The thought will probably provoke laughter. A well-known stock like Tesla (TSLA), up already over 400% this year, still has another 1,000% to go compared to its December 31, 2012 close. No question that Tesla currently trades at nosebleed valuation levels using any historic ratio you can dream up and compare them to long-established car companies such as General Motors (GM) and Ford (F). So how on this green Earth can I sit here and tell you $500 per share may very well be in the cards?
The answer is using simple math and clues from Tesla's conference call. Let me walk you through it while I simultaneously remain conservative.
Step #1: Sales And Production
First and most important point are two key statements from CEO Elon Musk from the Q2 conference call:
We have production constraints, not demand constraint.
So that's where we are really spending our time line, is clearing up those production bottlenecks or supply chain bottlenecks. I think we should have probably cleared most of the amount in the next six months.
Okay, so where does he see production? Aside from the 40,000 annualized bare minimum in production in late 2014 with upside potential of it being higher, where is he ultimately targeting production?
ultimately...producing 0.5 million vehicles a year...I certainly see a clear path. I do not see obstacles. I see a fairly clear path to that vehicle.
Okay, so the target is 500,000 vehicles. But that would involve building entirely new facilities from scratch, no? No. More from Elon Musk:
What we did was, we brought about half, I guess, of the south land parcel and NUMMI as a whole as a factory had about half million unit capacity. So production needs to be slightly more space efficient than to achieve the 500K number or buy some more land.
NUMMI, or New United Motor Manufacturing Inc., used to be jointly owned by Toyota and General Motors for 26 years and had a 500,000 vehicle capacity. As Elon Musk mentioned, they need to be "slightly" more space efficient to achieve 500,000. It doesn't sound like much of a challenge.
Step #2: Demand and Gross Profit Margins
A common misconception is that the Tesla vehicle will always be a luxury car only affordable to financially elite. The misconception continues that demand simply won't be there to absorb all the extra vehicles produced as production ramps, and Tesla will be forced to cut its prices and margins severely.
I counter that myth with two more things from the conference call. First, Tesla is targeting 25% gross profit margins beginning in Q4 of this year (excluding ZEV credits, so even higher with ZEV credits). Let's assume zero ZEV credits to again remain conservative. At around $80,000 per car, that's $20,000 in gross profit margins.
Next, again from Elon Musk:
I have high confidence that we can create a compelling [COGS] for around $35,000, compelling meaning a 200 mile range.
This means Tesla can drop the price from $80,000 to $55,000 and still keep its gross profits of $20,000 per vehicle. At $55,000, the Tesla car is far more affordable. At $55,000, it's no longer a super luxury car, yet it is equally as profitable to Tesla. Deduct another $3,000 for gas savings from the free supercharging stations and add in any other state or local various subsidies and credits available and the cost gets even cheaper. The monthly financing and other expenses will be less than many BMWs or Mercedes vehicles.
Step #3: R&D and SG&A
It's very difficult to predict the R&D and SG&A expenses in the future. We know they will all go up, but to what degree and at what percentage of sales? This bearish article uses 10% even though both General Motors and Ford had smaller figures for last quarter of less than 10%. Tesla certainly is on the path to producing far better ratios across the board. Nonetheless, in the effort to remain conservative with the numbers, let's use the 10% bear argument or $5,500 per vehicle.
Final Step: Add it all up.
500,000 annual vehicles forecasted.
$20,000 per vehicle gross profit margins.
$5,500 per vehicle R&D + SG&A.
Comes to $7.25 billion in profit.
Take out 30% in taxes (some bears have used 25%).
Leaves $5.075 billion in net income.
Use a 12 P/E ratio similar to often-compared General Motors and Ford (while ignoring the fantastic growth of Tesla) = $60.9 billion
$60.9 billion is roughly a $500 per share price.
Disagree with my math? Please comment below!