Big news for Rivian Stock: Here’s what’s next

Last month, we had a massive shakeup in the electric vehicle (EV) industry. Rivian Automotive (RIVN -1.61%) — one of the most successful EV brands besides Tesla — signs a $5 billion deal Volkswagen to fund future growth and build a software/technology joint venture group. Rivian shares jumped over 30% on the news and are now up 27% in the past month.

This deal is huge for Rivia. Burning through a ton of cash and running out of cash from its initial public offering (IPO), Rivian can use this funding to further scale its operations and hopefully achieve positive cash flow.

Here’s the lowdown on the deal and what’s next for EV stock.

Volkswagen deal: $5 billion capital cushion

The $5 billion deal with Volkswagen comes in multiple steps. There is an initial investment of $1 billion and then $4 billion coming over the next two years. In addition, $2 billion of future investments will be in Rivian’s equity (ie, common stock), while $2 billion from Volkswagen will contribute to the newly formed joint venture group.

At the end of the first quarter, Rivian had a cash balance of $7.9 billion. While that seems like a lot, the company is burning through $5.6 billion a year in free cash flow. This new funding extends Rivian’s timeline for reaching profitability, which is likely to take many years, given that the brand is still under scale (it expects to produce just 57,000 vehicles this year).

The deal not only gives Rivian a cash cushion, but also a major partner to deploy advanced vehicle software and technology. According to the announcement, Volkswagen is planning to deploy Rivian’s electronic hardware and software systems to its future vehicles starting in the second half of this decade. This will help Rivian further scale its operations and bring in more revenue on its fixed cost investments, hopefully leading to an operating leverage on the income statement.

Can Rivian achieve positive cash flow?

Rivian is burning a ton of money. It lost $5.6 billion in free cash flow over the past 12 months on just $5 billion in sales. It is clear that it needs to scale up its production of electric vehicles in order to curb this burn and eventually achieve positive cash flow. Otherwise, the stock won’t be worth much.

At the last Investor Day, management stated that it can achieve annual production of 150,000 vehicles in its current operations. It then plans to reach 215,000 with the addition of the new vehicle called the R2, and eventually another 400,000 in capacity from future vehicles called the R3 and R3X. This would bring annual production from 57,000 today to over 600,000 within just a few years, a 10-fold increase in volume.

If/when that happens, Rivian believes it can continuously lower its unit costs. The plan is for a 20% cost reduction for the second generation of its first vehicle, called the R1, and then a further 45% cost reduction in the R2. With gross margins of -44% today, it is imperative that the company achieve these cost reductions. Right now, her unit’s economy is unstable.

Free RIVN Cash Flow Data from YCharts

What comes next?

In the near term, there are two things Rivian investors should be watching: production volume and gross margins. Both are tied for a carmaker and will need to improve in the coming years in order to stem the current unsustainable cash burn.

Over the next three to five years, Rivian will need to increase its deliveries to reach its planned production capacity of 600,000 vehicles. More scale along with cost cuts on a per-unit basis could help gross margins move from -45% to 25%, management’s stated long-term goal.

In the long term, investors should track whether Rivian achieves its long-term goal of a 10% free cash flow margin. If they achieve this valuation while increasing production volumes by 10x, the stock will likely be a good one for investors buying today. If they keep burning money forever, the stock won’t be worth much.