Is This Heavily Shorted Penny Stock a Buy Near Its All-Time Lows?

Barchart · 10/16 07:35

Nikola (NKLA) is often featured on lists of the most-shorted stocks, and not without good reason. The stock has been falling to new lows, so short sellers have their reasons to love this ailing hydrogen fuel cell truck maker. That said, at times, buying heavily shorted stocks can be a good contrarian call, as these stocks often see short-squeeze rallies.

The term “short squeeze” became quite popular during the meme stock mania, where retail traders targeted heavily shorted names like AMC Entertainment Holdings (AMC) and GameStop (GME) to get the better of institutional investors. However, short-squeeze rallies are generally not sustainable, and stocks eventually settle near their fundamental values.

Nikola Fell to Record Lows in September

As for Nikola, the stock hit yet another record low late last month, even as broader markets were rallying to new highs. NKLA bounced back from these levels after its Q3 delivery update, which revealed that it delivered 88 trucks to dealers in the quarter. The metric was within the range provided by the company, and even if it was a third-quarter “record,” the steep rise in the stock after the update was likely due to two reasons.

First, markets have set a low bar for Nikola, which mean that even an update that meets expectations is cheered. Second, it could be a case of a short squeeze, as the positive update led to a buying spree, which triggered short covering.

While Nikola briefly topped $5 earlier this month and escaped the penny stock category, it's now back on that dubious list, and has fallen to levels not very far from its record lows.

NKLA Stock Forecast

Nikola is covered by just 5 analysts, and only 1 of these rates the stock as a “Strong Buy,” while the remaining 4 have deemed it a “Hold.” The stock’s mean target price of $11.33 is 166% higher than Tuesday’s closing prices, and even the Street-low target price of $10 implies NKLA more than doubling from current levels.

I wouldn't harp much on NKLA's consensus target price, though, as analysts have been gradually lowering their estimates for the troubled company.

Nikola Has the First Mover Advantage in Hydrogen Fuel Cell Trucks

To be sure, Nikola has the first-mover advantage as the only Original Equipment Manufacturer (OEM) with Class 8 hydrogen trucks commercially available in North America, and has also started realizing revenues from sales of regulatory credits. It has been adding to its dealer network, and looks like a much different company than it did a couple of years back.

Nikola has sold the Badger pickup truck program, exited Europe, and is now focusing on hydrogen fuel cell electric trucks and HYLA hydrogen infrastructure solutions.

Nikola’s Weak Balance Sheet and Recurring Losses Remain a Challenge

What hasn’t changed for the company, however, is its recurring losses and cash burn, and the need for frequent capital raise. Nikola has raised capital in multiple tranches since it went public in 2020, making it difficult to keep count. It now has over 50 million outstanding shares, which is more than triple the amount when it went public. Also, the company has several convertible notes that will further bump up its outstanding share count when converted to common equity.

The generous share-based compensation has added to its already bloated share count. The company’s 2024 guidance calls for a share-based compensation of $30 million in 2024. While that number is less than half of the 2023 actual, it is still 10% of its market cap.

Nikola has been issuing new shares in a frenzy, and given its precarious financial condition and weak balance sheet, we can be pretty well assured that the company will need to raise a lot more capital. Also, while Nikola is not too bothered about competition – including from Tesla (TSLA), which has the battery electric Semi in its arsenal – that's another risk that Nikola investors should watch out for.

Should You Buy Nikola Stock?

My investment thesis for NKLA stock hasn’t changed much, and I would continue to avoid the stock. While there could be intermittent rallies driven by short squeezes, the company's weak balance sheet and terrible finances make it a no-go for me.

To be sure, if Nikola can successfully sell its hydrogen trucks profitably without raising a lot of capital, it could eventually be a multi-bagger. That's easier said than done, though, as these are conflicting demands. Nikola needs a lot more capital to become sustainably profitable. Plus, its falling share price has meant that subsequent capital raises have been happening at lower stock prices, which has translated to even more dilution.

While investors with a high risk appetite can consider the stock, they should be mindful of its past performance - and while past performance is no indication of future returns, in Nikola’s case, history has just been repeating itself, and I fear things won't change much in the near term, either.

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On the date of publication, Mohit Oberoi had a position in: TSLA . All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.