Don't Rush To Short Tesla - Its Profit Potential May Surprise You

|
 |  About: Tesla Motors (TSLA)
by: Michael Blair

Tesla Motors Inc. (NASDAQ:TSLA) has been on a roll for a few months now and the stock has been on fire.

Click to enlarge
(Click to enlarge)

A lot of chatter questions whether the stock is way ahead of the company's results and destined for a sharp correction. This article seeks to peek into the economics of assembling Tesla's vehicles and give some insight into the results it will have to achieve to make the stock price make sense.

Tesla Q2 results showed sales of $401 million and a loss of $31 million or $0.26 per share. During the quarter the company sold 5,150 vehicles - a result somewhat greater than the 4,500 most expected. With those quarterly results, the company's stock moved close to $150 per share and market capitalization of Tesla exceeded $18 billion. Whoa! - was a common reaction.

The Q2 results can be simplified as I have set out in the table below:

Tesla Motors Inc.

Volume

ASP*

NSB

5,150

$ 78,668

$ 405,139

Cost of sales

$ 304,656

Gross Profit

$ 100,483

R&D

$ 52,312

SG&A

$ 59,963

Sub-total

$ 112,275

Operating loss

-$ 11,792

Interest and other

-$ 18,409

Pre-tax loss

-$ 30,201

Tax provision

$ 301

Net loss

$ 30,502

*Includes powertrain components sold separately from vehicles

Click to enlarge

One of the beauties of the automobile industry is that, despite the complexity of the vehicles themselves, the economics of car assembly are pretty straightforward. Assembly plants source parts from the supplier base, assemble them into vehicles, and sell the cars through dealerships or directly. Not much to it really.

In the quarter Tesla sold 5,150 vehicles and realized an average revenue per vehicle (including power train components and services sold separately from the vehicle) of $78,668. Margins were roughly 25%. The company spent about $52 million on research and development and another $60 million on selling, general and administrative expenses.

The electric vehicle industry is in its infancy. Forbes reported that total industry electric vehicle sales in 2012 were on the order of 56,000 cars. No doubt the market has grown in 2013, but Tesla's quarterly sales of over 5,000 vehicles must still be seen as a significant accomplishment.

One of my neighbours recently purchased a Tesla so I had a chance to see one up close and personal. For my money, the vehicle is absolutely gorgeous.

Click to enlarge
(Click to enlarge)

Even more impressive, it sports a zero to 60 m.p.h. time that compares to most sports cars, has an upscale and attractive interior, and is so quiet you can hear a whisper while driving at highway speed. Despite looking somewhat like a sports sedan, the Tesla has extra seats in the rear area which look rearward making it possible to carry 6 passengers if two of them are children and enjoy the back seat - which my neighbour's children found a wonderful experience.

I think Tesla will sell a lot of vehicles. Some see 40,000 in 2014 and continued growth thereafter. The existing Tesla assembly plant on 3 shifts is likely capable of producing 300,000 vehicles, so scaling up should not be much of a problem.

Taking the quarterly results, annualizing research and development costs and selling general and administrative expenses and then inflating each of these materially, I prepared a model of Tesla at 125,000 vehicles annually, set out below:

Tesla Motors Inc.

Volume

ASP*

NSB

125,000

$ 75,000

$ 9,375,000

Cost of sales

$ 7,049,784

Gross Profit

$ 2,325,216

R&D

$ 300,000

SG&A

$ 400,000

Sub-total

$ 700,000

Operating income (loss)

$ 1,625,216

Interest and other

-$ 73,636

Pre-tax income (loss)

$ 1,551,580

Tax provision

$ 449,958

Net income

$ 1,101,622

Earnings per share

$ 9.32

Click to enlarge

At that volume Tesla should earn over $1 billion net income, more than $9.00 per share. Is that pie in the sky? I don't think it is. Well designed cars can capture a significant share quite quickly. Ford's new Fusion, for example, sold over 180,000 units year to date July in the United States alone, and each of the top 25 vehicles is likely to sell over 125,000 units this year. The question is whether a $75,000 upscale sports sedan can capture that kind of volume.

Of course Tesla is not only sold in the United States but also in Europe and Asia. If Tesla continues to advance its technology there is little doubt in my mind that it will gain traction. In my view, Tesla has a decent shot at 40,000 vehicles in 2014 and continued double digit growth beyond. It does not hurt that the vehicle recently was awarded the highest safety rating by the National Transportation Safety Administration.

North American sales of the Tesla should be sufficient to get the company to 40,000 vehicles annually. Sales in Europe and Asia will likely be needed to go beyond that figure, and the build out of infrastructure to support electric vehicles will be necessary before such cars become main stream. But I would not count Tesla out or conclude it is grossly over valued. Tesla is highly valued, but with the possibility to grow into that value over a relatively short number of years. And, unlike its major competitors it does not have legacy pension issues, difficult labour relations with militant unions and a spotty record of quality and service. Perhaps those will come in time, but for now it is on a winning track and while I would stop short of suggesting it as a buy at today's price I would caution against shorting the stock. This car can run.

I have no position in Tesla but will buy on weakness.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within 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.