EV Pair Trade: Sell Tesla, Buy NIO Stock

SpaceX Falcon-9 Rocket And Crew Dragon Capsule Launches From Cape Canaveral Sending Astronauts To The International Space Station

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Recently, I have a super bad feeling about Tesla, Inc. (NASDAQ:TSLA) due to several negative drivers impacting the company in the near or medium term. At the same time, NIO Inc. (NYSE:NIO), affectionately called the Tesla of China by some quarters, is rising like a phoenix following the reversal of cautiousness towards Chinese stocks and the passing of the lockdowns in China. Hence, I see a potential for a pair trade: ‘Buy’ NIO and ‘Sell’ TSLA.

I believe the majority of my followers on Seeking Alpha became acquainted with my writings on Chinese companies like Alibaba Group Holding Limited (BABA)(OTCPK:BABAF), JD.com Inc. (JD)(OTCPK:JDCMF), and Baidu, Inc. (BIDU). Long-time readers would appreciate that I ‘study’ China intently. My main coverage in the past couple of years has been Chinese American Depositary Receipts [ADRs] as I sought to provide an on-the-ground perspective enriched by my frequent travels to China (before the COVID-19 pandemic struck).

However, I started as a contributor on Seeking Alpha writing mainly about true blue American companies such as Tesla. Tesla: Wonders Of Crippleware, Tesla: Dispelling Misconceptions, and Shorting Tesla On Elon Musk’s Earnings Call ‘Tantrum’ Would Be A Mistake were among my first articles on the electric vehicle pioneer.

During my China trips, I would make efforts to visit Tesla retail fronts across the country (such as the one captured in the following photograph). Over the years, I continued to occasionally opine on TSLA such as in Tesla Stock Forecast: Who Will Be The Biggest Competitors By 2025 and Chinese EVs Are Making Tesla Look Cheap. In this article, I will lean heavily on Tesla’s and NIO’s China circumstances to explain the rationale of the pair trade.

Tesla Qingdao Showroom (Shandong, China)

Tesla Showroom (Shandong, China), (ALT Perspective (author’s photograph))

The Unsurmountable Second Quarter 2022 Output Shortfall At Tesla Shanghai

I felt compelled to revisit Tesla and NIO after a series of major developments from both companies. In particular, I believe the extended Shanghai lockdown is going to impact TSLA stock in a magnitude not well appreciated by Wall Street analysts yet. For the quarter ending June 2022, the consensus revenue estimate is currently $17.8 billion, representing a 48.7% year-on-year growth.

Tesla consensus revenue estimate changes

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This is down 1.5% and 8.6% from a month and three months ago, respectively. However, this is 1.0% higher than six months ago (late 2021), before the world knew China was prepared to strictly lockdown a metropolis with a population size between that of Florida (21.8 million) and Texas (29.5 million), or roughly three times as many as who lives in New York City. The mega city is a center for global transport, manufacturing, as well as finance and trade. Shanghai is home to the world’s busiest port and it accounted for 7.3% of China’s exports and 14.4% of imports in 2021. Its GDP is slightly more than Sweden’s $660.92 billion.

Most importantly, Shanghai is where Tesla situated its car-making in China and where the majority of its sales are. In April, Tesla’s China-made vehicular sales plunged like a rock. It sold a mere 1,152 cars from 65,814 cars in March. May saw sales roaring back but still less than half that of March’s numbers at 32,165 cars.

China-made Tesla Vehicle Monthly Sales

CnEVPost/CPCA

In the first quarter of 2022, China accounted for 25% of Tesla’s overall revenue and a total of 182,174 Made-in-China Tesla vehicles were sold. For the second quarter to match the prior quarter’s number, Tesla China would have to sell 148,497 vehicles. This is 2.45 times higher than March’s sales or 2.1 times higher than its all-time high of 70,847 achieved in December 2021.

Tesla China’s production is likely to be in a similar situation. Even if it is mechanically and logistically possible to catch up, it is going to come at a huge cost. In November last year, Tesla chief, Elon Musk, wrote in an employee memo that he didn’t want the company “spending heavily on expedite fees, overtime and temporary contractors just so that cars arrive in Q4.” Musk said that this is because historically, Tesla “sprint like crazy at [the] end of [the] quarter to maximize deliveries, but then deliveries drop massively in the first few weeks of the next quarter.” Over a six-month period, Tesla “won’t have delivered any extra cars, but we will have spent a lot of money and burned ourselves out to accelerate deliveries in the last two weeks of each quarter.”

