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  • Tesla Motors Stock Price Driving Too Fast?

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    Tesla's Future Charged With Uncertainty By Morningstar Investment Research

    The carmaker is a formidable disruption threat, but even its CEO says the stock price looks high.

    Tesla Motors (NASDAQ:TSLA) has the momentum and charging infrastructure to be the dominant electric vehicle firm, but we do not see it having mass-market volume for at least another decade. Tesla's product plans for now do not mean an EV for every consumer who wants one, because the price points are too high. We think the Model X crossover due in 2015 will start somewhere between $55,000 and $70,000, but will average higher as consumers add options. The Model 3 sedan will start at about $35,000, according to an interview with CEO Elon Musk earlier this year, and will start selling in 2017 or 2018. This price is before any tax credits, but the $7,500 U.S. federal tax credit only applies to the first 200,000 vehicles Tesla produces starting Jan. 1, 2010.

    Tesla "Profit Rockets" Stock Pick

    About a year ago we put a buy recommendation on Tesla in our "Profit Rockets" Stock Pick Service. With Teslas current stock price at about $250 a share, that's a 100% gain in just over one year.

    07/29/13 - Buy Tesla Motors TSLA

    Buy Entry: 121.90 to 131.70

    Stop-Loss: 119.55

    Take Profit Areas: 141.56 to 144.85, 151.89 to 163.29, 180.93 to 210.36

    Tesla has said that when its gigafactory--a lithium-ion battery plant under construction in Nevada--is fully operational by 2020, it will be able to produce 500,000 vehicles a year at its sole assembly plant in Fremont, California. Without the gigafactory, Musk said on the July earnings call that the firm can make 200,000 vehicles "if you really push it." Even if demand exists for these vehicles, this quantity is quite small relative to total global auto production, which is likely to reach 100 million units in the next few years. Therefore, we think global mass adoption of pure electric vehicles is still a long way off. In the meantime, Tesla will have growing pains and perhaps more than one or two recessions to fight through before reaching mass-market volume. Even if industry forecasts of sub-1% market share for EVs prove far too conservative, it is important to keep the hype about Tesla in perspective relative to the company's very limited production capacity. Tesla's mission is to make EVs increasingly more affordable in order to bring electric mobility to the world, which means more assembly plants must come on line to achieve annual unit delivery volume in the millions. This expansion will cost billions a year in capital spending and research and development and will need to be done even during downturns in the economic cycle.

    Growth Runway Lucrative, but Value Destruction Possible We do not see an economic moat yet because Tesla is still early in its life cycle. This dynamic creates huge uncertainty as to whether the firm will succeed in continuing to make great product at an affordable price and whether enough consumers will make the switch from internal combustion engine and hybrid vehicles. There is evidence suggesting Tesla will succeed, but if not, Tesla will remain an automaker for the wealthy. In a January Automotive News interview, Musk said in regard to Tesla making it, "I think we will, but this is not a bold assertion we unequivocally will. There is a possibility we may not."

    Tesla's growth runway looks very lucrative, but this growth also requires constant substantial reinvestment in platforms, the gigafactory--for which Tesla is only spending about 40% of the cost while suppliers pay the rest--and annual assembly capacity, since the current plant in Fremont will eventually be limited to about 500,000 units. During this growth phase there will almost certainly be a recession or two. In times of economic uncertainty, it is difficult to say what Tesla's sales volume will be or what access, if any, the firm will have to capital markets.

    For a narrow moat rating, a company must have excess normalized returns more likely than not be positive 10 years from today, and there must not be any substantial threat of major value destruction. All three of our valuation scenarios have returns on invested capital good enough for a moat, with the metric averaging above our weighted average cost of capital of 9.5%, but we also see risk of major value destruction should EV adoption flop or occur much slower than any of our three 10-year forecast periods assume. For that reason, we wait for now to award Tesla a moat, but we see a positive moat trend as a result of the strengthening of the firm's brand and its cost structure.

