Morgan Stanley upgrades NIO to $33

(cnTechPost) – Following JP Morgan’s bullish report two weeks ago, another Wall Street firm Morgan Stanley also joined the ranks of updating their views on Chinese EV maker NIO (NYSE: NIO).

In a report titled “A strong EV leader in the making” published on October 28, Morgan Stanley analyst led by Tim Hsiao revised up forecasts on better-than-expected Q3 deliveries, upside potential to margin and an update of our assumptions behind NIO’s vehicle and long-term take rate of NOP.

The bank stays Overweight on NIO and raise our price target to $33, up by 61% from $20.5.

Morgan Stanley says ‘NIO is a strong EV leader in the making’, raises price target by 61%-cnTechPost
Morgan Stanley says ‘NIO is a strong EV leader in the making’, raises price target by 61%-cnTechPost

Here is the full report:

A strong EV leader in the making

We revise up our forecasts on better-than-expected 3Q deliveries, upside potential to margin and an update of our assumptions behind NIO’s vehicle and long-term take rate of NOP. We stay OW and raise our price target to US$33.

What’s changed?

Although we’ve been positive on NIO’s operational breakthrough, findings from data points since 2Q results and our recent EV trip suggest the pace of NIO’s progress in achieving its strategic and investment ambitions is tracking ahead of our expectations on all fronts.

Meanwhile, we believe the capital market’s willingness to finance NIO’s innovations and investments could unleash more operational upside in the next 18-24 months.

Mastering the art of versatility.

While competition is set to become more intense in 2021 given the increasing numbers of players and products coming to China’s EV market, we believe it will be difficult for incumbent EV peers and new entrants in China to easily replicate NIO’s multifaceted strategies.

We look for NIO to reinforce its pole position through superior volume scale, good spectrum of model/market coverage, self-driving technologies and diversification into power solutions.

In our view, most of its key EV competitors in China can compete with NIO in some but not all of these areas.

NIO’s versatility should give it an advantage in gaining market share in China’s auto market.

Navigate on Pilot (NOP) puts NIO a big step ahead of domestic EV players, enabling navigation ADAS on designated roads, mostly highways for now.

While ADAS offered by most EV players (both start-ups and traditional OEMs) still provide individual functions such as Adaptive Cruise Control (ACC),Lane Keeping Assist (LKA), Auto Lane Change (ALC), Auto Parking,etc., NIO will soon offer an integrated ADAS solution (available for FOTA upgrade in October), that can take people from one place to another.

This feature will make NIO the second globally, and the first among Chinese EV makers, to possess and commercialize Navigation ADAS after the introduction of Navigation on Autopilot (NOA) by Tesla in 2018.

Remain OW with a new price target of US$33.

We raise our earnings forecast and price target, driven mainly by stronger sales momentum and a more visible growth outlook. Our new price target implies 2021e EV/sales of 10x for NIO Inc (or 13.1x EV/sales reflecting 76% holding in NIO China).

Mastering the art of versatility

Vehicle sales to see stronger volume uptake

We look for stronger volume uptake for the remainder of the year with escalating momentum into 2021. While we’ve been upbeat on NIO’s volume outlook, some key findings make us incrementally constructive on the volume outlook.

Better-than-expected demand for EC6 – Previously, we saw NIO’s coupe SUV EC6 as a window-dressing product to its flagship ES6. However, our recent EV trip and channel checks suggest that demand for EC6 has surprised on the upside.

According to feedback from our meetings with regional sales head and stores, EC6 caters well to a sizable group of young people, and consumers who place orders now won’t get the car till early 2021, implying a longer waiting time than other EV models.

Sweet spot of Rmb200-300k segment – For the EV camp to capture users from ICE vehicles; NIO’s 4th model is competitively positioned: Stronger 3Q sales stats of EV sedan models priced at Rmb200-300k make us more bullish on NIO’s upcoming 4th model.3Q sales volume of sub-Rmb300k EV models, like Tesla’s M3, BYD’s Han and Xpeng’s P7,etc.all show solid uptrend.

