Tesla (NASDAQ:TSLA), which is arguably the most popular of the momentum stocks, reported first-quarter results after the bell on Wednesday. By and large, the company did report solid numbers, but shares fell by around 8% after-hours. With its current multiple, Tesla has an amazingly high bar, and the good results are simply not enough to move shares higher. After all, Tesla's market capitalization is nearly half of General Motors' (NYSE:GM) despite the fact it sells 1% as many cars. It goes without saying that Tesla is growing exponentially faster than a mature company like GM, but with this valuation discrepancy, it needs to deliver perfect results with the promise of uninterrupted growth. Otherwise, future cash flows may not justify the current lofty valuation.
In the first quarter, TSLA earned $0.12 on $713 million in non-GAAP revenue while analysts were looking for $0.10 on sales of $700 million (all financial and operating data available here). Revenue was up 27% year over year. On a GAAP basis, revenue was $620 million because of the deferral of lease revenue. Gross margins were solid at 25.4%, up 20bp sequentially, and gross margins should continue to increase next quarter with the potential of reaching 28% by the end of the year as retrofitting expenses decline. With only $0.12 in earnings, Tesla will need to dramatically grow revenues over time to justify a share price over $180.
To do this, Tesla has been adding capacity to meet the demand for its luxury electric cars. Tesla's already announced, but yet to be located, Gigafactory will play a critical role in expanding capacity and lowering the cost of batteries so Tesla can offer a cheaper model. We are seeing the company make progress on capacity issues, and the company produced 7,535 model S cars. Production is now running at nearly 700 vehicles per week, up 15% from the fourth quarter. By the end of the year, Tesla expects to increase production by about 56% to 1,000 vehicles per week. Thanks to investments in capacity and production increases from suppliers, production should increase another 16% sequentially to 8,500-9,000 vehicles in the second quarter.
One slightly disappointing metric was car deliveries, which continue to lag production. First quarter deliveries were 6,457, which was below the fourth quarter's 6,892. In the second quarter, it expects to deliver 7,500 vehicles. This means that in the first half of the year, Tesla will produce about 2,250 more cars than it delivers. Tesla blames this discrepancy and longer lead-times for deliveries in Asia. These vehicles are mainly in transit to Asia and Europe, but in the second half of the year, I hope to see Tesla improve delivery times to minimize this difference and avoid a significant backlog.
To expand capacity and maintain its technical edge, Tesla is spending aggressively. Operating expenses doubled year over year, dwarfing the 27% revenue gain. SG&A spending was up 150% year over year, while R&D jumped 48%. This spending binge is not over, either, as SG&A should increase 15% quarter on quarter while R&D outlays will jump 31%. Thanks to these increases, Tesla will only be "marginally profitable" in the second quarter.
This spending binge also is impacting cash flow. Operating cash flow was $61 million in the quarter, but capital expenditures totaled $141 million. For the full year, TSLA expects cap-ex spending to be $650-$850 million. For the full year, Tesla will be free cash flow negative. Tesla has the balance sheet to afford this spending. At the end of the quarter, cash and short-term investments were $2.58 billion against $2.11 billion in long-term debt for a comfortable net cash position of $470 million. With this cash balance, Tesla can afford to be slightly free cash flow negative in order to invest in growth.
Investing in growth is critical because Tesla needs to accelerate revenue growth over the next three years if it is going to justify its current valuation. Tesla is making good progress in expanding production with its 1,000 vehicles per week end of year forecast. With this progress, Tesla is on track to deliver 44-50% revenue growth in 2015 on top of this year's 46-50% growth. Even then, Tesla will be delivering less than 55,000 vehicles in 2015, which gives it about $3.00 in earnings power. To merit today's price, Tesla will need to maintain the current pace of production growth and robust gross margins for several years.
If Tesla can get to 150,000 vehicles in 2017, it can generate about $8-10 in earnings power. To do that, Tesla will need to continue to expand production and significantly cut the cost of batteries to introduce an entry-level model that more consumers can afford. Even under this best-case scenario, Tesla is trading 18x earnings that are three years away. There is still significant risk that production growth becomes slower or that battery costs remain elevated. There is also the ever-present risk that another automaker is able to deliver competitive battery technology and steal share back from Tesla, which would dampen growth.
Tesla is a high-risk investment. The company is performing well and has a fantastic product; there is no doubt about that. Valuation, though, ignores the significant execution risk as it isn't easy to increase production six-fold over four years. Even if it does that, an 18x 2017 earnings multiple is not particularly cheap. Investors who are bullish on Tesla and believe CEO Elon Musk can continue to deliver should probably wait for the pullback to deepen before buying shares. At 15x 2017 bullish estimates or around $140-$150, Tesla does make sense as a speculative long for investors who believe in the growth story. Either way, if you had to buy a stock today and were not allowed to sell it for four years, I continue to believe you will do better buying GM. Tesla is priced for perfection, and letting the stock pull back further is the prudent strategy.
Disclosure: I am long GM. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.