Tesla (TSLA) was one of the hottest stocks of 2013. Shares of the company have appreciated more than 300% year-to-date and were even trading at over $193 during the end of September. But the stock took a beating in October as the company couldn't satisfy the analysts' estimates on sales. November wasn't any different either. The news of Tesla's Model S catching fire pushed the stock to below $125. However, the stock has started rising again and I believe that there is a good reason why it will drop again in the upcoming years, thus making it a worthy short candidate.
The company expects to sell 21,000 cars in 2013 and is presently trading at above $150, which translates into a market cap of just under $18.50 billion. But given the amount of cars Tesla sells, this valuation is too high to be justified.
In the table below, I have compared Tesla's share price with its production and profitability and compared it against the other big guns of the automobile industry and this is how the results stacked up.
General Motors (GM)
Toyota Motor (TM)
Honda Motor (HMC)
Source: Yahoo Finance, Bloomberg, Zacks and Author's Calculation
Evidently, Tesla is charging close to $878,571 per car, which translates into nearly 13 times the actual cost of the vehicle under the assumption that it is free to manufacture! Given real operating gross margins of 13% on its $70,000-priced Model S, Tesla is generating about $9,000 in gross profit from each car that it manufactures. Despite that, investors are placing an irrational valuation of around $878,571on every car! Going by such calculations, Tesla will need to enhance its production by 20 times in order to be twice as expensive as Honda, which is the next big car maker, on a value-per-car basis.
A 20-fold jump may seem far-fetched, but that is exactly what Tesla bulls anticipate and they expect it to happen before 2020. But even if the company somehow manages to multiply its production by a factor of 20, will it justify a market cap of $18.50 billion or will it have to sustain its growth for a longer period of time to justify today's share price? Let's take a look.
Obviously, there's no assurance that Tesla will meet the towering goals set by investors. As the company continues to ramp up the production of vehicles, there are a few roadblocks which may harm its progress. One major concern for Tesla is inadequate supply of batteries. Nevertheless, let's give Tesla the benefit of the doubt and assume that the company does manage to overcome all technical hindrances so that demand becomes the only parameter.
The company believes that there is adequate demand in the market for it to boost the production of the Model S to 40,000 units annually within a span of one year. The addition of a new crossover -- Model X -- in 2014 will augment the total demand, but on the flip side, the launch of the Model X might also cannibalize the demand of Model S to some extent. Whatever the case may be, it looks like Tesla will struggle to sell more than 100,000 luxury cars yearly anytime soon.
The real key to Tesla's success lies in the company's ability to innovate a lower-priced model without deteriorating its quality. Over the previous conference call, Elon Musk stated that he saw a "clear path" for starting the production of a $35,000 vehicle with a range of 200 miles, which could go into production by as soon as 2016.
Such an economical vehicle will have a lesser margin than the lavish Model X or Model S. Even though Musk is of the opinion that Tesla could probably provide competition to Porsche with gross margins of around 50%, it would only be likely if Tesla is able to maintain its Porsche-like average selling price of around $100,000.
A $35,000 car would have a lower gross margin of approximately 15%. But Tesla cannot afford to cut down quality; hence it must begin at a quality level consistent with other cars in the $100,000-price range, such as BMW's 3-Series, Daimler's Mercedes C-Class, or General Motors' Cadillac ATS. The cost of batteries and an electric Powertrain (when stacked up against a standard internal combustion engine) are added costs for Tesla. Also, if Tesla grows as per expectations, its vehicles will not be eligible for the $7,500 federal tax credit in the U.S., since the credit begins to phase out after a car maker manufactures 200,000 plug-in or all-electric vehicles.
Assuming Tesla can sell 400,000 "reasonably priced" cars in 2018 for $35,000 a piece at a 15% gross margin, it would earn just over $2 billion in gross profit. In comparison, Tesla's operating expenses currently clock an annual run rate of $450 million. However, with Tesla expanding its portfolio from one vehicle today to three to four different models in 2018, and growing sales by more than 20 times, operating expenses could easily jump to $2 billion, or higher, by then.
Simply said, while a cheaper car will help Tesla hit the mass market and sell higher volumes, most of the additional revenue will be negatively compensated by an accompanying increase in operating expenses. To generate billions of dollars in free cash flow -- which is what investors expect from Tesla going by its valuation -- Tesla will need to generate Porsche-like gross margins.
Hence, I think Tesla is highly-overvalued and will not be able to justify the stock price. With P/S of almost 11 and the stock pumped up by hype, it is not surprising to see that 48.60% of Tesla's float is short. Tesla has some real challenges ahead of it and that's why I think investors should consider shorting it.