NIO, Xpeng, and Li Auto Are Not the Next Tesla. Why It’s Time to Unplug From Chinese EV Stocks

Electric vehicles are the future of the auto industry, so it’s no surprise they have captured Wall Street’s imagination, especially in this pandemic-plagued year when so many other businesses are starved for growth.

Consider the rise in the American depositary receipts of three Chinese EV companies—Nio, XPeng, and Li Auto.XPeng’sADRs (ticker: XPEV) have tripled, to a recent $44.52, since the company’s Aug. 27 initial public offering, whileLi Auto(LI) is up 180%, to $32, from its July 30 IPO. ButNIO(NIO), which came public in September 2018, puts both to shame: Its ADRs are up nearly 600%, to $44, spurred by Chinese state subsidies, falling battery costs, and a rebound in car sales in China.

It can be hard to part with a stock after such enormous gains, but taking profits in the Chinese EV trio looks like the prudent thing to do. First, all three are richly valued: XPeng trades for more than 15 times 2021 estimated sales. NIO fetches 11 times sales, and Li, about 10 times sales. None will have substantial profits for at least a couple more years.

The Chinese EV companies also face several industry, government, and market risks. Chinese state subsidies are falling and could expire, while EV competition is growing in China. Moreover, a recent bill passed by Congress to delist Chinese companies whose accounting practices don’t measure up to U.S. standards could put an unwelcome focus on these companies’ bookkeeping. (See“Delisting Chinese Companies Could Be Bad for Investors. But It’s the Right Thing to Do.”.)

Then there’s the promise of imminent Covid vaccines, which could hasten the market’s rotation away from high-flying growth stocks and into the beaten-down shares of companies hurt most by the virus’ spread and the global economy’s struggles. That shift began last month, and many market strategists expect it to gather momentum in 2021.

A growing awareness of the risks has clipped the shares of NIO, XPeng, and Li by an average of 30% since late November. But more losses could be in store.

Looking for the Next TeslaInvestors have sky-high hopes for three U.S.-traded Chinese EV makers.

*Since August 27 IPO. ** Since July 30 IPO. EV=Enterprise Value; E=Estimate.

Sources: Bloomberg; FactSet

Motivated by environmental concerns, China has said it wants battery-operated vehicles to total 50% of all vehicles sold in the country by 2035. That’s up from about 5% this year. To accelerate EV adoption, Beijing has ladled out subsidies that total up to 30% of a vehicle’s cost. The government offers subsidies to consumers and Chinese auto manufacturers. It also provides infrastructure support and zero-emission-regulator credit programs, similar to those that benefitTesla(TSLA), the U.S. EV leader.

While all three U.S.-traded Chinese EV companies seek to capitalize on the country’s push toward electrification, each has its own strategy. Shanghai-based NIO, the largest in vehicle sales, will sell an EV without a battery, which it then leases to the car buyer for about $140 a month. That includes six monthly battery swaps at NIO-owned service stations, good for about 1,500 miles of driving. Separating the car and battery purchases makes the cars cheaper, and thus more attractive to buyers.

NIO delivered 36,721 vehicles year-to-date, up 111% compared with 2019. The company has sold approximately 69,000 vehicles since its founding in 2014. Like XPeng and Li, NIO sells only in China, although NIO and XPeng plans to sell cars abroad in the future. The company has three models; its best-selling ES6 premium sport-utility vehicle retails for just under $60,000, before subsidies. NIO rang up sales of about $1.8 billion in the past 12 months; analysts see revenue reaching $4.6 billion in 2021.

Li Auto, founded in 2015, sells cars with a gasoline generator that can recharge the battery when a plug isn’t available. The Li ONE SUV, the company’s only model, sells for 328,000 yuan or $50,000 before subsidies. Beijing-based Li began shipping late last year; it has delivered 26,498 so far in 2020. The company generated about $775 million in sales in the past year. Analysts project sales of $2.7 billion in 2021.

XPeng, headquartered in Guangzhou, sells a sedan and an SUV, and has invested heavily in autonomous driving technology. The company hosted an event in China in October where it compared its self-driving solutions to those of Tesla, a pioneer in the field.

XPeng, founded in 2014, has delivered 21,341 vehicles year-to-date, up 87% from last year. The company’s G3 SUV sells for about $25,000 before subsidies, and its P7 luxury sedan retails for about $50,000. Revenue is expected to reach $2.1 billion next year, up 300% from about $530 million in the past 12 months.

