China’s first-quarter economic growth beat forecasts, fueled in part by the rapid recovery in consumption. This is against a backdrop where the long-festering property market meltdown has only just begun restructuring, and the country’s youth unemployment has risen to a record high. As a result, the market is now cautious, fearing the growth momentum could slow, leading to a reduction in big-ticket item consumption.
To stay ahead of this possibility, electric vehicle makers have cut prices in China, with the latest to reduce the costs to customers being Nio Inc (NIO), which said on Jun. 12 that it would lower prices by RMB 30,000 for all EV models. This works out to a discount ranging between 6% and 9%. The company also said it will end free battery swapping services to new buyers.
Nio was not the first to adopt such tactics. As early as December 2022, Tesla slashed prices of the Model 3 and Model Y vehicles by as much as 13.5%. Another Chinese player BYD (01211) followed suit as it announced in March that it would offer discounts of up to RMB 20,000 on its Dynasty series and provide a cash award for those who switch to EVs from petrol vehicles.
Morningstar Is Not Worried About a Drop in Profit Margins
Vincent Sun, equity analyst at Morningstar, believes Nio’s discount is reasonable under the current environment and isn’t too worried about a margin compression. He regards this move as a positive, as a broad price drop will spur sales volume and broaden the customer base.
In general, by lowering its unit prices, the EV maker should be able to defend its margin by growing sales volume. “Building scale effect could effectively reduce manufacturing costs,” Sun explains.
Sun highlighted two other means Nio used to cushion any negative impact on its profit margin:
- Reducing the duration of warranty from 10 years to six years, and
- Ending free battery swapping services
For the first four months of 2023, China sold 2.1 million units of electric vehicles. The EV penetration, or the percentage of total vehicle sales, reached 31%. With purchase tax incentives for EVs extended to the end of 2023, Sun expects EVs to continue to take share from internal combustion engine cars. The penetration is forecasted to rise to 46% by 2025.
Morningstar’s Top Picks in the China EV Space
Shares of most electric automakers under Morningstar’s coverage are undervalued at present. At this price level, Sun thinks a recovery of delivery growth and margin improvement, driven by lower battery cost, for the second half of 2023 is not factored in.
“Many local governments have launched various types of subsidies to stimulate EV purchases, albeit at a reduced subsidy quantum compared with the national stimulus,” says Sun, adding that those stimuli include trade-in subsidies, cash incentives, and free license plates for EV buyers.
Sun picks two names that are undervalued, with solid sales outlook for 2023 and beyond – BYD and Nio.
Sun forecasts BYD’s total vehicle sales to reach 2.7 million units in 2023, up 45% year over year. “Recently launched new models (Song L SUV, Chaser 07) should further solidify its leading position in the mass new energy vehicle segment. It also unveiled the new entry-level small sedan for a wider customer base,” he says. Shares in BYD is now 12.6% below its fair value estimate of HK$ 295.
According to his estimates, Nio is also undervalued, trading a 39% discount to its fair value estimate of HK$108.
Nio enters a strong model cycle with improving sales momentum driven by new models. He expects Nio to sell 160,754 units of vehicles in 2023. “We believe Nio’s premium branding through exemplary customer service and innovative charging technologies will differentiate itself from the competition and benefit from vehicle upgrade demand,” says Sun. Nio continues to see breakthroughs and innovations in areas like battery swapping and autonomous driving technologies.
Given promotions to buoy sales for the short term, like other electric vehicle makers in China, Nio’s profit margin is under pressure. Into the second half of 2023, Sun expects the EV maker to enjoy economies of scale, which will offset upstream cost pressure with improvement in product mix and bring back sequential recovery.
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