    Although we stress the uncertainty in investing in Tesla today, the company's competitive position is better than some may expect from a tech startup that makes automobiles. Looking at our five moat sources, we see a case for brand (intangibles) and cost advantage as sources of a moat in the future. Some may argue for efficient scale, claiming that Tesla is the dominant pure EV firm. Although Tesla's long range gives it a huge advantage over pure EVs on the market (265 miles EPA range for the 85 kWh battery versus 84 miles for the Nissan LEAF and 76 miles for the Ford Focus), we consider Tesla's competition to be the entire auto industry rather than just EVs. There are far too many automakers all over the world for us to claim that Tesla's market is effectively served by a small number of players.

    Musk's own words do not support efficient scale. He wrote in a June 12 blog post announcing that Tesla would not sue companies that use its patented technology in good faith: "Given that annual new-vehicle production is approaching 100 million per year and the global fleet is approximately 2 billion cars, it is impossible for Tesla to build electric cars fast enough to address the carbon crisis. By the same token, it means the market is enormous. Our true competition is not the small trickle of non-Tesla electric cars being produced, but rather the enormous flood of gasoline cars pouring out of the world's factories every day."

    Outlook Uncertain for Electric Vehicles Investing in Tesla comes with tremendous uncertainties due to the future of electric vehicles and energy storage. Until the Model 3 goes on sale, there is no way to know for sure if consumers in large volume are willing to switch to an EV and deal with range anxiety and longer charging times compared with using a gas station. Tesla is fighting a state-by-state battle to keep its stores factory-owned rather than franchised, which raises legal risk for Tesla and could one day stall growth. The energy storage market for solar does not exist today, so there is very high uncertainty as to whether Tesla's plans will succeed. If the company's growth ever stalls or reverses, we would expect a severe decline in the stock price because current expectations for Tesla are immense, in our opinion. With a young, growing company, there is always more risk of diluting shareholders or taking on too much debt to fund growth. Tesla also has customer concentration risk, with the U.S., Norway, and China constituting about 77% of first-half 2014 revenue.

    We see Tesla's fate closely linked to Musk's actions, so should he leave the company we would not be surprised to see the stock fall dramatically. Also, Musk has more than 10 million Tesla shares as collateral for personal debt. Selling this block of shares quickly would cause a rapid fall in Tesla's stock price. Musk has also said that Tesla's stock price looks high and the short-term outlook on it is not clear. Given the many uncertainties regarding investing in Tesla today, our fair value uncertainty rating will remain very high for some time.

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    Disclosure: The author is long TSLA.

    Sep 15 7:33 PM | Link | Comment!
  • This Weeks Free Stock Pick - China E-Commerce

    DangDang China

    E-Commerce China Dangdang (NYSE:DANG) is a leading business-to-consumer e-commerce company in China. They have focused on selling books online since their inception and are now the largest book retailer in China. With a growing customer base, they have expanded into other products including fashion and apparel, baby, children and maternity and home and lifestyle products.

    In addition to offering products on its website, Dangdang also operates an online marketplace program, which allows third-party merchants to sell their products. Dangdang had its IPO in 2010. As of now, they resemble Amazon in its early years.

    Second Quarter Results

    Dangdang reported its Q2 results on August 14. Total net revenues for the quarter were $316.1 million, up 31.3% from the same period in 2013. Net Income for the quarter was $4.6 million, or 1.5% of total net revenues, compared with a loss a year ago. Results were better than street estimates.

    Dangdang expects about 30% year-over-year growth in net revenues for the third quarter.

    Rising Estimates

    Analysts have been raising their estimates for the company. Zacks Consensus Estimates for the current and the next year are now $0.18 per share and $0.42 per share, up from $0.07 per share and $0.34 per share respectively, 60 days ago.

    DangDang China

    Rising estimates sent the stock back to Zacks Rank # 1 (Strong Buy) Dangdang has beaten estimates in all of the last four quarters, with an average quarterly surprise of 99%.

