The last time I covered Tesla Motors (TSLA), I briefly gave an overview of why I think this stock is ready to be short-squeezed. I still recommend the stock as a buy. The stock has been shorted in large quantities because of the following factors:
- Investors believe that the market for electric cars is very small and will take a long time before it develops into a 'sufficiently' large size. By sufficient, I mean that the demand for Tesla's Model S is large enough to generate the first dollar of profit for the company. The company expects to make 90% of its revenues from the Model S.
- Investors also believe that even if a 'sufficient' demand is generated, the company does not have enough financial resources to ramp-up its production accordingly.
In response to the first concern, I have already described in my previous article that the Model S does not compete with other electric cars. Favorable product reviews from the Model S users tell us that the Model S is the only electric car that does not come with any compromise. Therefore, it competes with the Porsches and BMWs rather than the Leafs and Mievs of the auto world. In its recent earnings release, the company announced that it has already booked 13,200 units of the Model S (more than the analysts' estimates of 13,100 cars). Also, the reservations increased by 30% Y-o-Y and 15% sequentially in the last quarter. Moreover, the Model S was named as the 2013 Car of the Year by Motor Trend. The article released by Motor Trend uses the following words for the Model S:
"It drives like a sports car, eager and agile and instantly responsive. But it's also as smoothly effortless as a Rolls-Royce, can carry almost as much stuff as a Chevy Equinox, and is more efficient than a Toyota Prius."
The second concern needs a relatively more comprehensive answer as compared to the previous concern. At the start of 2012, the company's CEO, Elon Musk, promised to deliver 500 Model S cars in the third quarter and a total of 5,000 Model S cars in 2012. According to that guidance, the company would have made its first dollar of profit in the second half of 2013s.
However, prior to the 3Q earnings release, the management reduced the production guidance to 2,500-3,000 deliveries for 2012. Supply-chain issues and increased focus on the production quality were cited as the main reasons for a reduction in the guidance. This was a bad news for the investors given that the company heavily depends on the sale of the Model S cars for its earnings. The company's 10-K clearly states that the revenues can only be recognized after the car has been delivered. Therefore, a slower-than-expected production means that the investors will have to wait for some more time before the company's losses are turned into profits.
Recently, the company announced it has ramped up its production to 200cars/week. This means that the company is set to achieve its target of 2,500-3,000 cars for the year.
In its recent earnings release, Elon assured the shareholders that although the company will not be achieving its preset target of 5,000 deliveries for this year, it is well on its way to achieve the target of delivering 20,000 Model S cars in 2013. However, investors are still not sure whether the company will be able to ramp-up its production to 400cars/week (20,000 cars for the year). The market has concerns over the company's current liquidity standing. At the end of the third quarter, the company had $109 million in its cash reserves. This, added with the company's recent follow-on offering, enabled it to avoid mounting pressure on its balance sheet. The company has also completed its draw down of $465 million in a loan facility from the Department of Energy. Tesla was recently accused of violating DOE's loan covenants. However, the DOE did not charge Tesla on the condition that the company will have to pay the loan before the scheduled time of repayment. Elon announced that he wants to maintain a healthy relationship with the DOE. Therefore, TSLA is expected to pay the loan before the scheduled date.
Elon also announced that the company is set to make positive free cash flows by the end of this year. However, the sell-side expects that the company will not reach the above-mentioned target by the end of this year.
The Stock Price Catalysts in the Future
The future performance of the stock depends on the company's ability to demonstrate that it can:
- ramp-up its production to reach a production rate of 400cars/week by the end of this year.
- achieve its targeted gross margin of 25% by the end of 2013.
While the second target (gross margin) is important, I believe that management still has a few quarters to demonstrate the progression towards its target range, given the gradual ramp-up in the production level. The first target, however, is likely to be a major focus point in the near-term, particularly given that management has had some missteps in meeting its initial production targets. In this context, Barclays believes that the inherent risk in lifting the production from 200 to 400 cars per week is likely to be lesser than the initial risk of ramping up the production from 0 to 200 cars per week. In other words, it sees lesser risk in the company's ability to achieve its year-end run rate today vs. a few weeks ago. Therefore, the company could be in a great position to achieve its desired run-rate by early to mid December.
An Update on the Superchargers and the Distribution Network
The company has been working hard to facilitate the Model S users in different ways. Recently, the company announced that it plans to build a supercharger network in Boston to D.C. corridor. The network is expected to be in place by the end of 2013. The superchargers will be placed next to the restaurants so that the electric car is charged while the user takes half an hour to finish his/her meal. A 90 kilowatt (KW) charge to the battery in about 30 minutes will allow the Model S to cover an additional distance of 150 miles. The use of supercharger will be free for the consumers. The main purpose of placing such a network is to address the "range anxiety" concerns inherent with owning a full electric vehicle.
