Demand For The Model S Looks Solid But Will Tesla Live Up To The Hype?

| About: Tesla, Inc. (TSLA)
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Electric vehicle maker Tesla (NASDAQ:TSLA) announced fourth quarter results Wednesday afternoon that showed progress toward achieving breakeven. Revenue surged nearly 700% year-over-year to $306 million, exceeding consensus estimates. Tesla's non-GAAP loss of $0.65 per share was worse than expected, and that loss balloons to $0.79 per share on a GAAP basis. The firm also burned through $101 million of cash, which was better than the prior quarter by about $60 million (but worse than the year-ago quarter by $20 million).

Though it isn't abnormal for a fast-growing company like Tesla to have a cash burn, we'd like to see the company at least breakeven with respect to operating cash flow, which it believes it can do in 2013. Liquidity isn't an issue at this point, but if the company does need additional capital, we think it will tap the equity markets and likely dilute existing shareholders.

As for fourth quarter performance, we were pleased to see the firm ramp production. The firm produced over 400 vehicles per week for three consecutive weeks, and it has maintained the current run-rate going into 2013, making its goal of producing 20,000 units in 2013 appear feasible. Importantly, CEO Elon Musk noted that the amount of post-production work needed to be performed on vehicles has fallen. As Musk noted on the conference call:

"There was a time several months ago where every car that came off the line would require some degree of rectification, but now that is very a fairly small percentage. I don't have the exact percentage on hand, but it's a fairly small percentage, and the other thing that's also worth noting is that, anything which is software related can be addressed by an over-the-year update which is something that no other car company can do. And I think that's actually worked quite well."

If the amount of rework continues to fall, we could see the savings directly benefit the bottom line. The other major hurdle during the quarter came from the optimization of its production process. Unlike Ford (NYSE:F) and Toyota (NYSE:TM), which have been refining the process for the past hundred years, Tesla is a young company still figuring out best practices for production. This resulted in the company posting automotive gross margins of about 5% for the quarter-a far cry from the 2013 guidance of 25%. Nonetheless, the firm anticipates a decline in overtime and labor hours that will end up boosting gross margins, and we see no reason to disagree.

Order trends heading into 2013 were strong, but Musk noted in his letter to shareholders that reservation growth has declined after the company increased prices at the beginning of the year. The company added 6,000 reservations in the fourth quarter, more than doubling the reservations it added in the prior quarter. We are fairly impressed, especially considering the lack of electric vehicle infrastructure in the US, and the fact that the company has spent virtually nothing on advertising. Though traditional automakers slug billions of dollars into advertising, Tesla has built a nice following primarily on being named Motor Trend's car of the year for 2013. We imagine Tesla will be able to break the 20,000 unit demand mark in 2014, but it may require the company to ramp (or start) advertising.

Unfortunately, the cash situation remains troublesome. The firm posted a free cash flow deficit of $505 million for 2012-more than 60% higher than its deficit in 2011. Much has been made about the fact that Tesla anticipates it will run "breakeven" in 2013, but that may have been exaggerated, in our view. Admittedly, Musk clearly states in his letter to shareholders that the firm expects to be operating cash flow breakeven in Q1. However, there's no mention of breaking even for the year, and the firm will invest in new retail stores and charge stations throughout 2013. This capital spending could mean that free cash flow will be significantly negative again in 2013.

Due to the new guidance and slowing cadence of reservations in the first quarter, we've lowered our fair value estimate of Tesla. We're huge fans of the Model S, but we remain cautious on the market potential of electric vehicles (though recent gas prices could change that). We're also hesitant to believe that Tesla will be profitable for the full-year 2013, even if it does scratch out a few cents of non-GAAP earnings in the first quarter. The long-term future could be bright at Tesla, but near-term hiccups should continue to be expected. The company is acquiring attractive, high-income consumers, and if it only needs to sell 20,000 units to be profitable, we could see the firm generate some incredibly strong free cash flow in the future. We're keeping a close eye on shares.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.

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