Image source: Sam Robson, The Motley Fool UK
This year has started badly for the shareholders of the electric vehicle manufacturer CHILD (NYSE: NIO). NIO shares have fallen 31% since the beginning of last month. In five years, it has dropped 42%.
But, with a market capitalization of $12 billion even after the crash, NIO still has a considerable presence in the stock market. So, should I take advantage of the much lower price to buy some shares for my portfolio?
Can NIO prosper?
The first question I ask as an investor when considering the potential earnings of a stock is what I think the long-term prospects of the business are.
That's not the only thing that matters: the valuation is too. But unless the business looks like it's going somewhere good, I won't even bother considering its valuation.
The electric vehicle market is already large and I expect it to grow substantially in the coming years. This offers an opportunity for NIO, although it also means it is fighting for market share with a number of competitors such as tesla. That risks squeezing profit margins, something that has already been weighing on Tesla's profits.
NIO has some advantages: its premium brand is one of them and so is its battery swapping technology. In fact, I think that helps overcome a barrier some drivers have when it comes to purchasing an electric vehicle: range.
In the most recent reported quarter, NIO deliveries increased 75% compared to the prior-year quarter, topping 55,000.
It has the makings of a substantial business as far as revenue is concerned. But what about the profits?
Profitability concerns
The earnings outlook is where questions about the business model really arise, something I think helps explain the downward momentum in NIO's share price recently.
Last year, the company lost $2.1 billion. That wasn't its worst performance ever (it lost $3.4 billion in 2018, for example), but it's a substantially worse bottom line than the previous year. The company, which generates serial losses, continues to shed red numbers. For six consecutive years, it has lost at least $700 million a year.
For now I have no liquidity concerns. NIO had about $6.2 billion in cash and cash equivalents at the end of September. That's enough for now, although I see the risk that at some point the company will dilute existing shareholders to shore up its balance sheet.
What worries me as a potential investor is: where (if anywhere) will the red ink end up?
Looking for more signs of money-making potential
Tesla lost billions of dollars before going into the black.
Automobile assembly is a very expensive business and NIO remains at the stage where it is making investments to boost the business.
But its business model has not yet proven that it can be profitable. The electric vehicle industry is increasingly saturated, putting pressure on sales prices and profit margins.
If this continues, which I believe it will, NIO could move further and no closer to profitability. That has been the case in recent years.
If the company moves toward profitability, I think NIO's current share price could look like a bargain. But for now, I would like to see more evidence of a proven, profitable business model before considering investing.
