NIO - The End Of Free Battery Swaps: NIO's Pivot To Profitability Path

2023-11-07 22:53:58 ET

Summary

• Since receiving an investment from the Abu Dhabi government in June, NIO has seen several positive developments that have strengthened its financial position and outlook.
• NIO's monthly delivery volumes have rebounded to growth in the third and fourth quarters.
• NIO raised $1 billion to prevent it from bankruptcy.
• NIO's decision to discontinue the free battery swap program and implement cost-cutting measures has helped the company get back on track.

Turnaround after the Abu Dhabi Government's Investment in NIO

NIO ( NIO ) is likely to report its Q3 earnings On Nov 2023, according to Seeking Alpha. This pre-earnings review can serve as a guide for investors to evaluate NIO's recent progress heading into its upcoming earnings announcement. NIO is focusing on the high-end electric vehicle market in China and is not directly competing in the low-price electric vehicle market with strong peers such as Tesla and BYD. We believe the company still deserves investors' attention as it works to improve its profitability.

Since NIO received an investment from the Abu Dhabi government in June, we have observed several positive developments that have improved the company's financial position and outlook.

1. NIO's monthly delivery volumes have returned to growth in Q3 and Q4 after declining earlier in the year. This indicates recovering demand trends.
2. NIO raised $1 billion through a convertible bond issuance. This provides additional capital to fund operations and expansion plans.
3. The company is making cost-cutting efforts to improve efficiency and conserve cash.
4. NIO canceled its free battery swap program.

Overall, these four events are likely to have a positive impact on NIO's path to profitability and reduce the risk of bankruptcy in the near term. We will discuss further the potential impact on NIO in the following sections.

Monthly Delivery Trends

The company reported sequential improvement in monthly deliveries in Oct.

However, compared to its peers XPeng (XPEV) and Li Auto (LI), NIO's roller coaster ride in monthly deliveries seemed worrisome. NIO explained the reason for the peak in July as the result of their announcement of cancel free battery swap service for new car owners, hence potential buyers were rushing to buy before the promotion ended.

Ultimately, NIO's improved gross margin would result from its return to unit growth. Management expected its automotive gross margin to recover to 15% by Q4, after dropping to 6.2% in Q2 due to an unfavorable product mix shift.

along with our sales and volume ramp-up of our -- all our NT2 product, our target to achieve double-digit gross profit margin in Q3 and 15% in Q4"

Earlier this year, NIO launched more lower-priced vehicles, which reduced average selling price and margins. But with no new model launches planned for 2023, NIO expects margins to bounce back as production scales on existing models.

Financial Challenges and Convertible Bond Offering

A key reason NIO's stock dropped 17% YTD is that the company has consistently burnt through cash in recent quarters, averaging around $1 billion per quarter. This massive cash burn has raised concerns about NIO's financial stability.

Typically, if a company's cash position can only support about 12 months of operations, the market will start pricing the stock at distressed valuations. For NIO, it seemed to be approaching that scenario which could have triggered severe selling pressure.

However, NIO bought itself more time by completing a $1 billion convertible bond offering in early November. This capital injection provides NIO with more of a cash cushion as it works to reduce operating costs and losses.

While the convertible bond offering provides short-term relief, NIO will need to demonstrate improved execution in the coming quarters to regain investor confidence. Cutting costs, increasing margins, and boosting deliveries are all essential to stopping the cash burn and proving NIO's long-term viability against rivals.

Cancellation of the Free Battery Swap Program

NIO's decision to cancel its free battery-swapping program for new customers is likely a positive long-term move despite some initial criticism. While battery swapping has been touted as a competitive advantage for NIO, the reality is that it is more of an added convenience service rather than a true strategic asset.

The trend in unit sales indicates that the elimination of the free battery swap has little effect on unit sales. We assume that those who can purchase NIO don't really care to pay the additional cost for the battery replacement. Furthermore, we don't think battery swapping is a strategic advantage for NIO because its loyal customer base ought to be able to charge their own devices at home.

