NIO: Improving Setup (Rating Upgrade)

Chinese electric vehicle makers have seen a strong rebound in delivery volumes in the third-quarter, indicating that the demand situation in China is improving and pent-up demand is being unleashed from which companies like NIO (NYSE:NIO), XPeng (XPEV) and Li Auto (LI) are benefiting. While Li Auto is still crushing it in terms of deliveries with considerable momentum in both August and September, NIO and XPeng posted smaller growth rates… but the momentum is back here, too. Growing delivery momentum could also bode well for NIO's vehicle margins in the third and fourth-quarter.

NIO also recently completed a $1.0B convertible senior notes offering, alleviating concerns over the company's cash burn. With deliveries soaring and the share price being down, I believe the risk profile has greatly improved lately and I am adding NIO back to my strong buy list!

Previous rating

Since I last covered NIO a number of things have changed: (1) NIO's delivery growth is showing signs of reinvigoration, (2) the demand situation appears to improve and (3) NIO has addressed concerns over its cash burn by successfully completing a convertible notes offering at the end of September. The strong increase in deliveries, especially in the last two months, could also foreshadow a gradual improvement in vehicle margins in the second half of the year. Together with a drastic decline in market cap since August, shares are now looking too attractive to ignore.

NIO's delivery momentum is back

NIO and XPeng, both laggards with regard to delivery growth relative to Li Auto, have seen a robust resurgence of delivery growth in the last couple of months. NIO delivered 15,641 electric vehicles in September, showing 43.8% growth. XPeng managed to also deliver more than 15 thousand EVs to customers, showing 81% growth year over year. Li Auto is still out-performing its EV rivals: the EV start-up delivered more than twice as many electric vehicles as either NIO and XPeng. The strength in delivery numbers in the last two months especially is the result of pent-up demand being unleashed in China and EV companies rolling out newer models.

(Source: Author)

Strength in SUVs

Interestingly, most recent delivery gains made by NIO were driven by the SUV-portion of NIO's portfolio. While in the last one and a half years, NIO did especially well in the sedan category, the company most recently experienced an upsurge in deliveries in the sport utility vehicle category: NIO sold 4,137 sedans in September compared to 7,314 sedans in July, showing a decline of 43% month over month. The growth in SUV deliveries is encouraging, but the company recently prioritized sedan production in order to diversify and tap into a new segment of emerging demand in the EV market.

(Source: Author)

$1.0B convertible senior notes offering

EV companies are turning increasingly towards convertible debt offerings to raise capital in order to finance the ramp of electric vehicle production. At the end of September, NIO completed a capital offering, including $500M in convertible senior notes due 2029 and $500M in convertible senior notes due 2030. Rivian Automotive (RIVN) also just announced that it would raise $1.5B (+$225M option) from private shareholders in order to raise enough cash to ensure the production ramp of the R1T and R1S.

NIO is using the proceeds to repurchase other outstanding convertible senior notes: the company purchased $256M of convertible senior notes due 2026 and approximately $244M of convertible senior notes due 2027. The remaining $500M will be used to improve NIO's balance sheet and finance the production of a number of electric vehicle models, including the new EC6 coupe sport utility vehicle. The convertible debt raise helps the company to stem its cash burn as NIO is still losing a ton of money on its EV business.

NIO's valuation vs. Chinese EV rivals

NIO is currently the cheapest of the three Chinese EV start-ups and shares, following the consolidation that started back in August, is now trading at a 24% discount to its 1-year average P/S ratio. NIO is valued at 1.15X forward revenues and could trade at the same multiplier factor as XPeng (currently 2.05X). Li Auto, on the other hand, would be truly deserving of a premium valuation factor given that the company continues to be an out-performer.

Risks with NIO

The biggest risk for NIO remains the margin situation. NIO's vehicle margins saw massive pressure earlier this year (a combination of weakening pricing power and headwinds to demand). If vehicle margins remain in the single digits (they were just 6.2% in Q2'23) and deteriorate going forward, I would consider this to be a serious headwind for NIO's financials, operating performance and valuation. With regard to vehicle margins, however, I see surprise potential for NIO's upcoming Q3 report.

Final thoughts

Given the resurgence of delivery momentum, not just for NIO, but across the board, I believe NIO is in a much stronger position than it was in just in the second-quarter. NIO's soaring delivery growth also indicates that the EV start-up has the potential to report an improvement in its vehicle margins in Q3 and Q4. Since NIO also managed to raise additional capital to bankroll the production ramp of new EV models, alleviating concerns over cash burn and high operating losses, I believe the EV company has an improving setup and, following the valuation drawdown since August, a much more compelling valuation: I am upgrading NIO to my strong buy list again!