In fairness and for all the craziness around Tesla Motors, Inc. (TSLA) it is important to separate reality from an overzealous and over reactive stock market. Lately, all the hindsight experts have been quick to seize on the opportunity to comment on "bubble" predictions they never made. Tesla's 52 weeks range from $31.52 - $194.50 inherently has qualities of a bubble. A drop, however, to the low $120's is more of a reset than the burst that it is being made out to be. The stock has lost some buoyancy but I am sure the early investors have no complaints with a YTD return greater than 200%. A 200% pick is relatively rare, so let's not be quick to dismiss it and make it less of the success it actually is. Investing in Tesla was always a bet on the company's potential rather than its fundamentals. Investors who buy stocks on potential must accept that they are taking a risk which can be hard to quantify. In my opinion, the market is simply rethinking how it evaluated the price it set for Tesla's potential and every cycle of review only helps to make the valuation process more accurate. In this article, I am going to crawl through the most recent 10Q and shareholder letter from Tesla Motors. My objective with this review is to provide a platform to judge Tesla on what it is actually supposed to deliver.
It would not be a Tesla article if I totally avoided any mention of the Model S fire incidents. These incidents have received exhaustive coverage on Seeking Alpha and other portals and I will not rehash them. I deem the fires to be a static issue and an expected outcome as more Model S hit the roads. The perception of perfection related to the Tesla brand was always senseless any way you looked at it. The fallout from the incidents will be material if it turns out the Model S has engineering or design flaws that can translate to increased liabilities or impact future demand or sales. Otherwise, they are blemishes that will be polished off with the next good headline. With that out of the way, let's get back to the Q3 10Q and shareholder letter for nuggets on material factors that can help with our determination of the investment quality of Tesla Motors Inc.
Revenue and Revenue Drivers:
- Revenue grew 966% over the same quarter in 2012 driven by the delivery of 5500 Model S vehicles (European deliveries commenced in August)
- Third quarter zero emission vehicle (ZEV) credit sales were $10.4M compared to $51.5M in Q2 with total regulatory credits recognized in Q3 at $14.8M. ZEV credit sales contribute to margin, so continuous decline could impact margins even though the 10Q stated margins should rise to 25% with no revenue from ZEV credit sales.
- As of September 30, 2013 deferred revenue for undelivered items was $7.2M for Supercharger network usage and $17.5M related to purchase of vehicle service plans
- Powertrain component and related sales fell by about $2M and as a percentage of total automotive sales from 21% to 2%.
- Development services revenue which is revenue derived from development of electric vehicle powertrain components and systems for other automobiles manufacturers, including design and development of battery packs, drive units and chargers developed to customer specifications was at $1.2M for three months ended September 30, 2013. An increase of $0.1M from same period in 2012. The nine months period total for 2013 was $11.3M, a decrease from $15.6M for the same nine month period in 2012.
Vehicle, options and related sales is clearly outpacing other automotive sales categories. Production of the Model S is at 550 units per week with over 5,500 deliveries in Q3. All other sources of revenue have declined as a percentage to total automotive revenue and in most cases also declined over previous or comparable periods. Development revenue increased very slightly but no new contracts were reported. A headline item related to this was a Daimler related comment expressing a desire to increase its relationship with Tesla. The latter is not a 10Q or shareholder letter item and is added only for relevance.
Car Sales: Improvements in sales, global expansion, production and strong demand
Powertrain/Components: Needs to grow to validate market acceptance of Tesla's powertrain technology
Development/ZEV Credit: Development revenue has potential to grow but ZEV credits may decline to zero
Sales Related Initiatives:
- The resale value guarantee offered to customers is accounted for as an operating lease on a "best estimate" basis. The accuracy depends on actual depreciation and can be adjusted if estimates are materially different from actual. As of September 30, 2013 $160.8M was recorded as deferred revenue and $159M in resale value guarantee related to Model S deliveries.
- Provision for Warranty allocation for the three months ended September 30 was $18.4M or 4.27% of automotive sales for the quarter. For the nine months period ending September 30 the total provision was $43.8M or 3% of total automotive sales.