We expect more users to switch from ICE to EV in this pricing segment, in which EV models can offer richer hard-/software features to differentiate from ICE; meanwhile, our recent talks with the supply chain indicated that consumers seeking sub-Rmb300k models are still price sensitive,a nd so the waiver of purchase tax, subsidy and license plates remains important.

The long-awaited debut of NIO’s 4th model is currently scheduled for January 9, 2021 during its annual NIO Day.

Despite the lack of pricing details of NIO’s upcoming model, we think it likely that it will be priced in the Rmb200-300k range.

Stronger geographical presence – Our analysis of registration stats in 3Q suggests NIO has further enhanced its presence in non-license restriction cities.

Compared to its peers that have sales largely coming from plate-restricted cities, NIO has much more diversified sales distribution.

We believe broader market coverage will make NIO’s growth momentum more sustainable and scalable into 2021.Looking ahead, its long established presence in low-tier cities should also ensure NIO’s long-term growth trajectory even after EV sales in plate restricted cities become saturated.

Broader spectrum of model coverage – With the debut of the aforementioned sedan model in early January 2021, NIO is likely to be the first major domestic EV player to offer a full spectrum of EV models, including sedan (expected be introduced during 2020 NIO day)/mid-SUV/coupe/large-SUV with prices ranging from high Rmb200k to Rmb600k.

Although this should be well anticipated by the market, we think the upside of market potential might still be underestimated by the market.

EV models priced below Rmb200k have been the key driver of industry growth in the past five years, we think Rmb200-400k EV models will become the key growth engine in the next five years, and NIO should have greater consumer access backed by its competitive branding and prestige-to-masstige product strategy.

Vehicle autonomy demonstrates more aggressive inroads

Previously, we expected NIO to be taking a more conservative strategy in SAE L3 autonomous system to ensure a quality user experience, which would put it in a more passive position when competing in self-driving capability vs. peers.

Instead, NIO has kick-started the autopilot arm race with the launch of new NOP features that puts it a big step ahead of domestic EV peers by enabling navigation ADAS on designated roads, mostly highways for now.

While ADAS offered by most EV players (both start-ups and traditional OEMs) still provide individual functions such as Adaptive Cruise Control (ACC), Lane Keeping Assist (LKA), Auto Lane Change (ALC), Auto Parking,etc., NIO will soon offer an integrated ADAS solution (available for FOTA upgrade in October), that can take people from one place to another.

This feature will make NIO the second globally and the first among Chinese EV makers, to possess and commercialize Navigation ADAS after the introduction of Navigation on Autopilot (NOA) by Tesla in 2018.Favorable fleet size with shadow mode should further enhance NIO’s self-driving capability, in our view.

Separately, according to a recent report from Gasgoo, NIO plans to develop its own autonomous driving chips, similar to what Tesla is doing now. Although the plan, if accurate, should still be at the nascent stage, it would mean that we’d have to reevaluate NIO’s autonomous driving strategy and competitive landscape among EV startups.

While developing chips could be a pricey and somewhat distractive move for EV players like NIO, Tesla’s success in this area could be a strong reference that autonomous driving chips could act as a silver bullet for self-driving race.

Why do we think this is critical and relevant? While it’s still early to look for meaningful revenue contribution from software/service, we believe the high-profile launch of its SAE L3autonomous features and comparison to Tesla will help NIO gain traction with the public and its potential consumers.

The impression of leadership in autonomous driving would continue to occupy growing mind share and discussion with the public, the media and the investment community. We see this as critical to further enhance its vehicle sales, user experience and value proposition over time. We now look for on average 50% of users across models to activate the NOP function with true differentiated features, which may generate recurring/software related service revenue for NIO in the long run.

Power solutions receive stronger industry endorsement

As one of the pioneers commercializing battery swapping and BaaS later on, NIO’s charging/power solutions have invited a lot of debates from day one. However, as we highlighted in our previous note, we value the successful commercialization of the battery swapping/platform even more, which would further demonstrate NIO’s bellwether role in the EV realm.

Growing adoption of battery swapping by EV makers make it a strong case.

Lately, Dongfeng Motors and Geely both announced further progress in their battery swap plans. Although the prevalence of battery swapping or BaaS might not all follow NIO’s standards nor directly benefit the company, the tendency would again put NIO in a commanding position to attract more government support.

