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Summary

  • Tesla, as a stock, has never seen a long-term downtrend.
  • It's going to happen at some point, but the question is when?
  • With the market robustly valued and Tesla pushing all-time highs, we can't force ourselves to buy it.

Tesla (NASDAQ:TSLA) has certainly been one of the biggest names in the stock market since it first made its initial public offering. Since then, shares have made an outstanding run to the upside that has been a real money maker for those that bought early on.

I see Tesla salivated about by bulls on this site often, and I understand the appeal. The company has a beautiful product with a CEO that some hail as the "next Steve Jobs."

The question we ask, however, is "how long can this continue?"

TSLA Chart

TSLA data by YCharts

If there's one thing we've seen in our time investing, it's that every Cinderella story eventually has to meet some type of reality. We watched this with the dot com bubble in 2001 and we saw it with the sub-prime crisis of 2007.

On a day-by-day case, different Cinderella stocks eventually wind up paying the piper one way or another. Look at Vringo (NASDAQ:VRNG), for instance, just days ago. Another example is the reality Twitter (NYSE:TWTR) faced months ago before turning itself around.

"All good things must come to an end."

One worry we have is the valuation in this market climate. Tesla is able to support its very forward thinking P/E ratio due to the fact that many investors are either:

  • betting on the momentum
  • betting on the long-term future
  • investing based on analyst and blog opinions

We're not sure that Tesla's multiple can stay this high in today's macroeconomic climate. There have also been questions raised recently about the quality of the company's drivetrain.

Elon Musk posted a blog on Friday and addressed an "infinite mile warranty" for the drivetrain on their vehicles, something that is no doubt going to affect the accounting for warranty reserves the next time the company reports:

"The Tesla Model S drive unit warranty has been increased to match that of the battery pack. That means the 85 kWh Model S, our most popular model by far, now has an 8 year, infinite mile warranty on both the battery pack and drive unit. There is also no limit on the number of owners during the warranty period.

"Moreover, the warranty extension will apply retroactively to all Model S vehicles ever produced. In hindsight, this should have been our policy from the beginning of the Model S program. If we truly believe that electric motors are fundamentally more reliable than gasoline engines, with far fewer moving parts and no oily residue or combustion byproducts to gum up the works, then our warranty policy should reflect that.

"To investors in Tesla, I must acknowledge that this will have a moderately negative effect on Tesla earnings in the short term, as our warranty reserves will necessarily have to increase above current levels. This is amplified by the fact that we are doing so retroactively, not just for new customers. However, by doing the right thing for Tesla vehicle owners at this early stage of our company, I am confident that it will work out well in the long term."

Namely, our concern is that the company's warranty reserve is going to continue to grow. The number is up to $84.4 million from $36.9 million a year earlier. For now, this is moving in lock step with the amount of vehicles that are sold. Going forward, this number stands to get exponentially bigger, especially as Model S sedans get further and further into their lifecycle.

Kudos to Logical Thought for being the first to bring up this issue nearly a month ago. Talk about hitting the nail right on the head. He estimated that Tesla could be "under reserving" each vehicle to the tune of $2,000 to $2,500 per vehicle; startling figures that will no doubt catch up to the company before soon.

The second worry I have is that CEO Elon Musk is spread too thin. The wealthy young turk that presides over everything the company does also happens to be the Chairman of an entirely different public company, SolarCity (NASDAQ:SCTY). In addition to that, Elon is also the founder of the rocket company, Space X. Surely Elon loves to have his candle burning at both ends. However, here at the Peel, it's worrisome to us that:

  • He oversees and is in involved with so many projects
  • There have been musings about his eventual departure from Tesla
  • People like Elon Musk have a tendency to get bored, and have enough money to move on to whatever they want

The Peel's Feel:

You can see from our article here that we believe the market is robustly valued as whole, and that we're expecting a correction, if not the beginning of an end to the bull market we've been in for the last 5 years.

Buying Tesla here, at least for the short to moderate term, seems like a prescription to potentially be a bagholder. On the other hand, the momentum behind this stock is impressive and we're not sure that this is the time to get in on the short side, either.

Should Tesla fall much lower than our target, or should the company release positive news of a material nature relating to significant improvements in the speed and execution of its business, we'd be happy to take a second look.

We're initiating Tesla with a RIPE (HOLD) rating and a price target of $210, which we expect to see by the end of this year as a product of reality setting in on the stock, increased warranty reserves, changes in accounting, and the macro market climate losing its bullish fervor.

Source: Tesla Rated Ripe: Too Scared To Touch It