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Can NIO Pose a Serious Challenge to Tesla's China Presence?

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It seems that NIO Inc. NIO — touted as China’s Tesla (TSLA - Free Report) equivalent — has failed to live up to expectations. Electric vehicle (EV) startup Nio was talked up as a potential Tesla killer when it powered past its Chinese peers to make an IPO on NYSE last year. While NIO carries a Zacks Rank #3 (Hold), Tesla is a Zacks #2 (Buy) Ranked firm. You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

NIO’s unique selling proposition to provide EVs at competitive pricing has not been able to sustain the company as it is bearing the brunt of cost inefficiency. Since its IPO, the firm has tumbled roughly 64% as it is grappling with numerous challenges. While Elon Musk is accelerating Tesla’s China strategy with Shanghai Gigafactory, NIO recently appointed Wei Feng as new CFO amid financial struggles. It remains to be seen if NIO can weather financial crisis and make a comeback. However, we believe that it will be a tough task for Nio to rebound and challenge Tesla’s presence in China, at least in the near future. Let’s delve deeper.

Nio in Doldrums

Per Bloomberg, NIO has piled up more than $5 billion losses in just four years.In comparison, Tesla took almost 15 years to accumulate such losses. NIO has been navigating choppy waters since its listing and desperately needs a recharge to survive, as the competition in the EV market heats up in China.

As we know, NIO does not really manufacture its own cars. It contracts state-owned JAC Motors to make vehicles. In turn, JAC charges fee for every car. Due to its partnership with JAC, NIO generates lower margins than its peers that manufacture their own cars. While the company initially planned to construct its own manufacturing facility in Shanghai, it finally dropped the plan due to financing issues. As the company relies on JAC, there is not much scope to streamline manufacturing costs. On top of that, NIO does not have a dealership network and instead sells its vehicles through apps and a network of swanky NIO Houses, located in some of the most expensive areas of China’s largest cities.

Moreover, huge vehicle recalls are affecting the reliability and reputation of NIO, in addition to taking a toll on expenses and margins. In June, the company recalled around 5,000 ES8 electric SUVs after battery fires in China. Amid the recalls, the vehicle margin — a key metric to gauge how much a firm earns on each car it sells — plummeted to -24% in second-quarter 2019. Even excluding costs related to recalls, its vehicle margin was negative 4%. Despite falling deliveries and increasing loses in the second quarter of 2019, NIO has not outlined any long-term profitability path yet.

With the company bearing the brunt of high SG&A and R&D costs, gross margins are taking a hit. Hence, the discount at which NIO is selling cars is not a result of operational efficiencies. Instead, the firm is losing money on every sold vehicle. NIO’s sales-to-fixed asset ratio is one of the worst in the industry. This is particularly bad for a company that does not own assembly plants. The firm’s weak cash flow situation also alleviates problems. It raised $650 million through convertible bonds just a few months after its public listing. Recently, it raised another $200 million from Tencent Holdings through convertible notes.

Amid high overhead costs, the company has started slashing headcounts. However, even if NIO manages to trim costs and rev up deliveries, its path to profitability seems uncertain, given macro-economic headwinds in China and the reputational hit amid battery recalls.

Tesla Revs Up Expansion in China

In contrast to NIO that has been struggling amid headwinds, Tesla is making an aggressive push to China’s EV market. Tesla’s Gigafactory 3 in Shanghai will give the company access to the largest EV market on the planet. It will help Tesla to bypass tariffs and cut costs substantially. Gigafactory 3 is ahead of schedule, with cars appearing to be already out for delivery. In phase 1, the firm intends to produce 250,000 annually in Gigafactory 3 and eventually reach a capacity of 500,000 units. Tesla also intends to carry out after-sales network expansion in China by opening new repair and maintenance shops, along with charging stations in the country.

With the Gigafactory 3 being a significant catalyst for Tesla, it will become even more difficult for NIO to maintain strong margins, given its production rate and vehicle lineup.

Final Thoughts

China is battling an auto slowdown amid slowing economic growth, trade tensions with the United States and roll back of subsidies on new energy vehicles. In more than two decades, vehicle sales had slid for the first time in China in 2018 and the country’s car sales are likely to fall again this year amid macro-economic headwinds. China’s auto sales fell for the 16th consecutive month in October, with sales of new energy vehicles remaining a major concern, as the rate of decline for EVs has been increasing.

With the phasing out of subsidies, foreign carmakers are trying to make inroads into China’s EV market. While Ford F is revamping its product line in China, auto giants like Volkswagen, Toyota TM and Daimler AG are working to expand their market share in the country, thereby fueling up EV competition.

Amid such a macro-economic scenario, increased competition and NIO’s issues, we believe that the firm’s stock performance will remain muted in the near future.

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