Although U.S. investors understand the high upside potential of the electric vehicle (EV) market in China, the stock of NIO (NIO -3.35%), a Chinese EV manufacturer, has been out of favor since early 2021. In a terrible macroeconomic environment, investors have little interest in investing in many Chinese companies.
However, with a brightening Chinese economic outlook and the expectation that Nio's business will improve, the question is whether you should buy the stock or give this high-risk business a hard pass.
Why investors are wary of investing in NIO
NIO is an early-stage EV manufacturer battling significant headwinds from China's zero-COVID policies, supply chain disruptions, competition, a slowing economy, and the Chinese government's crackdown on private companies. In addition, most investors know that plenty of promising start-up auto manufacturers have wound up in the dustbin of history. In recent history, Fisker Automotive, Aptera, Faraday Future, Dyson EV, and Nikola Motor have gone down in flames.
Investors have also been cautious about investing in China since the late 2000s, when many China-based corporations entered the U.S. market through a reverse merger process. Unfortunately, many of those companies were frauds and cost investors significant funds between 2009 and 2012. Consequently, because of the high risk of investing in China-based companies, most U.S. investors will assign a Chinese investment like NIO a considerable discount to comparable U.S. investments.
Of course, NIO's heavy net income losses since it entered the U.S. market have likely inspired little confidence in the company. Plus, investors were displeased that gross margins in the third quarter of 2022 dropped to 13.3% from 20.3% in the third quarter of the previous year.
NIO Net Income (TTM) data by YCharts
Considering the numerous risks, there have been very few reasons to invest in this company over the last two years.
Significant long-term growth potential
The current CEO, William Li, founded NIO in 2014 and established it as one of the first Chinese-owned companies in the premium EV market. Potential shareholders should consider four things before investing.
First, it has numerous home-court advantages in China against foreign EV manufacturers, from understanding local customer preferences to having access to local industry expertise. Additionally, Beijing has made it more difficult for foreign companies to operate in China.
Second, NIO was among the first teams to compete in the ABB FIA Formula E Championship, and it actually won one of the first championships in 2015. The company eventually parlayed its involvement with Formula E into establishing a premium brand image in the Chinese market. NIO's premium branding means it can often set a higher purchase price than a competing brand for an equivalent EV -- it has pricing power.
Third, NIO is a leader in battery swap technology, which enables drivers to change to a fully charged battery in three minutes, alleviating drivers' worry about the EV range. Should NIO succeed in making battery-swapping technology mainstream, it could eventually threaten major car charging networks and differentiate the company as an EV manufacturer.
Last, China is the largest EV market in the world. Market research company Statista estimates the Chinese EV market will achieve 190.40 billion in 2023, growing at a compound average growth rate of 14.18% between 2023 and 2027. Suppose that is accurate; NIO would then have a little over 3% of Chinese market share and be in the perfect position to establish itself among the leading Chinese manufacturers.
Its fortunes should change in 2023
If you are bullish on NIO, you should expect deliveries and revenue to increase in 2023 in line with the Chinese economy, which many economic experts expect will rebound significantly after the winding down of the country's stringent zero-COVID policies at the end of 2022. For instance, Standard Chartered chairman José Viñals said to CNBC at Davos that China's economy would be "on fire" in the second half of 2023.
Another positive for NIO is that management believes it can achieve breakeven by the third quarter of 2023. Even better, many U.S. auto analysts believe the company will start generating profits in 2024, which would be huge.
If investors see this company progress toward profitability, the stock will likely rise significantly, especially considering the valuation.
NIO PS Ratio data by YCharts
Currently, the stock trades at a price-to-sales ratio of 3, slightly higher than before the pandemic. Suppose you are a risk-tolerant investor who believes that better days are ahead for NIO in 2023; considering the company's enormous upside, today is a great day to invest in the stock.