In fact, looking at NIO's vehicle delivery trends, the cancellation of free battery swapping has limited helped in boosting sales in July. This implies that the cancellation of the free battery swap service has not caused many potential customers of NIO's premium EVs to accelerate their purchase decision. For NIO's affluent customer base, paying extra for the flexibility of battery swapping appears to be acceptable. In fact, 50 % of NIO's clients reportedly own a charging station at home. Although NIO mentioned that the use of battery swaps has increased, we believe that the service's slow deployment speed has limited its ability to assist NIO in expanding its addressable market. Using NIO's own infrastructure as an example, as of October 2023, NIO had deployed 10,457 chargers but only 2079 battery swaps.

By ending free battery swaps, NIO will increase service revenues. Making this change sooner likely would have put NIO in a healthier financial position today.

Additional Cost-Cutting Efforts

On November 3rd, NIO recently announced additional cost-cutting measures, including laying off around 10% of its workforce. According to NIO, the layoffs will target non-performing teams and projects that failed to meet internal targets. By eliminating these underperforming areas, NIO aims to sharpen its focus and improve execution going forward.

If NIO can deliver on its gross margin recovery timeline while limiting operating expenses via layoffs and tighter spending, its financial position should improve markedly in coming quarters. Tighter execution and slowing cash burn would bolster confidence in NIO's turnaround plan.

Luxury Segment Market Share Position

During its recent Q2 earnings call, NIO's management claimed the company had achieved a 59% market share in the premium EV segment priced above RMB 300,000 (around $43,000) in China.

According to the retail statistics, in July, NIO was the best-selling brand in the premium electric vehicle segment with the transaction price of over RMB300,000, claiming a 59% market share.

According to Dongchedi's new energy vehicle sales rankings for July 2023, NIO's ES6 SUV model was the 10th best-selling EV priced over RMB 300k, with 11,118 units sold. This was below top sellers like Tesla's Model Y (23,632 units, #1 ranking), Li Auto's Li L7 (13,389 units), and BYD's Han (11,576 units).

On the surface, it appears NIO does not dominate the premium EV segment to the extent claimed on the earnings call. However, when looking at the competitive set, several conventional internal combustion engine models are also included in the same price bracket, such as the BMW 3-Series and Mercedes Benz E-Class sedans.

Given this wider competitive landscape, NIO maintaining a top 10 sales ranking among both EV and ICE models is still reasonably impressive. The company still holds its own against very strong competition from Tesla, BYD, and other EV startups targeting affluent Chinese consumers.

Valuation

NIO's target of restoring automotive gross margins to 15% by Q4 2023 would mark a significant turnaround after margins plunged to just 6.2% in Q2. However, 15% would still lag leading Chinese EV competitors like Li (19.9% gross margin in Q2 2023) and BYD (19.2% gross margin). NIO's overall profitability continues to be dragged down by losses in its service business.

While the recent addition of board members from NIO's Abu Dhabi government investor could potentially influence future strategy, the decision to cancel free battery swapping for new customers is an encouraging move toward service profitability.

NIO currently trades at a higher forward P/S ratio than Li Auto and BYD (BYDDF), but lower than highly-valued XPeng and Tesla (TSLA). Given NIO's weaker profitability outlook and competitive position, the stock does not appear cheap despite dropping 25% over the past year.

Excluding its battery-swapping network, NIO lacks major technological advantages relative to rivals. Tesla, Li, and BYD have superior margins and financial strength.

Conclusion

NIO has shown some positive signs of a turnaround in recent months after a turbulent period earlier in 2023.

The strategic investment and board representation from Abu Dhabi have coincided with reduced spending and prudent financial moves like ending free battery swaps. While early, these initiatives appear to be steps in the right direction toward profitability.

However, NIO still has work to do before it can be considered on par with leading rivals like Li, BYD, and Tesla who possess competitive advantages in technology, scale, branding, and execution. Reaching sustainable profitability, especially in its services segment, remains a key imperative.

Despite reaccelerating growth in Q3, we believe NIO's valuation looks full relative to peers given its weaker financial and competitive position. The risk of NIO's stock pricing in the distress scenario has receded somewhat after the recent convertible bond offering and cost optimization efforts. But uncertainties remain.

Considering the above risk and reward, we initiate a neutral rating on NIO. While the company appears to be making progress on its turnaround plan, more clarity is needed on the path to profitability and competitive differentiation before getting conclusively bullish. We will continue monitoring NIO's execution and financial results closely going forward to assess its investment potential.

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