Chinese EV manufacturer NIO Limited (NIO) has lost its momentum this year, after witnessing a stellar rally in 2020 on investor optimism over the industry’s prospects. The stock has gained 353.4% over the past year but declined 22.4% last month. The company’s mixed fourth quarter financial results, released yesterday, combined with other headwinds have led to an 11.2% year-to-date decline for the stock.

This decline was long overdue we believe because the stock had been trading at dangerously high valuations over the past year. NIO’s trailing 12-month price/sales ratio of 29.36 is more than 2000% higher than the industry average 1.40.

Because the global EV bubble may burst in the near term, with investors increasingly adopting a fundamental approach to investing following surging market volatility over the past couple of months, we think NIO could retreat further.

Click here to checkout our Electric Vehicle Industry Report for 2021

Here’s what could shape NIO’s performance in the near term:

Global Semiconductor Shortage

A  rising demand for semiconductors globally due to their vast applications in automobiles, electronic devices and forthcoming  5G technology has been driving up prices. Simultaneously, the semiconductor manufacturing industry is dealing with supply expansion problems due to the  limited output capacity of production facilities.

The limited supply of semiconductors has placed  increasing pressure on EV  manufacturers worldwide, given the vital role of microchips in the functioning of EVs. NIO’s plans to venture out and develop autonomous vehicles have been curbed owing to the lack of availability of key materials. Also, the rising price of semiconductor microchips are  raising the overall cost of production for NIO, threatening its growth potential, which is based on its relatively cost-effective vehicle production model.

The rising tensions between China and Taiwan might also affect the latter’s semiconductor supply because Taiwan is home to  the largest semiconductor company in the world, Taiwan Semiconductor Manufacturing Limited (TMSC). In addition,  in December,  China’s domestic semiconductor company, Semiconductor Manufacturing International Corporation (SMIC), was placed on the U.S. government’s Entity List, which prohibits U.S. suppliers from trading with the company on national security grounds. . As a result, SMIC is no longer privy to American technology and software upon which it was highly dependent to develop its chips.

With the global semiconductor industry currently operating at full swing, new production facilities need to be developed to meet  elevated demand. These facilities take approximately  two years to build. Thus, the continuing shortage of microchip supply should act as a major hindrance  in the growth of EV companies such as NIO.

Declining Sales and Weak Profitability

NIO’s total revenues have increased 107.8% year-over-year to RMB16.26 billion in the fiscal year, ended December 31, 2020. While the company reported a gross profit of RMB1.87 billion over this period, its net profits and income from operations are still in the red. Its trailing 12-month gross profit margin of 11.52% is 65.8% lower than the industry average  33.71%, while its net income margin and ROE are negative.

Its EPS of negative $0.16 for the fourth quarter, ended December 31, 2020, is 128.6% lower than consensus estimates. Also, NIO has yet to generate adequate net profits, despite having a market capitalization of higher than $64 billion. Furthermore, despite reporting stellar gains in monthly vehicle deliveries over the past couple of months, the company’s trailing 12-month net operating cash flow is negative $97.92 million.

Premium Valuation

In terms of forward price/sales, NIO is currently trading at 12.15x, which is 831.2% higher than the industry average  1.30x. Its forward price/cash flow of 890.76x is nearly 6,000% higher than the industry average  14.66x. Also, the company’s forward ev/sales and price to book ratios of 13.19x and 18.43x, respectively,  are significantly higher than industry averages.

Unfavorable POWR Ratings

NIO has an overall rating of D, which equates to Sell in our proprietary POWR Ratings system. The POWR Ratings are calculated by considering 118 different factors, with each factor weighted to an optimal degree.

It has an F grade for Stability, and D for Value, Sentiment and Quality. This is justified, given the company’s bleak financials and profitability. The company has a beta of 2.79, reflecting high volatility, in sync with its Stability grade.

NIO is currently ranked #81 of 85 stocks in the D-rated China group. You can view additional POWR Ratings for Growth and Momentum here.

Click here to view top-rated stocks in the China group.

Bottom Line

NIO’s miraculous recovery  from the verge of bankruptcy following a nearly $1 billion government bailout in April last year caught investors’ attention worldwide , who dubbed NIO  the “Tesla of China.” While the company has reported impressive revenues and vehicle deliveries, its financials are way below its current valuation. With the global semiconductor shortage expected to slump its growth even further, we think NIO is best avoided now.

Click here to checkout our Electric Vehicle Industry Report for 2021

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NIO shares were trading at $43.82 per share on Wednesday morning, up $0.53 (+1.22%). Year-to-date, NIO has declined -10.09%, versus a 3.23% rise in the benchmark S&P 500 index during the same period.

About the Author: Aditi Ganguly

Aditi is an experienced content developer and financial writer who is passionate about helping investors understand the do’s and don'ts of investing. She has a keen interest in the stock market and has a fundamental approach when analyzing equities. More...

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