ILLUSTRATION BY HARRY CAMPBELL

As these numbers imply, the gains in Chinese EV stocks aren’t entirely undeserved. In upgrading NIO from Sell to Neutral earlier this month, Goldman Sachs analyst Fei Fang explained what he had gotten wrong about the Chinese EV landscape. Penetration has been much faster than expected: Fang now expects EVs to account for 20% of new car sales in China in 2025, up from 5% in 2020, hitting the higher mark four years earlier than he had anticipated.

NIO is expected to turn profitable in 2022 and earn 79 cents a share in 2023. XPeng is likely to lose money in 2022; Li could make 20 cents a share.

Visions of higher profits—and comparisons with Tesla, which fetches 117 times 2022 estimated earnings—have helped stoke investor enthusiasm for Chinese EV stocks, which now sport market capitalizations approaching those of traditional auto makers. NIO is valued at about $58 billion; XPeng, at $35 billion; and Li at $28 billion.

General Motors(GM) has a market cap of $61 billion, andFord Motor’s(F) is $36 billion. GM, Ford, and Fiat Chrysler Automobiles(FCAU) together sell more than 17 million vehicles a year. XPeng, NIO, and Li might crack 100,000 in 2020.

NIO declined to comment on the stock’s ascent or its valuation, although Rui Chen, director of investor relations, says, “We are encouraged by our momentum and [the] positive progress of our fundamentals.”

XPeng declined to make executives available for this story, and Li didn’t respond toBarron’semails and calls.

High valuations aren’t a reason to sell a stock—just ask anyone who bet against Tesla, whose shares have soared about 650% this year. But China’s EV upstarts face potential risks that don’t appear to be factored into their stock prices. Subsidies, for instance, were due to be cut in 2020, until the pandemic hit. With vehicle sales plummeting 79% in February from a year earlier, the government reversed course and extended EV subsidies, helping sales revive.

Subsidy cuts aren’t off the table, however. Direct-purchase subsidies are expected to fall 10%, 20%, and 30%, respectively, over each of the next three years from 2019 levels, according to XPeng’s regulatory filings.

Competition also is heating up. NIO, XPeng, and Li are selling everything they can build and trying to ramp up production, but their inability to do so quickly enough could leave an opening for other auto makers. BYD(1211.Hong Kong), already a large player in China, is planning new EVs for the Chinese market in 2021, as are GM, Volkswagen(VOW3.Germany), and BMW(BMW.Germany), among others.

China is also a critical market for Tesla, which sold about 22,000 Model 3 sedans there in November, and just received approval to sell its Chinese-built Model Y crossover. The company’s China operations are worth around $100 billion, according to Wedbush analyst Dan Ives. That’s enough to make Tesla China the third-most-valuable auto maker in the world. Based on its total market value of $578 billion, Tesla is the world’s most richly valued car company.

In downgrading XPeng stock on Dec. 3 from Buy to the equivalent of Hold, UBS analyst Paul Gong cited the possibility of “intensified headwinds faced by [the] XPeng P7 in light of Tesla Model Y launches and BYD Han’s competitive pricing in the larger-size segment.”

Gong puts XPeng’s “fundamental” value at $40 a share, based on a discounted cash-flow analysis. But his stock-price target, $59, is benchmarked to Tesla’s current 12-month forward market value to sales. The gap between his price target and fundamental-value estimate is another thing that might give investors pause. Gong didn’t respond toBarron’scalls or emails.

Accounting issues, too, have surfaced at two Chinese EV makers. In filings this year with the Securities and Exchange Commission, both XPeng and Li identified what they called material weaknesses in accounting controls. Both cited insufficient staff with an understanding of accounting principles followed by U.S. corporations. In a prospectus for a secondary stock offering filed on Dec. 7, XPeng said it was implementing changes to address the problem.

The possible risks are twofold: Accounting errors can lead to subsequent restatement of a company’s financial results, something investors generally frown upon. But the issue could be more fraught now that the House of Representatives has unanimously passed a bill, approved earlier by the Senate, that could lead to the delisting of Chinese companies from U.S. stock exchanges if their accounting isn’t compliant with U.S. audit oversight rules within three years. NIO has said it believes it is in compliance with the new law.

The aforementioned risks don’t pose an immediate threat to Chinese EV stocks, but current valuations leave little margin for error. All three companies have sold stock in secondary offerings this year, taking advantage of the strong market to raise more cash. Li sold more shares on Dec. 4, just 127 days after its IPO, for $29 apiece, and XPeng sold stock on Dec. 9 for $45 a share. NIO sold stock at $17 in August, and filed Thursday to sell more.

Holders of NIO, XPeng, and Li might want to follow the companies’ lead. China’s EV ambitions are grand, and offer enormous potential for profits. But chances are investors will get a cheaper entry point in shares of these companies somewhere down the road.