Warranty cost is a line item that garners a lot of attention especially with recent Model S fires and an NHTSA investigation. Total warranty costs incurred for the quarter was at $6.4M. With about 19K cars on the road that is about $336.8 per car. This number should change with increased sales, age and usage of the cars. Accidents, thefts and other headline grabbing items should be covered by customer insurance policies so this number should not be impacted by the headline grabbing items.
The resale guarantee program is a brilliant method of incentivizing trial and protecting the resale value of Tesla cars. If reliability or safety issues emerge, the resale value guarantee could materially impact revenue and net income due to the accounting method of the resale guarantee program. There are currently no comments in the 10Q or industry research to indicate this could be the case. The total for provision for warranty is at 4% of total automotive sales.
Revenue by Region:
Tesla sold over 5,500 Model S vehicles in Q3 a slight increase over 5,150 vehicles for Q2. Over 1000 deliveries were made to European customers in Q3 with Norway and Germany getting specific references for sales and development of the Supercharger Network development. The 10Q mentioned that Tesla Motors started accepting reservations for Model S in China during Q3 with estimated delivery to begin in 2014. North America continues to be the key area with Europe not far behind considering that vehicle deliveries only began in August. No mention was made of the expected demand in China but if demand is only a portion of what other luxury brands sell in China, China could become a key market for the brand.
New Models and Batteries:
Clippings from the 10Q in relation to new models and battery arrangements are easy to understand and are quoted verbatim.
- Model X Related:
- "We currently plan to start production of the initial units of Model X in late 2014 and subsequently ramp up to full production by the second quarter of 2015".
- "The following three performance milestones were considered probable of achievement:
- Successful completion of the Model X Engineering Prototype (Alpha)
- Successful completion of the Model X Vehicle Prototype (Beta); and
- Completion of the first Model X Production Vehicle."
- "Finally, in October 2013, we entered into an amendment to our existing supply agreement with Panasonic Corporation in order to address our anticipated short- to medium-term lithium ion battery cell needs. While we expect that this supply agreement, as amended, will provide us with sufficient cells for the next few years, we may not be able to meet our long-term needs, including for Gen III and other programs we may introduce, without securing additional suppliers or other sources for cells. If we cannot secure such additional suppliers or sources, we could experience production delays, which could have a material adverse effect on our financial condition and operating results."
Tesla's responsibility is to manufacture cars, powertrain components and technologies that it sells to its customers and other OEMs. The 10Q addresses successes and challenges as fairly as you can expect from a biased source without creating the need for inferences or damage. You could, for example, infer that Tesla sees potential of issues related to its ability to meet future battery needs. You could also infer that Germany and Norway are crucial entry points into Europe. Tesla should not be judged for things beyond its control including outcomes beyond a reasonable range of expectations. The penchant by pundits and investors to gain from predictions can be blamed for the irrationality of the market. Without considering external factors Tesla continues to make gains in vehicle sales and production capacity. I am a bit concerned about the decline in development and powertrain components revenue relative to automotive sales. My concerns hinge on the fact that Tesla might never fulfill its valuation if it increasingly becomes a car company and has to compete with the more capable and diversified car manufacturers. Sales of components and development contracts provide revenue, diversification and also help with maintaining a competency gap to other manufacturers.
Tesla's stock will continue to fluctuate but with every cycle, a new opportunity opens to test new resistance levels and validate certain assumptions. At time of writing, Tesla's stock had just experienced its biggest jump in six months after the German Federal Motor Transport Authority cleared the Model S of any "manufacturer-related defects." The stock was up 17% up to $144.70 from the low $120's. Tesla has shown that it is a momentum stock and technical investors should watch the Keltner channels for movement especially if support is in the $120's. I am going to keep my eye on revenue or headlines related to powertrain components and development initiatives with other manufacturers. Ultimately, I believe that those two lines are a better market indicator of the gap between Tesla Motors and its competitors. Lastly, there needs to be some realism about Tesla Motors as it relates to the inevitable wear and tear factors including quality issues that will crop up from accelerating the car manufacturing process. Car companies do voluntary and involuntary recalls frequently and if it did not kill Ford (F) or Toyota (TM) it is not going to kill Tesla. Eventually, the fundamentals and the share price are going to converge. If today was the last day of 2013, TSLA would be a success story for those who believed early and bought the stock.