Niu Stock: Even With Exceptional Free Cash Flow, Too Much Risk (NASDAQ:NIU)
Niu Technologies (NASDAQ: NIU) is expected to deliver a new scooter called GOVA, and most investment analysts expect free cash flow generation. I ran several discounted cash flow models with conservative assumptions resulting in significant upside potential in the NIU assessment. That being said, there are significant risks that could ruin an investment in NIU. The fact that the company was incorporated in the Cayman Islands and that most of the assets are located in China will probably not help convince investors. I am not a buyer.
NIU: Use of Big Data and New Models Could Improve Sales Growth
NIU’s mission is to redefine urban mobility through intelligent two-wheeled electric vehicles, its application and the use of big data. The company showcased its technology with the following photos during a recent presentation.
In my opinion, what differentiates NIU from other peers is its cloud systems. Performance data and behavioral data are constantly evaluated to provide maintenance solutions and insights to build brand loyalty.
We use collected data to provide smart maintenance and services, and guide users on when and how to properly maintain our products to extend their lifespan and achieve better performance. We also analyze this data to help us improve our products and create new services. Additionally, we collect and analyze behavioral data from users of our NIU app and website, from which we derive insights to further engage our customers and build brand loyalty. Source: 20-E
The second revenue driver will likely be the inbound increase in the product portfolio. In the last quarterly report, NIU reported a new version of NIU’s GOVA vehicle. If customers appreciate the new features offered by NIU, revenue growth could head north.
Bottom Line: Customers Fund NIU’s Operations
As of March 31, 2022, NIU reported $17 million in cash, $27 million in term deposits and restricted cash worth $35 million. The balance sheet appears stable with an asset/liability ratio above 2x. In my opinion, the company has enough cash to pay for more marketing campaigns. If NIU wants to accelerate capital spending, I think bankers will likely offer more debt financing.
I kinda appreciate that NIU doesn’t declare a lot of debt and that customers help finance the company’s operations. Keep in mind that customer advances are $12 million.
Analysts expect a constant EBITDA margin of around 8% to 9% and a growing net income – My assumptions are close to these figures
Before I mention my own numbers, I took a look at the numbers provided by other investment analysts. Estimates include an approximately constant EBITDA margin of 8% to 9% and an operating margin of approximately 4% to 7%. It is also advantageous that analysts expect NIU to report positive and growing net income. By 2024, analysts estimate net profit could stay close to 558 million yuan.
Given previous estimates and the recent supply chain shortage reported by NIU, I ran a conservative scenario with reasonable sales growth. I assumed that NIU might come up with new products in the micro-mobility segment, and maybe undertake international expansion. Some of these assumptions were derived from management intentions:
Despite a challenging quarter with supply chain shortages, logistical disruptions and the unstable retail environment caused by the recent COVID outbreaks, we managed to deliver moderate sales volume and revenue growths per compared to the same period last year.
We are confident that our growth strategy to develop a diversified product portfolio, including our new product offerings in the micro-mobility segment, and our global market expansion plan, will help us overcome temporary shortcomings. of the Chinese market and to position the company well to capture the post-pandemic rebound in demand for electric two-wheelers. Source 10-Q
My assumptions for the next four years include double-digit sales growth, a conservative EBITDA margin of 10%, and an operating margin of around 7% to 8%. With capital expenditures of approximately $187-267 million and working capital/sales of 1%, the free cash flow sales ratio is 4%-7%. I believe my numbers are conservative.
If we also include a 6.8% discount and an ultra-conservative exit multiple of 7x EBITDA, total equity would be $1.4 billion. The fair price would be around $19 per share and the internal rate of return could reach 30%.
Several risks could lead to a valuation of $3.5 per share
NIU reported an increase in commodity prices in the latest quarterly report. Management believes that future gross margin figures could be affected. With this in mind, I decided to run another DCF pattern with bearish assumptions.
The continued increase in raw material prices, particularly lithium-ion battery prices in the first quarter, created additional pressure on our gross margin. Source: 10-Q
In this scenario, NIU would not be able to successfully introduce NIU’s GOVA vehicle. For some reason, customers don’t like new features and revenue growth would decline. This would be very detrimental to free cash flow. Keep in mind that the NIU would invest in capital expenditure, which would significantly reduce the FCF.
The success of our operations depends on our ability to introduce new or improved smart electric scooters and other new products. Consumer preferences differ between and within each of the regions in which we operate or plan to operate and may change over time in response to changes in demographic and social trends, economic circumstances and the marketing efforts of our competitors. There can be no assurance that our existing products will continue to be preferred by consumers or that we will be able to anticipate or respond to changes in consumer preferences in a timely manner. Source: 20-E
Also, given NIU’s access to some necessary components, in my view, the company could suffer from significant supply chain issues. It should also be noted that significant increases in component prices could have a material effect on NIU’s financial results. If free cash flow declines and EBITDA falls short of market expectations, the stock price could fall:
To date, we have not found qualified, cost-effective alternative sources for most single-source components used in our products and we generally do not maintain long-term agreements with our single-source suppliers. We have integrated vendor technologies into our products in such a way that having to switch vendors can significantly disrupt our operations. In the event of an interruption in the supply of key components for any reason or in the event of a significant increase in the prices of these key components, our business, financial condition, results of operations and prospects could be adversely affected. significantly and adversely. Source: 20-E
In this scenario, I used sales growth close to -50% in 2023 and 10% to 5% from 2024 to 2026. I also increased the total amount of capital expenditure to around 300 million yuan per year. As a result, free cash flow would be negative from 2023 to 2026.
Now, with an exit multiple of around 5x and a discount close to 6%, the implied price would be $3.5 per share. Note that these figures are, in my opinion, the worst that can happen to NIU.
Risks Related to NIU’s Operations in China
Among the risks investors should consider is the risk of regulatory burdens in China. If the government decides to limit the amount of data companies can collect, or if they require user consent, revenues could drop. NIU has explained some of these risks in its annual report.
Possession and use of users’ personal information in connection with our business may subject us to regulatory constraints in China and other jurisdictions, such as the European Union, which would require us to obtain users’ consent, would restrict our use of that personal information and interfere with our ability to expand our user base. In the event of a data breach or other unauthorized access to our user data, we may be required to notify users of the incident and we may be required to provide some form of remedy to those affected by the breach. incident. Source: 20-E
ADS owners are not buying stakes in NIU in China, but stakes in Cayman Islands. Operating assets are also in China. This means that judges in the United States will probably not be able to enforce actions against the company or the board of directors:
Investors in our ADSs do not buy an equity stake in the VEE in China, but instead buy an equity stake in a Cayman Islands holding company. Our Cayman Islands holding company, variable interest entity and investors in our company face uncertainty about potential future actions by the PRC government that could affect the enforceability of contractual agreements with the entity variable interest entity and therefore materially affect the financial performance of the variable interest entity and our company as a group. Source: 20-E
Given NIU’s free cash flow, new version of the GOVA vehicle, and big data capabilities, my DCF model implied a valuation close to $19 per share. Therefore, in my opinion, the financial numbers indicate that NIU is undervalued.
That being said, I think many investors will steer clear of this company due to its significant risks. Operations are conducted in China, so judges in the United States may not be able to enforce legal actions. Furthermore, the fact that the stakes sold come from entities in the Cayman Islands is not ideal. Personally, I am not an ADS buyer.