In other words, Musk suggested that there is no such thing as “catch up on lost production.” The robotic arms should have already been programmed to operate as fast as they can pre-lockdown. The workers can only accelerate their efforts as fast as humanely and safely possible. Considering that they had already “sprinted” in December 2021 and March this year to accelerate output at the end of the quarter, it is unfathomable that a more than doubling in throughput can be achieved in June to close the wide gap.

Furthermore, we would be pinning our hopes on a team of workers who have been working, living, and sleeping on the same factory premises and away from their families since March. It was tough keeping sane while quarantined in a cozy hotel room for three weeks. It is hard to imagine how the folks in Tesla Shanghai would be able to cope with the working-living conditions and be pushed to do whatever they can to help the company achieve the numbers shareholders are expecting. Even if they could, would there be quality issues, and at what costs?

Hefty Revision Cuts To TSLA Stock By Analysts Are Forthcoming

Let’s assume the Chinese workers are willing and capable. What about the availability of parts from Tesla suppliers? In the first quarter of 2022 earnings call, Musk admitted “there are some parts that are sourced in China that apply worldwide. And that would be — that would impact production elsewhere.” He claimed that Tesla management “don’t think this is going to be a big deal.” Should shareholders find out the hard way when Tesla reports its second quarter earnings?

On 9 June 2022, NIO guided its second quarter total revenues to be between RMB9.340 billion ($1.47 billion) and RMB10.088 billion ($1.59 billion), representing an increase of approximately 10.6% to 19.4% year-on-year. This was substantially below the consensus expectation of $1.79 billion, representing year-on-year growth of 37.4%. 11 days later (at the time of writing), the revised consensus revenue estimate for NIO has fallen to $1.44 billion. This represents a year-on-year growth of 10.5%, even lower than the low end of the company guidance.

Consensus revenue estimate changes for NIO stock

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The conservative estimate suggests that analysts believe the executives of NIO had provided an overly optimistic forecast with just 21 days left before the end of the quarter. The latest consensus estimate is 32% and 33% lower than three months and six months ago, respectively. This contrasts with the 8.6% 3-month difference and 1.0% 6-month difference for Tesla.

Sure, NIO’s production is wholly in China, and the majority of its sales are from China. Tesla only has 25% of its sales from China as of the first quarter of 2022. However, we should not forget that Tesla is also pressured by the slowdown in economic activities in the U.S. and around the world. The slashing in the market valuations of tech companies and the swoon in the broader market has diminished the potential customer pool for the premium cars that Tesla sells. Elon Musk might have been looking at Tesla’s sales trends when he remarked earlier this month that he had a “super bad feeling” about the economic outlook.

TSLA bulls may point to the price raises announced in the past weeks that could bump the revenue numbers. However, it should be noted that the price hikes may also deter some buyers and potentially push them to lower-priced offerings from competitors. The strong U.S. dollar has a double whammy on Tesla. It makes its cars more expensive in local currencies and reduces the overseas contributions to the total revenue when foreign sales are converted to USD.

TSLA And NIO Stock Metric Comparison

Year-to-date, TSLA stock has underperformed NIO, falling 38.5% versus 34.4% for the latter. There appears to be more downside for TSLA considering its down trending pattern while NIO has achieved a bottom in May.

Tesla and Nio share price change

YCharts

Shareholders of both TSLA and NIO are still smiling to the bank with the returns at 14 times and 8 times, respectively, over the past three years. In early 2021, NIO shareholders saw the stock appreciate over 25 times, just behind the rise of TSLA in the same period.

Tesla and Nio share price change

YCharts

For those who prefer looking at the paper loss from the peak, Tesla is doing better on this front, down 46% based on enterprise value versus NIO’s 67%. NIO’s steep loss is, however, a recovery from the more hefty 81% plunge a few weeks ago. Investors who are thinking ‘enough is enough’ for TSLA’s decline should note that it had fallen over 58% in March 2020 off its then high.

Nio and Tesla enterprise value off highs

YCharts

Since Tesla Inc is such a mega cap, its 46% off the high of its enterprise value meant that $568 billion evaporated since the peak, which happened early this year. NIO hit a peak enterprise value of $91.4 billion and lost two-thirds of that to settle at $30.4 billion currently. While Cathie Wood’s ARK Invest (ARKK) has sold the majority of its Chinese ADRs, NIO remained, and she has continued to add.

It would take just a few more fund managers to take fancy on NIO and the stock gets pumped up with several billions of dollars. Similarly, we just need some TSLA shareholders who decide to diversify part of their holdings and reallocate the proceeds within the EV sector and into NIO to see a big jump in NIO’s market cap.

Tesla and Nio enterprise value (peak versus current)

YCharts

Looking at the past three years, NIO hit a peak price-to-sales ratio of 34 times in November 2020, three months ahead of TSLA’s peak (30 times) in January 2021. However, over a year later, the PS ratio of NIO has fallen to a mere 5.6 times, less than half that of TSLA’s 11.8 times.

