TSLA - NIO: Time To Be Bullish (Rating Upgrade)

2024-01-02 06:48:54 ET

Summary

• NIO's strong fresh Q4 delivery figures add a lot of optimism to me given the fact that consensus estimates forecast almost no YoY Q4 revenue growth, making estimates upgrade probable.
• Apart from strong top-line dynamics, I see several positive developments for the company's profitability prospects.
• My valuation analysis suggests NIO stock is about two times undervalued.

Investment thesis

My previous bearish thesis about NIO ( NIO ) aged well, as the stock's performance has significantly lagged behind the broader U.S. market since early October. I doubted NIO's ability to meet its long-term growth projections due to unstable deliveries in the first nine months of 2023. However, the latest Q4 delivery data suggest that NIO is gaining strong momentum, and its last quarter's strong delivery numbers will likely lead to the upgrade in Q4 earnings consensus estimates. I also see several other strong positive catalysts, which made me more optimistic regarding NIO's prospects. Furthermore, my valuation analysis suggests the stock has a massive upside potential, outweighing all the uncertainties. At the moment, NIO represents an attractive investment opportunity for long-term investors seeking exposure to Chinese EV makers. That said, I assign NIO a "Strong Buy" rating.

Recent developments

NIO released its latest quarterly earnings on December 5, when the company topped consensus estimates. Revenue grew by 47% YoY, and the adjusted EPS demonstrated a slight two-cent decrease. The operating margin was still deeply negative in Q3, though there was a four percentage points YoY improvement, which is a positive trend.

The earnings release for the upcoming quarter is scheduled for February 29, 2024. Consensus estimates forecast quarterly revenue at $2.33, which will be almost flat on a YoY basis. The good point is that the adjusted EPS is projected to improve significantly YoY, from -$0.52 to -$0.32.

The latest vehicle delivery numbers suggest that the flat YoY Q4 revenue expected by consensus is pessimistic. According to the official press release from the company, it delivered slightly more than 50 thousand vehicles in Q4, which is a 25% YoY increase. Since there were no dramatic selling price discounts from NIO offered to customers, I expect the top line to correlate with the delivery figures dynamics notably. That said, it will be fair to expect a double-digit YoY revenue increase in Q4. For example, Q3 deliveries were 75% higher on a YoY basis, and revenue demonstrated a 47% YoY increase in Q3.

Furthermore, I look optimistic at the NIO's recent release of a new premium ET9 executive sedan, which will be the company's most expensive model with a pre-sale price of around $112k . Experts expect the model to compete primarily with Porsche Panamera and Mercedes Maybach, which might look like a too-ambitious task. However, ET9's price is by far lower compared to its rivals, which will likely be a solid competitive advantage for NIO. Mercedes Maybach's price is well above $200k , and the Panamera starts at around $140k in China. It is also important to underline that the new model will not affect the company's near-term revenue prospects as ET9 sales are expected to launch in 2025.

Apart from positive solid developments for the top line, it is also crucial to underline that the management now also focuses on the cost side of the profitability equation, which was multiple times underlined during the latest earnings call . According to December 2023 news, up to 30% of the headcount might be laid off, which will be a substantial profitability boost. The recent decision to spin off NIO's battery unit also looks like an indication of the management's commitment to accelerate the path to profitability. Last but not least, the recent $2.2 billion strategic investment raised by NIO from Abu Dhabi's CYVN is also a positive development. This is a huge boost to improve the company's balance sheet, which makes the company well-prepared to continue investing heavily in R&D and marketing to fuel revenue growth.

All in all, I think that recent developments suggest that NIO is now balancing between delivering healthy and sustainable growth instead of growth at all costs. Strong top-line performance, together with improving financial discipline and solidifying balance sheet, is a very strong combination of positive catalysts, which makes me bullish about NIO.

Valuation update

NIO substantially underperformed the U.S. stock market in 2023, with a price decline of 5.8%. The stock also underperformed compared to its closest competitors, LI and XPEV, in 2023. Valuation ratios are sky-high, but these should be ignored, given the company's growth profile and the fact that it is still unprofitable.

I want to base my valuation analysis on the discounted cash flow [DCF] approach. I use a high 15% WACC for discounting, given the substantial risks inherent to investing in Chinese companies as well as a high level of uncertainty about NIO's profitability timing. Revenue consensus estimates forecast a 19.5% WACC for the next decade, which I consider fair compared to the optimistic broad expectations for the whole Chinese EV industry. I expect the FCF margin to turn positive in FY 2026 and expand by 150 basis points yearly.

According to my DCF simulation, the business's fair value is $31 billion. This is around two times higher than the current market cap, which means NIO has a massive upside potential. If a 94% upside potential is applied to the current $9 per share, the target price for NIO is $17.5.

Risks to consider

Investing in Chinese stocks is inherently risky due to substantial political risks. Chinese political system is not democratic, which means that the massive political power is concentrated in the hands of a very limited circle of individuals. In these circumstances, there is a high probability that decisions and policies are conducted without a clear and open process, making it difficult for businesses and investors to anticipate political or legal changes that can adversely affect prospects. Escalating geopolitical tensions between the East and West might also undermine NIO's capacity for international expansion in the future.

Despite demonstrating strong Q4 deliveries, it is also important to understand the context by comparing NIO to the company's closest Chinese rival, Li Auto ( LI ). As shown below, NIO's Q4 and full-year delivery numbers are multiple times behind LI, and the YoY growth is also incomparable, even considering Li's much larger scale. That said, the competition from the closest rival is fierce, and there are also EV giants like BYD ( BYDDF ) and Tesla ( TSLA ). This means that there are substantial risks for NIO to lag behind the overall Chinese EV growth market over the long run.

Bottom line

To conclude, NIO is a "Strong Buy" now. Latest delivery figures suggest that strong earnings estimate upgrades are highly likely. This will likely be a strong positive catalyst for the stock price, especially considering the attractive valuation with substantial pessimism already priced in. Apart from the improving deliveries trajectory I also see several other positive developments, which will likely add optimism around the stock.

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