    Booming E-Commerce Market in China

    With a fast expanding middle class and rising incomes, the Chinese e-commerce market looks set to grow exponentially in the coming years. According to a McKinsey report "the Chinese middle class, those earning from $9,000 to $34,000 a year, is poised to balloon over the next 10 years. More than 75 percent of China's urban consumers will fall into that demographic by 2022".

    Further, China has the largest number of Internet users in the world-more than 600 million-- about twice the population in the US. China is also the world's largest mobile phone market and smartphone sales which accounted for 82% of all mobile phone sales last year are still growing.

    It is thus no surprise that online shopping, particularly through mobile phones is seeing explosive growth in China. For Dangdang, mobile orders were 17% of total orders in the second quarter 2014 and rose to 22% in June.

    Per KPMG, "by 2015, e-commerce transactions in China are projected to hit USD 540 billion, or approximately 10 percent of total retail transactions, and by 2020, China's e-commerce market is forecasted to be larger than those of the US, Britain, Japan, Germany, and France combined.

    This report further states that "in 2012, mobile transactions totaled $7.8 billion, representing 3.7% of all e-commerce transactions in China. However, by 2015 mobile commerce in China is forecasted to more than quintuple, to $41.4 billion". Growing confidence in China's online payment systems further fuels this exponential growth.

    Alibaba IPO in Focus

    Earlier this year, my colleague Kevin Cook featured Dangdang as the "Bull of the day", He wrote "If Wall Street makes the Alibaba IPO a success, it will be a big validation for lots of Chinese companies. And for DANG investors specifically, it could be a real boost. A cash-rich Alibaba may look to expand its e-commerce empire with further partnerships and acquisitions".

    The Bottom Line

    With rising margins and profitable product lines in a fast-expanding market, Dangdang looks poised for solid growth in the coming quarters.

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    Disclosure: The author has no positions in any stocks mentioned, but may initiate a long position in DANG over the next 72 hours.

    Sep 15 7:03 PM | Link | Comment!
  • Would Crude Exports Mean The End For Refiners' Moats?

    Energy Investing

    Would Crude Exports Mean the End for Refiners' Moats? By Morningstar Investment Research

    They would eliminate a key competitive advantage, but aren't necessarily a death knell.

    The Commerce Department's decision to allow two companies to export lightly processed lease condensate raises the question of whether a full repeal of the domestic crude export ban is coming. Unmitigated exports of domestic crude remain unlikely, but the risk is now higher. In the event of repeal, we think refiners would lose the primary source of their cost advantage, as light crude feedstock discounts would be diminished. While refiners' narrow moats rest largely on this cost advantage, its loss does not automatically mean they will lose their Morningstar Economic Moat Ratings. Some refiners would continue to enjoy a feedstock cost advantage, while other competitive advantages could contribute to ensuring excess returns. After analyzing refiners' competitive advantages and returns, we find HollyFrontier (NYSE:HFC), Western Refining (NYSE:WNR), and Phillips 66 (NYSE:PSX) would retain their moats. Valero (NYSE:VLO), Tesoro (NYSE:TSO), and Marathon Petroleum (NYSE:MPC) would not. We find the greatest value in Western and Tesoro. HollyFrontier is undervalued as well, but is more exposed if exports occur.

    With Crude Exports, Most Refiners Lose a Key Competitive Advantage

    Access to cost-advantaged feedstock was the primary factor behind U.S. refiners earning narrow economic moats. Growing U.S. unconventional light crude production and a ban on crude oil exports resulted in domestic production being discounted to world prices. This discount granted U.S. refiners a cost advantage relative to international peers. With discount light crude, U.S. refiners' crude slates could be composed completely of cost-advantaged feedstock. The earnings uplift from light crude discounts, combined with the relatively low capital intensity of the logistics assets and processing equipment needed to capture those discounts, produced higher sustainable returns compared with the past. Thus, refiners earned narrow moats.