Price to sales ratio of Tesla and NIO stock (PS ratio)

YCharts

When viewed from the price-to-book value metric, TSLA stock is trading at 19.8 times, more than triple that of NIO’s 6.5 times.

Price to book ratio of Nio and Tesla Inc (PB ratio)

YCharts

A very clear advantage Tesla Inc has over NIO Inc. is its positive and growing free cash flow, reaching $6.9 billion by the first quarter of 2022. NIO reported a negative free cash flow of $2.9 billion in the same quarter.

Free cash flow of Tesla and NIO (<a href='https://seekingalpha.com/symbol/FCF' title='First Commonwealth Financial Corporation'>FCF</a>)

YCharts

That glowing free cash flow of Tesla is thanks to the healthy spurt of cash from operations in the past two years. Meanwhile, NIO is struggling to grow its cash from operations.

Tesla and Nio cash from operations

YCharts

Nevertheless, to the credit of NIO, its cash and equivalents to market cap at 0.22 times is nearly 14 times that of Tesla’s 0.016 times. Notably, NIO’s prevailing ratio is higher than its historical average since its public listing, while Tesla’s ratio has been falling since the second half of 2019 and is now way below its four-year historical average.

Nio Inc and Tesla Inc cash and equivalents to market cap quarterly

YCharts

Tesla is also showing its superiority over NIO when viewed from the net income perspective. Tesla’s net income on a trailing-twelve-month basis is $8.4 billion, compared to NIO’s net loss of $1.2 billion.

Tesla and Nio Inc net income

YCharts

TSLA And NIO Stock Ratings

Under Seeking Alpha’s quant system, both TSLA and NIO are rated ‘Hold’, though TSLA has a higher score of 3.37 versus NIO’s 2.76. TSLA’s factor grades are also flashing green and just one red (F for valuation). It scored a respectable A+ for profitability, A for growth, A- for momentum, and B+ for revisions.

Tesla quant rating and factor grades

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In contrast, while NIO also scored an F for valuation, it has much worse grades than TSLA for the other factors. Other than an A- for growth, NIO scored C- for revisions, C+ for momentum, and D for profitability.

NIO stock quant rating and factor grades

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TSLA stock currently has a consensus price target of $920.35, representing a 44% upside from its last closing price of $650.28 (17 June 2022). At the consensus price target of $36.10, NIO stock has a 74% upside from its last closing price of $20.77 (17 June 2022).

TSLA and NIO stock price target upside

YCharts

NIO’s larger price upside may be deemed unrealistic, but it should be noted that Wall Street analysts have already revised their targets on NIO substantially. Year-to-date, NIO’s consensus price target has already fallen 39.8%, exceeding the 34.4% decline experienced by the stock itself. In contrast, the price target for TSLA is even 3.0% higher than at the beginning of the year, while the stock has tanked 38.5% over the same period.

TSLA and NIO stock price target changes

YCharts

The elevated price target for TSLA suggests analyst optimism for the EV leader. However, the consensus call for TSLA is only a ‘Buy’ with a score of 3.61, higher than Ford Motor’s (F) 3.42 (‘Hold’), but lower than NIO’s 4.52 (‘Strong Buy’). Warren Buffett-backed Chinese EV-maker BYD Company Limited (OTCPK:BYDDF)(OTCPK:BYDDY) has the highest score of all at 5.00 (‘Strong Buy’). The low score for TSLA could mean analysts aren’t all that bullish and price target revision downwards may be forthcoming.

Analyst Ratings History for TSLA, NIO, Ford and BYDDF

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Is NIO Stock A Better Buy Than TSLA?

Elon Musk has demonstrated his ability to “get things done” in several well-publicized circumstances, such as when he managed to keep Tesla going despite the company being days away from bankruptcy at one point years ago. So has William Li, the founder and CEO of NIO, who also brought the company out of the brink in the past.

NIO operates in a country that has been painted as having an authoritarian government and the recent “draconian” lockdowns imposed at will on even economically important cities like Shanghai and Guangzhou have raised the specter of business hardship should the “dynamic COVID-zero” policy cause further disruptions to manufacturers again in the second half of the year. However, Tesla faces the same challenge with its China plant.

Besides the output and sales losses from possible fresh lockdowns, Tesla bears have flagged the geopolitical risks facing the leading EV-maker with its Shanghai plant. Elon Musk may not be beholden to the Chinese government, but he could be forced to abandon Tesla China in the same fashion that McDonald’s (MCD) has exited from Russia due to political and consumer pressures.

