Shares of Chinese electric vehicle maker Nio (NYSE:NIO) have surged more than 30% this month despite a troubling first-quarter earnings report. And NIO stock is up 44% from its recent low, made 10 days ago.
Much of investors’ enthusiasm for NIO stock likely comes from the easing of Chinese Covid-19 restrictions and supply chain issues, as well as news this week that China will be taking steps to boost its manufacturing industry.
However, clear minds should prevail here, as demand issues could hamper any upside in NIO stock.
Demand Issues Are Surfacing
Shares of Chinese EV makers, including NIO stock, rallied this week, on news that China’s Ministry of Industry and Information Technology reportedly plans to implement “extraordinary growth policies” to support the country’s manufacturing industry.
Much of the downfall in Chinese EV stocks over the past year has been due to supply-chain concerns. However, the economy has shifted lately, and the auto sector is stuck with demand-side issues.
Providing substance to my claim is a recent statement by OL USA Chief Executive Officer Alan Baer: “Some industries are forecasting purchase order reductions of 20 to 30 percent, while others see no interruptions in their order flow. Overall, the risk appears to be to the downside. The decrease appears tied to economic uncertainty and not the migration of operations out of China.”
It’s easy to see why certain companies would aim to reduce inventory, and I base my claim on economic policies, as well as the interlinkages within our global economy. To elaborate, I’d like to use the U.S. Treasury yield curve as a reference point. The curve suggests that interest rates will rise for the next two years, subsequently eroding the spending power of the everyday consumer for the foreseeable future.
How does eroding U.S. spending power apply to China and NIO stock?
Despite rapid industrialization, China remains an exporting nation reliant on foreign consumers. Thus, China’s gross domestic product per capita will likely recede whenever areas such as the United States and the eurozone experience economic contractions. In addition, durable goods sales tend to fade whenever consumer spending power declines.
Nio’s Q1 Loss Widens
Nio delivered better-than-expected revenue and earnings when it announced first-quarter results earlier this month. However, while revenue was up 24% year over year to $1.56 billion, the loss of $281.2 million was much steeper than the year-ago loss of $68.8 million.
Nio’s deliveries were hit by coronavirus-related shutdowns in China, with the company delivering just 5,074 EVs in April and 7,024 in May.
Nio’s outlook also disappointed the Street. Management said it anticipates second-quarter revenue between $1.47 billion and $1.59 billion. Analysts had been calling for $1.74 billion.
Lastly, NIO’s gross margins are a continuing concern, as they retreated to 14.6% in Q1 from 19.5% the year before.
The Bottom Line on NIO Stock
Based on various data points, I see a company that doesn’t exhibit a pathway to economies of scale, leaving it with a mountain to climb during this challenging economic period.
In addition, NIO’s return on invested capital (ROIC) of -29.47% implies that it’s struggling to obtain further market share without underpricing its vehicles in the marketplace.
The latest surge in NIO stock probably isn’t warranted. Shares are severely overvalued, trading at nearly 6 times sales and more than 120 times cash flow.
NIO stock is a strong sell.
On the date of publication, Steve Booyens did not hold any position (either directly or indirectly) in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.