Foam On Tesla's Wave

| About: Tesla Motors (TSLA)

On a warm afternoon four and a half decades ago, I was body surfing off Hawaii's Poipu Beach. A strong breeze blew from the land and the waves, held back by the breeze, rose into thin high slabs of warm, tropical water. I was carried up waves so thin and tall that standing upright my feet were above the shoreward surface and I could stretch one arm out of the water toward the shore and the other out of the water toward the sea. Then the wave would more collapse than break, dropping me into a mass of foam.

Looking at the plot of recent Tesla (NASDAQ:TSLA) shares reminded me of that afternoon so long ago. Reading the Tesla shareholder letter, listening to the earnings conference call and perusing the Q1 numbers, was like falling into a dreamy sea of foaming tropical water. All was light and warm and supporting and good.

At the end of March, Tesla announced that they would report a profit for Q1 on both a non-GAAP and a GAAP basis. This drove the market wild. Shares shot through the long-term $40 resistance and as investor anticipation continued, the market hardly looked back at the new support level around $42. Yesterday was the proof. All hopes of Tesla "longs" and fears of Tesla "shorts" are realized. Tesla shares spiked above $72 in after-market trading. Everything is looking up for Tesla now that they have demonstrated they can make money in the electric car business.

Or not, because Tesla's reported results specifically do not show that they are making money making cars. To be sure, these are the best results Tesla has had as a public company, they are delivering a great product; they just aren't making money in the car business quite yet. Let's go through the numbers and then take a look at what actually lies ahead for Tesla.

January through March of this year, Tesla had $562 million of revenue mostly from selling cars, up 83% from the last quarter of 2012 and 1,863% higher than the same quarter last year. Net profit on a non-GAAP basis was $15 million ($0.13 per undiluted share) and on a GAAP basis $11.2 million ($0.10 per undiluted share). These earnings numbers were higher than the analyst consensus and the market clearly was impressed. But on digging into Tesla's reported numbers, not everything is what it seems.

A Tenth of a Billion in Foam

Buried in the earnings report are almost a tenth of a billion dollars of one-time or otherwise unsustainable Q1 items that flow directly to Tesla's bottom line. That's a lot of foam!

One-time and Unsustainable Q1 Items

Item

Amount

(millions)

Why it matters
ZEV Credits $68 Tapering to zero by Q4
Stock Based
Compensation
$14.9 Employee stock compensation equals entire non-GAAP profit.
Foreign Exchange
Gain
$6.4 Doesn't happen every quarter...
Canceled Loan
Warrants
$10.7 This IS the GAAP profit...
Total "Foam" $96 Six times non-GAAP and nine times GAAP reported profit!
Click to enlarge

One-time items and income streams that cannot be sustained over time contribute many times more to Tesla's bottom line than their reported non-GAAP or GAAP profits. Tesla is not yet, in fact, making money making cars.

Tesla's gain from ZEV credits and foreign exchange was five TIMES their reported non-GAAP income. And with employee stock compensation essentially equal to their entire non-GAAP earnings, it is fair to say Tesla's profit last quarter was made not by selling cars, but rather by selling stock to their employees. By accelerating repayment of their government guaranteed loan and thereby taking government warrants out of play, Tesla realized $10.7 million in non-cash gains that together with $6.4 million in foreign exchange gains effectively 'fixed' any GAAP loss in Q1.

While the foam floating around Tesla's Q1 financials tends to obscure the fact they are not yet really making money making cars, nothing in the Q1 report suggests Tesla is about to drown financially. Tesla is making progress. They are building more cars, more efficiently for more customers every day. And if they aren't yet making money making cars, at least ZEV credits and good luck have kept them afloat to fight another day.

What About Q2?

The quarter we are in now presents some financial challenges for Tesla. Guidance suggests Model S production essentially the same as Q1, but with several hundred cars (at least) going into the European delivery pipeline, Model S unit sales in the U.S. may be flat, or even decline from Q1 while the proportion of lower priced 60kWh cars is slated to increase. At the same time, CapEx for SuperCharger and service center build-out, and working capital tied up in European pipeline inventory will be a drain on Tesla's cash. Furthermore, the rapidly appreciating stock price will mean much higher stock based compensation expense appearing in Q2 GAAP results. Next quarter, I would expect the shareholder letter to dwell rather more on non-GAAP results and 'European sales', and less on their GAAP results.

Bottom Line. What's Tesla Worth?

The market promptly pushed Tesla shares into the $42 -$45 range on learning that the company was making rather than losing money, that essentially Tesla's head was finally above water. Since April, one Tesla announcement after another has excited the market, and as expectations have risen, so have Tesla shares. The great looking earnings per share announced yesterday are the final, frothy cap to the wave, and while some Tesla price appreciation can certainly be tied to a short squeeze, a good part of it stems from inflated expectations of Tesla fans.

Sales in Q2 should be lower than in Q1, simply because fewer cars will be sold and a larger proportion of these cars will be lower priced 60kWh cars. ZEV credits will be lower too based on guidance that the price per credit AND the proportion of cars sold in California are likely to go down. Foreign exchange gains seen in Q1 may or may not be there in Q2. Stock based compensation expense will significantly increase due to appreciation of the stock, and no one-time boost in GAAP earnings from warrant cancellations is on the Q2 horizon. Absent some game changing revelation or fundamental departure from Tesla's Q2 guidance, I believe anyone buying Tesla shares for more than $50 will be unhappy when Q2 results get reported at summer's end.

Between now and August we will see the Tesla wave collapse into a sea of foam. This won't be a bad thing. It will not represent a collapse of the company, but only of over heightened investor expectations. And after investors emerge from the foam, we will be all set to ride the next Tesla wave.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in TSLA over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.