As part of our process, we perform a rigorous discounted cash-flow methodology that dives into the true intrinsic worth of companies. In Tesla's (NASDAQ:TSLA) case, the firm's shares are finally fairly valued.
At Valuentum, we think a comprehensive analysis of a firm's discounted cash-flow valuation, relative valuation versus industry peers, as well as an assessment of technical and momentum indicators is the best way to identify the most attractive stocks at the best time to buy. This process culminates in what we call our Valuentum Buying Index, which ranks stocks on a scale from 1 to 10, with 10 being the best. Essentially, we're looking for firms that overlap investment methodologies, thereby revealing the greatest interest by investors (we like firms that fall in the center of the diagram below). More interest = more buying = greater likelihood the stock price will increase to intrinsic value.
If a company is undervalued both on a DCF and on a relative valuation basis and is showing improvement in technical and momentum indicators, it scores high on our scale. Tesla currently posts a VBI score of 4 on our scale. In our relative valuation component, we compare Tesla to peers Ford (NYSE:F), General Motors (NYSE:GM), and Honda (NYSE:HMC).
• Tesla's strategy is to accelerate the world's transition to electric mobility with a full range of increasingly affordable electric cars. The Model S, the world's first premium sedan to be engineered from the ground up as an electric vehicle, began deliveries in June 2012.
• Tesla's stock volatility is not for the faint of heart. Shares have been on a roller coaster ride, and investor expectations have been ratcheted higher. At current levels, we still view it as a very speculative play.
• Tesla continues to transition to a mass production car company. At the beginning of the third quarter 2012, it was producing 5 cars per week. By the end of that quarter, it was making 100 cars per week. The company plans to consistently produce 400 cars per week and generate 25% gross margins, goals we expect the firm to reach during 2013.
• Tesla reached profitability in the first quarter of 2013 for the first time in its ten year history. During the period, the company exceeded its own targets for deliveries, while it significantly improved its gross margin. We were impressed.
• The firm experienced a revenue CAGR of about 26.5% during the past 3 years. We expect its revenue growth to be better than its peer median during the next five years.
Cash Flow Analysis
Firms that generate a free cash flow margin (free cash flow divided by total revenue) above 5% are usually considered cash cows. Tesla's free cash flow margin has been poor during the past 3 years. As such, we think the firm's cash flow generation is relatively WEAK. The free cash flow measure shown above is derived by taking cash flow from operations less capital expenditures and differs from enterprise free cash flow (FCFF), which we use in deriving our fair value estimate for the company. For more information on the differences between these two measures, please visit our website at Valuentum.com. At Tesla, cash flow from operations decreased about 126% from levels registered two years ago, while capital expenditures expanded about 21% over the same time period.
Our discounted cash flow model indicates that Tesla's shares are worth between $96 and $160 each. Why such a large range? Click here. The margin of safety around our fair value estimate is driven by the firm's MEDIUM ValueRisk™ rating, which is derived from the historical volatility of key valuation drivers. Our model reflects a compound annual revenue growth rate of 67.6% during the next five years, a pace that is higher than the firm's 3-year historical compound annual growth rate of 26.5%. Our model reflects a 5-year projected average operating margin of 10.7%, which is above Tesla's trailing 3-year average. Beyond year 5, we assume free cash flow will grow at an annual rate of 15.4% for the next 15 years and 3% in perpetuity. For Tesla, we use a 10.7% weighted average cost of capital to discount future free cash flows.
Margin of Safety Analysis
Our discounted cash flow process values each firm on the basis of the present value of all future free cash flows. Although we estimate the firm's fair value at about $128 per share, every company has a range of probable fair values that's created by the uncertainty of key valuation drivers (like future revenue or earnings, for example). After all, if the future was known with certainty, we wouldn't see much volatility in the markets as stocks would trade precisely at their known fair values. Our ValueRisk™ rating sets the margin of safety or the fair value range we assign to each stock. In the graph below, we show this probable range of fair values for Tesla. We think the firm is attractive below $96 per share (the green line), but quite expensive above $160 per share (the red line). The prices that fall along the yellow line, which includes our fair value estimate, represent a reasonable valuation for the firm, in our opinion.
Pro Forma Financial Statements
Additional disclosure: F is included in the portfolio of our Best Ideas Newsletter.