It is difficult not to like an ambitious company like Tesla Motors (TSLA). The groundbreaking technological progress and the quality both from a performance as well as aesthetic perspective are to be admired. However, at current valuations, we believe Tesla is worth $100 per share. One of the biggest challenges moving forward is whether Tesla can carry over its domestic success to international markets.
Tesla is pursuing an aggressive path to expansion both domestically as well as internationally. The Model S has sold around 15,000 models since its debut and the demand is expected to ramp up to around 20,000 per year moving forward. Customer opinion on the model has been so far positive, scoring a perfect score in terms of safety and reliability.
Whereas domestic sales are picking up, international sales are still in early stages. Sales in North America have jumped more than 3600% year over year for the first half of 2013, whereas European revenue growth was cut by half in the same period, suggesting European sentiment for Tesla may not be as strong as it is domestically.
So far, most European success has come from Norway, with over 800 units delivered, more than Netherlands, Denmark and Germany combined. The success of Tesla in Norway is tied to favorable government tax incentives and other perks that bring the cost of owning a Tesla down. However, we see price as a factor that could limit demand in the rest of the European countries. Most other European countries can expect a 20% markup due to additional expenses on logistics and import taxes. The European Model S has a 60K Euro base price ($82K), compared to the US domestic price of $62K after tax incentives.
One particular European country that could pose a problem to Tesla is Germany. The country is home to the top 3 leaders of luxury automobiles, namely Mercedes Benz, BMW and Volkswagen. For the month ended August 2013, the top three best-selling brands were Volkswagen, Mercedes, Audi and BMW taking 5th spot. The German automobile market is essential to European success as it represents more than 20% of all new passenger car registrations within European Union countries. Even with or without tax incentives, it may be hard to challenge the German consumer's loyalty to these iconic local manufacturers.
From a luxury point of view, Tesla is overall an elegant automobile. For a Mercedes enthusiast that sees a Tesla for the first time, he will notice the Model S uses the same gear shifter on the steering wheel as many Mercedes models have used in the past. This aesthetic similarity may seem the Model S is copying the Mercedes brand, although in reality there is a trade of technology between the two companies. The Model S also misses some small features that are either standard or available for most luxury brands. Some of the features are auto folding rear view mirrors, soft close assist for doors and parking sensor, among others. The lack of these small features knocks the Model S one notch below its competitors.
As an electric car, the Model S must compete with the likes of Smart EV, Renault Zoe and Nissan Leaf. All 3 models outsold Tesla in the month of September in Germany. Tesla is in no way similar to these models in terms of size or body style, but in the eyes of German consumers, they serve the same purpose: eliminate fuel consumption.
The biggest difference between the European and American automobile market boils down to fuel type used, as Diesel is the top fuel choice in Europe. Mercedes, Audi and BMW are the top producers of new diesel cars that are not only environmentally conscious, reducing CO2 emissions, and offer better mileage per tank as well. Diesel is also cheaper than regular gasoline in Europe, compared to the United States where the opposite is true.
The value of the stock is well ahead of the company's fundamental valuations. The stock price defies conventional investing principles and is propelled by high expectations, factoring in expected earnings for models like the Model X that is not even available for sale yet. With no solid financial data, the current share price is speculative.
Gross profit margin currently sitting at 16% will improve as more units are sold. Capital spending is likely to increase in the near future due to infrastructure expenses both domestically and internationally. Tesla plans to have a facility within a 200-mile range for a select number of European countries by the end of 2014. The problem is there is no free cash flow and, while there is cash on hand, Tesla is also looking to expand in Asia at the same time. The company may be stretching its financial reach to the limit too soon. Even if we assume Tesla will sell 90K units in 2017 and operating margin drops to 15%, which is close to that of Porsche and an estimate of $55K per unit, we believe Tesla should currently be priced at $100 according to our DCF model.
It will be a difficult task for Tesla to break not only the German market, but the overall European automobile market. Domestic and international consumers may not share the same vision for the company. Tesla expects to sell 20,000 units within the European market, but this feat may not be easily accomplished in the near future.
Domestically, Tesla started offering in April 2013 a "resale value guarantee," whereby customers are welcome to sell their car back to the company within 36-39 months of initial purchase. It will be an interesting statistic to see how many customers decide to take advantage of this offer. This would be a good indicator whether Tesla is more than just a short lived trend.
Additional disclosure: Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. Business relationship disclosure: I have no business relationship with any company whose stock is mentioned in this article. The Oxen Group is a team of analysts. This article was written by David Ristau, one of our writers. We did not receive compensation for this article (other than from Seeking Alpha), and we have no business relationship with any company whose stock is mentioned in this article.