    Reversal of the export ban has always been the greatest threat to this advantage. Without the ban on exports, we estimate U.S. light crude discounts would narrow and refiners would lose their structural advantage. We think the decision to allow exports of lease condensate that has been minimally processed increases the risk of an export ban reversal from when we first awarded refiners narrow moats. However, the decision really marks more of a clarification of export rules rather than a wholesale change in policy. As a result, we think a complete export ban reversal remains a low-probability event.

    We expect any change in policy would face immense political opposition. The condensate announcement alone prompted several members of Congress to question the Commerce Department about the decision. The department subsequently issued a statement essentially reiterating the existing policy, implying no changes had been made. Reports indicate subsequent applications have been put on hold. The swift response probably portends an even greater one in the likelihood of an official proposal to allow exports. Combined with the midterm elections later this year, further action in 2014 seems unlikely.

    That does not mean a reversal of the export ban is inconceivable. In addition, a wide variety of policies exist between the current situation and a complete export ban reversal. Instead of trying to identify each one of those potential policies and the impact on refiners and differentials, however, we just consider a worst-case scenario--a complete and unconditional reversal of the crude export ban--to assess the implications for refiners' moat ratings and valuations.

    Light crude differentials would narrow. If the export ban were reversed, some light crude differentials would persist, albeit at narrower levels, while others would dissipate completely. However, a reversal would not result in a complete return to the conditions before 2010, when the U.S. was producing only 5.4 million barrels a day of crude oil and refiners were importing 9.0 mmbd. Instead, domestic production would be capable of meeting PADD 2, 3, and 4 light crude demand, as it does today.

    In that case, exports would provide a relief valve to avoid excess inventories and a blowout in differentials. Refiners may even end up processing less light crude than they do now as narrower differentials reduce the incentive to maximize light crude throughput. Regardless, we would still expect a compression in differentials, with the balancing point between domestic and international prices on the Gulf Coast. The result would probably be parity between Light Louisiana Sweet and Brent, with West Texas Intermediate, Permian, and Bakken crude maintaining a discount to compensate for transportation cost to the Gulf Coast.

    Refiners outside the Mid-Continent would lose their light crude cost advantage. Narrower differentials eliminate access to cost-advantaged light crude for West and East Coast refineries. Gulf Coast refiners would see access limited, while Mid-Continent refiners would maintain access. With LLS trading at or near parity to Brent, the economics no longer exist to encourage marine shipments of excess Gulf Coast light crude or rail shipments of Bakken crude to the East Coast. California rail also becomes uneconomical. Rail shipments of Bakken crude to Washington refineries would remain viable thanks to equivalent transportation cost to the Gulf Coast of about $10 per barrel. Refineries also would realize additional margins of $3-$5/bbl from improved yields due to the substitution of lower-quality Alaska North Slope with Bakken crude. The margin uplift, along with the option of shipping Canadian heavy, also would maintain the viability of rail to marine facilities in Washington to supply California refineries.

    Whether a refiner maintains a light crude advantage depends on the location of its assets. Refineries in the Mid-Continent region where light crude discounts will persist should retain a light crude cost advantage, while those in the Atlantic Basin (U.S. East Coast and Europe) are likely to lose it completely. The outlook for West and Gulf Coast refiners is more complicated than a simple geographic breakdown offers.

    HollyFrontier and Western continue to maintain a light crude cost advantage. Western's advantage is also secured by its assets' proximity to the Permian Basin. Phillips 66 would be at risk given its large Atlantic Basin (including European refining) and West Coast exposure. Valero has some Mid-Continent exposure, but is primarily a Gulf Coast refiner. However, projects to move inland discount light crude to the Gulf Coast as well as a primarily western Gulf Coast position (more than 70% of its total Gulf Coast capacity) leave it better positioned. Marathon has a large Mid-Continent presence as well, with half of its coastal position in the western Gulf.

    Tesoro is exposed primarily to the West Coast; however, it is already railing Bakken crude to its Washington refinery and could continue to do so in the event of exports. Meanwhile, the company is building a rail-to-marine facility to supply its California refineries with Bakken crude. While the economics would be less attractive in an export scenario, the project would still bestow Tesoro with better margins than it would otherwise realize by processing ANS, thanks to the improved yield.

