Following a strong NIO (NIO) earnings report, management highlighted multiple short-term headwinds impacting NIO’s growth. The current chip shortage will retard vehicle production and deliveries in Q2. With weekly checks on the spot price of the auto chips, do not expect continued vehicle margin improvements in Q2. In fact, I choreograph for a small decline in vehicle margin in Q2, contingent on the chip situation.
The positive tailwinds for NIO are concentrated in the second half of 2021, as the chip situation ameliorates. Multiple long-term partnerships, including Metro AG and Sinopec infrastructure agreements and the NeoPark project, will improve margins for both vehicle and subscription services. NIO will likely continue to outperform luxury brands, including Audi, BMW, and Mercedes in the Chinese market, enjoying the combination of branding, cost, and continued EV subsidies. Taken together, NIO will continue its triple-digit improvements in revenue and high double-digit earnings growth.
Through this, we realize that the determining factor in NIO’s success is no longer a question of vehicle sales or production. Following in TSLA’s footsteps, with the blessing of the government in swap-tech, and with a clear market niche in the mind of management simplifies our job considerably. In fact, during the earnings call, William explicitly remarks that (paraphrasing) “The NIO brand will not be for the mass market.”
This significantly improves our valuation metrics and margin assumptions going forward. Away from the mass-market razor-thin margin, I began with Ferrari (NYSE: RACE) as a template for long-term COGS and Margin assumptions. NIO isn’t Ferrari, it will never be, I did not just copy-paste margin assumptions. Ferrari’s COGS is stable around 47-52% of revenue, SG&A at 10.5-9 long term, and R&D at ~20%. My assumptions for NIO go a bit lower, proxying for competitor brands like Benz, BMW, and Audi; therefore, COGS trends towards 65-60%, SG&A toward 10-9.5%, and R&D around the same. The argument for COGS not being higher is management guidance for high-take rates involving subscription services. Management has emphasized NIO not just being a car company, but also a service/lifestyle company (“We intend to directly our gains from the margin towards better products, better tech, and better service”).
This is the core issue currently at the heart of NIO, and I encourage you all to discuss and find out the future: It’s not selling vehicles, it’s building swap stations.
In the short term, noting NIO’s presence in a highly competitive market, with a past history of uncertainty, we assign a Terminal EPS of 20 and a discount rate of 10%, giving us a valuation of $50.85 fair price and appreciation potential of 33.96%.
In the midterm, we expect NIO’s EU expansion, Swap station deals, and chip issues all to be resolved, Quoting Graham/Dodd, “we disregard negative earnings as a quantitative measure of financial health, and only use it as a qualitative measure of company performance.” NIO has made significant improvements in EPS, and will likely continue to do so. Altering the probability weighing of our Bull, Bear, and Base cases to favor strong performance in Luxury EV markets also justifies a higher Terminal EPS valuation and a lower risk.
In the longer term, I strongly believe in the viability of BaaS, ADaaS, and the superiority of battery swapping in high-density urban sprawl markets; Tesla has its place in countries with similar suburban housing as the US, but markets in Pan-Asia and EU, with poor access to personal charging options, are better suited for battery swapping. In the future, NIO may support both Supercharging and Swap capabilities, lowering downtime overall; in either case, NIO’s unique presentation and positioning (NIO houses lol) will ensure strong brand stickiness and continuously improving margins (from services) as take-rate improves. Therefore, with a terminal EPS multiplier of 35 and discount rate of 9%, we have an appreciation potential of 151.54% and a 3-5 year target price of $160.