Rivian Automotive (RIVN -1.20%) highlights the dangers of investing in initial public offerings (IPOs) -- a time when hype and excitement can cause investors to lose sight of a company's value. Down by a whopping 86% from its starting price, Rivian is proof that patience is often the better strategy.
But after several years of decline, is this automaker finally ready to turn over a new leaf? Let's discuss what the next three years could have in store.
The EV industry is getting tougher
It is no secret that the electric vehicle (EV) industry has lost some of its luster compared to when Rivian first hit the market three years ago. Back then, industry leaders like Tesla were stunning Wall Street with exceptional growth and margins. And investors were willing to assign high valuations to smaller, pure-play EV makers like Rivian because they expected these companies to replicate some of that success.
By Nov 10, 2022, Rivian's market cap soared above $100 billion, making it the world's second-largest automaker at the time (behind Tesla) despite reporting practically no revenue and substantial quarterly losses.
In hindsight, Rivian's overvaluation made absolutely no sense. Aside from its fresh and edgy brand, the company has no distinct economic moat separating it from its traditional automaking rivals, which are also pivoting to EVs. In fact, Rivian's small size probably makes its moat weaker because it likely has fewer economy-of-scale advantages and less ability to sustain the losses necessary to build a brand-new business almost from scratch.
Revenue is up, but losses continue
As EV industry competition and interest rates rose in 2022 and 2023, the market began rethinking Rivian's valuation, especially as it continued to miss its lofty production targets. But on a fundamental level, Rivian's situation hasn't changed much. Revenue is still growing at a breakneck pace, and operational cash burn remains enormous.
First-quarter revenue almost doubled year over year to $1.2 billion based on a 71% increase in vehicle deliveries (to 13,588). However, Rivian's bottom line is still moving in the wrong direction, with an operating loss of $1.48 billion -- up slightly from $1.43 billion in the prior year period.
Image source: Getty Images.
With less than $8 million in cash and short-term investments on the balance sheet, Rivian can't sustain this level of cash burn for much longer without relying on outside sources of capital, such as debt or equity dilution, which involves issuing and selling more units of the stock. Investors generally don't like this because it dilutes their ownership of the company and reduces their claim on future potential earnings.
Profitability will be a make-or-break issue
Over the next three years, Rivian's management aims to scale the business into profitability -- an achievement that will reduce the threat of equity dilution and make investors more comfortable returning to the stock. According to CEO R.J. Scaringe, the company can hit its first milestone, gross profitability, by the fourth quarter of this year.
Gross profits refers to a company's income after subtracting the cost of manufacturing and delivering its products without factoring in overhead expenses like office salaries, research, or advertising. In the fourth quarter, Rivian generated a gross loss of $527 million, which means it costs the company more to make its cars than it can recoup by selling them.
Scaringe believes he can change this in just three quarters by improving manufacturing efficiency, reducing component costs for the vehicles, and generating more non-vehicle revenue, such as in-car software. If successful, a gross profit would pave the way for Rivian to hit other milestones, like operating profitability over the next few years, by simply scaling up a proven business model.
Bullish about Rivian, but on the sidelines for now
Rivian allows investors to bet on a growth stock at a substantial discount to its previous highs. If the company can achieve gross profitability in 2024, it could set the stage for it to outperform over the next three years by scaling into positive cash flow and net income.
With that said, Rivian's cash burn and dwindling liquidity make it high-risk -- especially now that high interest rates make external financing more expensive. Investors may want to wait for more quarters of data before taking a position in the stock.