    Complex Assets Become a Critical Advantage Again For refiners that have lost a light crude advantage, highly complex assets and the ability to produce higher amounts of clean product from cheaper, lower-quality crude become critical advantages again. Without access to light crude differentials, the only other way to reduce feedstock cost will be by processing a discounted heavy barrel. Refiners that already have highly complex assets will be the most advantaged. While refiners could decide to invest in new heavy processing capability, we think it will be harder for them to deliver excess returns, given the higher construction cost (greater invested capital) and potential for narrower light/heavy spreads (lower earnings). Light/heavy spreads are likely to narrow as light crude supply increases, with greater production and heavy crude demand increases from narrower light crude differentials and the recent addition of heavy processing capacity.

    Among complex refiners, those in the Mid-Continent are the best positioned thanks to their proximity to an increasing supply of Canadian heavy crude, or WCS. As greater volume of WCS flow from Canada to the Gulf Coast is added, we expect WCS to price off of Maya, less transportation cost, implying a $25/bbl discount to Brent. However, given their proximity to Canada, Mid-Continent complex refiners will enjoy a roughly $6/bbl additional differential compared with Gulf Coast refiners thanks to lower transportation costs.

    HollyFrontier holds a clear advantage with highly complex assets located entirely in the Mid-Continent. It also has access and the ability to process black wax crudes in Utah, extending its location and asset advantage. Western's complexity is the lowest of the group, but that's actually an advantage. Western's proximity to the Permian Basin means it generates the greatest returns from maximizing throughput of locally sourced light crude. Highly complex Gulf Coast refiners Valero and Marathon also are well positioned, thanks to the growing availability of heavy crude from Canada that ultimately could price more attractively than waterborne supplies, given its export potential.

    Complexity on the West Coast (primarily California) is relatively high for every firm operating in the region. Originally configured to process California heavy crude production, those refiners such as Tesoro are likely to eventually see Canadian heavy crude volumes via rail/marine. The differential, however, will be less attractive than what Mid-Continent refiners will realize. With much lower complexity, Atlantic Basin refiners' troubles are compounded as they have neither access to discount light crude nor the ability to process heavy crude. Once again, with a relatively larger Atlantic Basin footprint and lower West Coast complexity, Phillips 66 is disadvantaged.

    U.S. Refiners Continue to Hold an Energy Cost Advantage The competitive advantage U.S. refiners derive from low domestic natural gas prices merits little discussion, as it will be unaffected by any change in the crude oil export ban. While U.S. and international natural gas prices remained largely in line over the past decade, the emergence of unconventional gas created a disparity. The lower domestic prices offer U.S. refiners an advantage that we think will persist. Our long-term price assumption is $5.40 per thousand cubic feet, leaving U.S. refiners with significantly lower costs than comparable refiners in Europe and Asia, where the price of natural gas remains oil-linked or much higher due to limited supply. Additionally, efforts to extract shale gas in other countries that could result in lower prices have proved fruitless to date.

    Loss of Light Crude Advantage Doesn't Mean the End of Exports

    If crude exports are permitted, U.S. refiners should be able to maintain their cost competitiveness in the global market and continue to export products. The ability to export and its contribution to refiners' narrow moats could be considered a circular reference. Exports contribute to the narrow moat rating in two ways. First, they allow the U.S. to maintain links to international refined product prices, despite the decline in product imports, ensuring crude differentials don't just result in cheap gasoline. Second, they allow U.S. refiners to maintain high levels of utilization, thus lowering per unit costs, while preventing oversupply in the domestic market as demand declines. In turn, the growth in exports has rested largely on U.S. refiners' cost advantage. The benefit of exports is clear when comparing the U.S. with Europe. Despite product demand decline in both regions, U.S. refiners increased utilization and capacity while Europe refiners realized declines in both.

    With differentials likely to narrow in an export scenario, U.S. refiners would lose some of the cost advantage that has led to the increase in exports. However, we do not think that means U.S. export growth would reverse. In fact, we think continued export growth is likely.