The Biden administration and global Tesla car buyers may demand Musk to give up Tesla China citing national security or should the much-touted takeover of Taiwan by mainland China take place, culminating in a series of sanctions and businesses pulling out of the populous country. In mid-June, Wall Street Journal reported that bipartisan lawmakers are proposing new legislation to block U.S. investments “in countries like China seen as adversaries to protect U.S. technologies and rebuild critical supply chains.”

The nightmarish worst-case scenario of a full withdrawal from China for Tesla shareholders may be unlikely to happen, but if market players choose to hype up such concerns, sentiment on the stock would suffer. We have seen this happening for e-commerce and cloud giant Alibaba Group Holding, which led me to write Alibaba: There’s Always Something To Fear two months ago.

As a reminder, and for the uninitiated, Tesla’s Gigafactory Shanghai subsidiary was granted a beneficial income tax rate of 15% (compared to the 25% statutory corporate income tax rate in China) for 2019 through 2023. Tesla may not be able to get an extension. Tesla also needs to keep investing in China or face consequences.

For the land-use rights for Gigafactory Shanghai, Tesla is obligated to spend RMB 14.08 billion in capital expenditures by the end of 2023 and to generate RMB 2.23 billion of annual tax revenues starting at the end of 2023. If Tesla is “unwilling or unable to meet such target or obtain periodic project approvals, in accordance with the Chinese government’s standard terms for such arrangements,” Tesla would have to “revert the site to the local government and receive compensation for the remaining value of the land lease, buildings and fixtures.” Hence, there will be no easy exit for Tesla should geopolitical tensions demand it to do so.

Meanwhile, Elon Musk is distracted by the drama surrounding the proposed Twitter (TWTR) acquisition, sexual harassment allegations against the CEO, and autopilot issues. All these while managing his other businesses like SpaceX and The Boring Company.

On the contrary, William Li has kept himself out of the limelight and shrewdly avoided any political commentary. NIO’s strategy of relying on Battery as a Service (BaaS) has also been welcomed by the Chinese government. In April 2020, the authorities revised their New Energy Vehicle [NEV] policy such that EVs over RMB300,000 are eligible for subsidies only if they support battery swapping. The combination of BaaS and subsidies has helped to reduce the prices of NIO models considerably.

Counterpoint Technology, an industry researcher, believes that battery swapping is advantageous for NIO as it can obtain critical user data, including the frequency of battery change, and offer tailored services. Since the owners of NIO cars avoid any battery degradation cost, the car’s resale value is unaffected by the age and the condition of the battery. At the same time, they can upgrade to a more powerful battery pack or switch to a battery with the latest technologies. Rising awareness of such appeal would drive new buyers to NIO, supporting its revenue growth.

NIO stock jumped last Monday as market players eyed the coming launch of its fifth production model, the first SUV to run on its second-generation platform. Tesla could pull similar tricks, but investors are still eagerly anticipating the commercial rollout of its past previews such as Tesla Semi and Tesla Cybertruck.

Warnings about investment risks in Chinese stocks are aplenty. However, the “Great Wall of Worry” appears to be crumbling and institutional investors are increasingly vocal about getting back into the sector. Vincent Mortier, Amundi’s Chief Investment Officer, recently said that “to be underweight Chinese equities today is risky. It’s better to be overweight because medium-term, we think there is value.”

Finally, the long-anticipated Chinese homegrown mRNA vaccine trials are getting favorable results. Market players are expecting the eventual approval and the subsequent rollout to the Chinese population as a booster shot would drive bullish sentiment significantly due to the potential lifting of China’s strict COVID-zero policy. NIO, with sales predominantly in China, should benefit disproportionately compared to Tesla.

Hence, considering the multifaceted opportunities and challenges for both EV leaders mentioned in this article, and most importantly, the overly ‘punished’ estimates for NIO while analysts are seemingly still ‘sleeping’ on TSLA, I am calling for a ‘Buy’ for NIO and a ‘Sell’ for TSLA.

From the price chart, TSLA could weaken to the next support at around $590 before finding a stronger support at around $450. Many SaaS stocks touting artificial intelligence, automation, a futuristic outlook, etc. have seen their share prices fallen to early 2020 levels or lower. Hence, if the two illustrated supports fail to hold TSLA, it could fall to around $200.

TSLA share price chart with key supports

ALT Perspective

On the other hand, NIO stock could potentially rise to the price channel between $33 to $45. Taking the mid-point of $39, this represents an upside of around 72% from the close on June 21 ($22.66). If TSLA falls to $450 (the stronger support level), it represents a downside of around 37%. I anticipate a timeframe of 6 to 12 months for the pair trade to see maximum spread.

NIO share price chart with upside price channel

ALT Perspective

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