Tesla, Nio, Xpeng: How Do We Make Sense Of EV Stock Valuations?

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Electric vehicle (EV) stocks have been on a tear this year. Tesla (NASDAQ:TSLA) stock is up over 6x year-to-date and has a market cap of over $550 billion – making Tesla more valuable than the next five car manufacturers combined, despite the fact that it sells a fraction of the cars. (Tesla is on track to sell about 500k vehicles in 2020, versus Toyota which sells about 10 million vehicles a year). Even relatively newer Chinese EV stocks haven’t missed out. Nio (NYSE: NIO) and Xpeng (NYSE: XPEV), who have been selling cars for less than two years, are worth about as much as General Motors and the Ford Motor Company, respectively.

Interestingly, the rally has come at a time when the global economy slipped into the deepest recession seen in decades. While economic contractions typically result in a flight to safety, with investors preferring mature, blue-chip stocks with robust cash flows, through Covid-19 investors have doubled down on riskier, higher growth companies such as EV manufacturers. In this analysis, we take a look at what’s driving these sky-high valuations, what the risks are, and when these stocks could see a reality check.

Why EV Stocks Rallied Through The Pandemic

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There are multiple factors driving the surge. Firstly central bank actions, which have resulted in ultra-low interest rates and abundant liquidity have caused investors to bet on high-growth stocks as other sectors face headwinds. Secondly, investors anticipate that the Covid-19 related disruption will at least temporarily slow down mainstream automakers’ transition to electric vehicles, helping current players. The big EV names, such as Tesla, also have a significant lead in the self-driving space – and getting more vehicles on the road sooner helps them gather data and improve algorithms. (related Just How Far Ahead Is Tesla In The Self-Driving Race?) Investors have also assigned a big premium for companies with a strong software component to their business models and this also appears to have helped the likes of Tesla. (related: How Do Tesla’s Software Sales Impact Its Gross Margins?) Separately, the regulatory environment in the U.S. is likely to be favorable to electric vehicles, given the renewable energy plans of the Biden administration which enters the White House in January.

Valuations Are Looking Stretched At The Moment

However, the valuations at this point look stretched. Tesla trades at about 18x projected 2020 Revenue and at over 150x projected 2020 earnings – which will still largely come via the sale of regulatory credits. Nio, which is not yet profitable, trades at about 29x projected 2020 Revenue. While these companies are growing quickly – with Tesla likely to grow sales by over 45% next year and Nio likely to double revenue, per consensus estimates – it’s not clear that they can sustain this in the long-run. See our interactive dashboard analysis on Tesla’s Valuation for more details on the trends driving Tesla’s revenue & valuation. Our analysis Nio, Xpeng & Li Auto: How Do Chinese EV Stocks Compare? compares the financial performance and valuation of the major U.S. listed Chinese electric vehicle players.

What Are The Risks And When Could We See A Correction?

What are the factors that could cause EV stocks to correct? Firstly, there are extrinsic risks that could cause stocks to correct in the near-to-medium term. With the availability of multiple highly effective Covid-19 vaccines (Pfizer & Moderna) looking likely in early 2021, things are likely to gradually start returning to normal. The Fed could also eventually revisit its stance on ultra-low interest rates as the economy shows signs of picking up.  As this plays out investors could rotate out of high-growth stocks to more cyclical names such as energy, industrials, and financials, hurting valuations for high growth EV stocks.

Secondly, there are industry-specific risks as well. Mainstream automakers are committing to invest more in EVs. For example, in November, GM said it would increase its investment in EVs and autonomous vehicles over the next five years to $27 billion (up from its initial investment of $20 billion), with plans to release 30 new EVs globally by 2025. GM has already invested considerably in battery technology and its driver assistance systems are also very well-reviewed. While the technologies are falling into place, GM – and other big players such as Daimler and the VW Group – have not been able to combine them into a hit product just yet. However, if they do deliver a compelling EV that’s well-received with customers, it could change the narrative around the auto majors, and potentially hurt the valuation of pure-play EV companies.

There’s a threat specific to the self-driving and connected automotive technology space, as well. Silicon Valley giants are also looking to become platform players, providing self-driving and systems that car manufacturers can buy. For instance, Google’s Waymo – which ranks only behind Tesla in terms of autonomous miles logged – has partnerships with manufacturers including Daimler, Nissan-Renault, Fiat Chrysler, Jaguar Land Rover, and Volvo to integrate its technology. If this platform concept catches on and is eventually deployed at scale by many manufacturers, it could diminish the early data-driven lead Tesla (and other EV players) are building in this space.

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