The company also plans to expand the coverage of its service centers. At the start of 2012, the company had ten stores, one gallery and nine service centers. Under the expansion plan, the company plans to open nine new stores, two new galleries and 18 new service centers. Elon claims that, after the planned expansion has been achieved, 85% of all the Model S reservation holders in North America will be within 50 miles of a Tesla Service Center and 92% will be within 100 miles. This will address the concerns of Model S users who think that a limited battery range makes it highly inconvenient to drive the car for long distances to a service facility.
Two Recent Concerns For Investors:
- The Controversial Retail Strategy
Elon hired George Blankenship to design Tesla's showrooms. George is an accredited designer who is responsible for the successful brand building strategy of Apple (AAPL). Most of Tesla's stores are located in the shopping malls and are operated by Tesla itself. This ownership of dealership with the company has caused indignation among different auto dealers in the country. They claim that, according to the prevalent law, the manufacturer cannot own a dealership as it will bring it in direct competition with the dealers who have invested ample amount of resources in order to promote their businesses. However, in this context, Tesla claims that given that it has not granted a single franchise to any dealer in the world, therefore this law does not apply on it. This is why a judge denied the request of Massachusetts' dealers for a preliminary injunction against Tesla. However, the dealers still plan to press on with a lawsuit against the company.
Elon believes that when people buy a car from a local dealer, they have already decided on which car to buy. In this way, Tesla will never get a real chance to market its product. Placing Tesla showrooms in the shopping malls will help the company to win attention from the general customers. Also, the company's employees, present at the showrooms, will market the product in a more elegant manner.
2. A Price Hike
TSLA's shares are up by more than 2% after the management confirmed the anticipated price increase for its flagship vehicle. The implementation of the announced price increase will give the Model S a new base price of $59,900 before the federal credits. The price hike has sent both bullish and bearish signals to the market. The bears think that the company is facing a problem in achieving its target of 25% gross margin by the end of the next year. The production problems have inflated the costs which will require a rise in the prices to protect the margins. Also, they are cautious that a higher price will reduce the demand for the Model S sedan in the price-sensitive consumer segments of the market.
The bulls have a different point of view. Tesla plans to introduce the Gen-3 model in 2014 which will be sold for a tag price of around $30,000. An increase in the price of the Model S car seems to be part of a broader strategy to explicitly distinguish the Model S as a higher-end alternative to the Gen-3. Also, the bulls think that a possible rise in the prices is somehow linked to the Model S reservations.
Today's announcement stated the following:
"This price increase will not apply to anyone who has or makes a reservation by end of day on December 31, 2012... as long as they finalize their order within a reasonable, predefined timeframe after being invited to configure their Model S."
This means that Tesla wants the current reservation holders to confirm soon. While a reservation requires a deposit of $5,000, it is refundable until the reservation holder finalizes the features/specs that he wants to be added in the standard package.
Currently, almost 44% of the total share float has been shorted. The bullish target price for the stock is $42. The estimate for the EBITDA in FY 2013 has been reached in the following manner:
- 20k Model S cars sold @ $90k each= $1,800M; 25% GM = $450M
- $20M earned through Daimler's contract; 30% GM = $7M
- $35M earned by making EV parts for Toyota's (TM) RAV4; 30% GM = $11M
- $10M earned through spare/repair work; 50% GM = $5M
- Total Gross Profit comes out to be approximately $475M
(GM stands for gross margin)
The R&D costs for the year are expected to be $225M for 2012. They are expected to remain the same in the next year (stated in 10-Q). The increase in the R&D costs for the Model X is expected to be offset by a decrease in the R&D costs for the Model S.
The SG&A costs are expected to increase modestly in 2013. The SG&A costs for the year are expected to be $142M which are expected to rise to $150M in the next year.
So the EBITDA comes out to be:
$475M - ($225M + $150M) = $100M
The estimate for the EV/EBITDA multiple for 2013 is 50x. Following table shows that the target price comes out to be $42 (25% upside):
*All values are in millions, except the stock price
*Smart Equity's estimates
I recommend the stock as a buy to benefit from at least 25% upside in the future. Why I use the word 'at least' is because most of the estimates (are bearish) used in the calculation lie at the lower end of the range. The cash estimate is a good example of that. Also, I have not included the cash inflow from the Model X reservations. I have included the entire R&D cost in the expenses. This is not a correct accounting procedure given that the development costs are capitalized and not expensed out.
Key risks: Tesla may not be able to ramp up its production to 400cars/week in 2013.