In addition, management guided for an accelerated deployment plan of its 2nd generation battery swap station (halved capex to Rmb1mn per station) with one for each day in 2021, on top of a possible 160-170 stations by end-2020, implying a total of 500+ swap stations by 2021 year-end, further driving wider adoption of the company’s BaaS plan with more accessible infrastructure support.

NIO also announced its Power Up Plan during the Beijing Auto Show, planning to deploy another 30,000+ destination charging piles in co-operation with other partners, and providing a subsidy of Rmb1000/year/pile for a total of 3years. The infrastructure subsidy move, which is normally a government responsibility, demonstrates NIO’s determination to further optimize the customer experience and push the industry forward, in our view.

Where we could be wrong?

Deteriorating market sentiment: NIO, like most EV start-ups, is not yet in an internally self-funding position and needs to raise capital on a regular basis. A strong share price would enhance its access to funding, in our view, underpinning its operations and investment value.

As highlighted in our investment thesis, the wind is currently in its sails and will create self-reinforcing momentum to NIO’s development.

However, market sentiment is quite volatile and the self-reinforcing trend could also turn should the market’s risk appetite for EV start-ups fade. This is evidenced by US$1.19-29.4 swing in NIO’s stock price over the past 12 months.

Muted recovery of China’s EV market: While we expect leading EV start-ups, like NIO, could outgrow the industry, a sluggish EV market would undermine the growth prospects and encourage more aggressive pricing competition among major EV players, including both start-ups and traditional OEMs.

Re-escalating concern over US listing risk: Investors are still concerned about US moves to tighten regulations further for Chinese listed stocks. Further escalating US-China tension and introduction of tightening measures, if any, could curb the market’s investment appetite for China ADRs and lead to greater stock volatility.

New models fail to lend extra volume impetus: Our base case models ~90-120% YoY volume growth for NIO in 2021-22e. The volume upside can’t be bolstered by a single product but depends on solid growth of a full model line-up in the upcoming year.

ES6 has proven itself as a successful volume model, while EC6, ES8 and the sedan to be launched have yet to. To achieve 100k volume sales, NIO would need at least two models that can register 3-4k monthly sales, for which the next sedan model targeting 2021 launch would be crucial.

Too much on the plate: We like and appreciate NIO’s several initiatives, like BaaS, user oriented events, NIO Pilot self-driving upgrade, potential overseas inroads, etc., which would enhance its pole position in China’s EV realm.

However, its ambitions in hard- /software development as well as defining industry standards in the EV ecosystem will require immense effort and investments, which would occupy a lot of NIO’s resources.

Although NIO is now financially solid after several rounds of fund raising, the strategy will still be challenging and needs quality execution.

Changes to Estimates and Price Target

We factor in the following in our base case DCF model:

Our base case DCF-derived price target rises to US$33, implying 16% upside potential for the stock. Our new price target implies 2021E EV/sales of 13x for NIO Inc, representing 10x EV/sales for NIO China (which is 76% owned by NIO Inc. – the ListCo).

For our bull case, we incorporate 20%/10% growth in total volume and ASP, as well as an additional 2ppts expansion in gross margin from 2020E.

The volume growth would imply 102k units of vehicle sales vs. our current forecast of 85k units in the base case in 2021E;volume upside reflects mainly the better sales of EC6, ES8 and the new sedan model, which enable NIO’s spectrum of market coverage.

The favorable mix of vehicle models, as well as incremental contribution from software sales also bodes well for NIO’s ASP as well as gross margin in the forecast period.

In our bear case, we assume 30%/20% decline in volume and ASP, as well as a 4ppts contraction in gross margin from 2020E.

This suggests 59.5k units of vehicle sales in 2021E, on weaker industry demand and market share loss with much lower shipments by NIO, which would be more vulnerable to industry volatility, if any. Tougher industry backdrop might impair sales of NIO’s flagship model ES8 more and thus bring ASP down.

More significant contraction in vehicles’ gross margin reflects both the operating deleverage caused by inferior scale and unfavorable sales mix shift to cheaper models against a tough macro backdrop.

Our bull and bear case values are US$46 and US$17, respectively.

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