    First, U.S. refiners will continue to maintain a crude advantage. While U.S. coastal light crude prices such as LLS should trade in line with international benchmarks such as Brent, Gulf Coast refiners can still source inland discounted light crude. Even with exports of light crude, European refiners will not realize a light crude advantage as exported condensates or light crude converge to international pricing, leaving E&Ps to capture narrower differential. In addition, U.S. Gulf Coast refiners will continue to capture heavy crude discounts thanks to their highly complex assets and increasing supply of heavy crude. While Canadian heavy crude may eventually find its way to Europe, U.S. refiners will still process greater amounts at a lower cost due to the proximity to Canada.

    Second, U.S. exports to Europe are not a new phenomenon spurred by light crude differentials. Historically, the U.S. and Europe have exchanged excess gasoline and diesel. With the collapse in U.S. and European demand in 2008-09, however, the relationship changed. Though both regions were oversupplied, a cost advantage allowed U.S. refiners to maintain high utilization levels and avoid the severe capacity cuts Europe experienced. Combined with lower demand, the U.S. market for European gasoline imports was largely eliminated.

    However, the market for U.S. exports grew. Europe's decline in demand was not uniform. Beginning in 2009, total demand declined steadily each year, reaching approximately 2 mmbd by 2013. However, distillate demand held steady after an initial decline in 2009 of 200 mbd. The refinery closures due to overall demand deterioration, however, resulted in less diesel supply and created an opportunity for U.S. refiners.

    We think the European market for U.S. diesel exports will continue to grow. With depressed margins and little change in their competitive position, European refiners' profitability will remain challenged, leading to additional closures. With remaining existing facilities geared for gasoline production, diesel supply will fall. Meanwhile, the divergence in demand between diesel and other products will likely persist as tax policy and greater diesel engine efficiency continue to drive gasoline to diesel switching. In fact, ExxonMobil just authorized a $1 billion investment in its Antwerp refinery premised in part on long-term distillate demand growth in Europe. The result will be a growing European diesel deficit.

    In addition, Latin America will remain a viable market for U.S. exports as demand grows and supply shortages continue. Exports to Latin America have increased by 800 mbd in the past four years, more than all other regions combined.

    Two factors drove the growth of Latin American exports: first, the combination of U.S. oversupply and refiners' cost advantage; second, a supply shortfall amid robust demand growth. A decline in refining capacity and poorly run assets resulted in insufficient supply issues. Refining capacity in Latin America has fallen about 500 mbd since 2008 while utilization remained poor (below 80%). Consequently, imports were required to meet demand.

    We expect Latin America to remain a viable export market for the U.S. as capacity additions fail to meet demand growth. The International Energy Agency expects Latin America to add only 800 mbd of refining capacity by 2019. More capacity could be added beyond then, but if history is any indication, many of these projects will be delayed or not completed. In fact, last year's IEA estimate called for 1.6 mmbd of new capacity by 2019. Additionally, the reliability of the new capacity, if completed, is unlikely to be much better than existing operations, resulting in an inability to meet the current deficit much less the 1.0 mmbd in anticipated demand growth.

    The greater risk to U.S. exports is that new refinery construction in other parts of the world, particularly in China and the Middle East, leads to global oversupply. As a result, U.S. refiners could find themselves competing with government-owned refiners that are more concerned with running their facilities at capacity than generating economic profits. However, we remain confident in U.S. refiners' ability to compete, given their aforementioned cost advantages, proximity to end markets, and logistics/export infrastructure. Meanwhile, European refineries are likely to continue to suffer the brunt of any closures as global supply increases. Chinese and Middle East refineries are not immune to delays or cancelations, either. While the IEA reduced new Latin American capacity additions by 800 mbd, it decreased Chinese capacity additions even further, by 1.25 mmbd. Total global downward revisions for 2016-18 totaled 2.4 mmbd, demonstrating the tendency of planned refining capacity additions to be derailed.

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