trajectory to profitability before mid-decade:

Through the introduction of NIO Technology platform 2.0 (“NT 2.0”), a brand-new higher margin technology platform for its new vehicles starting with the ET7, as well as the build out of new plants, NIO aims to achieve a vehicle gross margin of 25% in the long-run, which puts it in a competitive range compared to industry peers. NIO’s accelerated research and development (“R&D”) timeline also enables it to increase its product mix offered to users, leading to higher sales while achieving scale in productions to drive down overall production costs.

Source: “ Where Will NIO Stock Be In 10 Years? ”

The improved economics of NT 2.0 will be critical for NIO given rising competition and decelerating demand growth ahead of near-term macroeconomic uncertainties. Specifically, the Chinese EV makers continue to operate in a supply-constrained environment that is victim to persistent inflationary pressures. This makes it increasingly difficult to compete against more mature rivals like Tesla and BYD, which are actively pulling the “pricing lever” to optimize demand. And with pricing power likely to fade across the auto industry as local consumer sentiment remains tepid, ramping up NT 2.0 will be critical to helping NIO defend and preserve its vehicle margins, without the need to materially trim operating and capital expenditure needed to fund growth – a strategy currently undertaken by American counterparts like Rivian ( RIVN ) ahead of looming recession risks in the U.S.

The new SUV models will also play favorably to the more resilient vehicle segment in the Chinese EV market. Specifically, SUVs currently account for close to half of China’s passenger vehicle sales. Meanwhile, EV penetration in the region continues its push towards 40% . Local home-grown brands and luxury models like those offered by NIO are also consistently demonstrating greater resilience against a shaky economy and accounting for more than half of EV adoption in China. With initial deliveries on the new premium SUV models slated for mid-year, it will likely coincide with early stages of anticipated economic recovery in NIO’s core Chinese operating market, and better the EV maker’s capitalization of returning durability in secular electrification tailwinds before year-end.

China’s Macro Backdrop

Looming macro uncertainties amid China’s messy COVID Zero exit, an ongoing slump in the property sector, as well as broader risks of a global economic downturn are contributing to a bleak outlook for the auto industry heading into 2023. The nation reported its slowest pace of economic activity since the onset of the pandemic, with businesses across construction, services, and goods manufacturing sectors contracting for months straight.

This is corroborated by NIO’s recent warning of demand challenges in China through the first half of the year, which is consistent with a slew of sales-salvaging tactics undertaken peers in recent weeks amid protracted economic disruptions that have hampered confidence among investors and consumers alike. Yet, considering China’s record-setting household savings rate in the 30%-range, or close to $2 trillion accumulated this year, the second half of 2023 makes a potential boost period for NIO as growth confidence returns in the region with transitory COVID pivot disruptions fading, and Beijing continuing its support for the private sector.

With economic growth returning to the front seat in China’s political agenda this year, and key agencies including the PBOC pledging to “support domestic demand and maintain effective growth of credit” as the country re-emerges from years-long COVID restrictions, markets will likely see a gradual return of consumers’ confidence through the second half. The Chinese economy is currently forecast to expand by 4.8% in 2023, contrasting the “dual threat of elevated inflation and slowing growth” facing global peers. Paired with already battered valuation multiples across Chinese equities – particularly long-duration growth names like NIO that are not yet profitable – to reflect investment risks specific to the segment over the past several years, the Chinese EV stock remains well-positioned for a potential recovery that will likely pick-up in pace later in the year.

Final Thoughts

NIO’s modest valuation at current levels of merely 1x forward sales, paired with recovering fundamental prospects in the near-term buoyed by internal operating efficiencies and an improving domestic economic backdrop creates the perfect set-up for a potential comeback in the stock’s performance later in the year. While lingering geopolitical tensions between the U.S. and China, which have recently shown signs of alleviation, and a looming global economic downturn will remain an overhang, we believe much of the related concerns have already been priced into the Chinese EV maker’s valuations at current levels and fundamental estimates, which puts the shares at a potential bright spot ahead of its American counterparts as the new year unfolds.

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