Is Tesla's Drive Out Of Energy?

| About: Tesla, Inc. (TSLA)
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Tesla (NASDAQ:TSLA) has zipped more than 340% from just $35 on January 2, 2013 --jumping to a new all time high of $158 on August 8, 2013. At the current point in time they are valued at more than $17.5 Billion: at first glance it seems unrealistic. In the quarter ending June 30, 2013 (announced Wednesday) they earned $26 Million (though they lost $31 million if you include one time charges) on $551 Million in revenue -- up from $27 million in revenue in Q2 2012. In a mere year Tesla has captured the hearts of investors and consumers, skyrocketing in share price and car production (while keeping quality). They received a 99 out of 100 in Consumer Reports, delivered more than 12,000 Model S cars, expanded their retail segment, and announced plans to create a national charging system -- does it justify the price?

To start with the fundamentals, Tesla has repaid their government loan nearly 10 years early, leaving no debt on their balance sheet (though they settled their loan with a one time payment this quarter) and nearly $750 Million in cash, an increase of nearly $500 million due to the infusion of over $1 Billion. They currently trade at a P/B of 28 (current shareholder equity is $629 Million), and a P/S of 16.5. The average analyst predicts $2.25 Billion in sales next year (representing 25% year over year growth), as well as $1 EPS representing a forward P/E of 152.

In this article I would like to provide views from both sides, as how Tesla can grow to surpass their current evaluation as well as how they could fall short. Tesla has become a wall street darling due to both their aggressive growth as well as domination of the Electric car market. The Model S starts at a base price of $63,570 summarizing Tesla's current market -- high end electric car buyers. At the lower segment include the Chevrolet Volt (NYSE:GM)($34,995), and Nissan Leaf (OTCPK:NSANY)($29,650) -- but you get what you pay for. The Chevy Volt can go just 38 miles on an electric charge, while Tesla can go up to 265 miles on a single charge. As a result, other auto makers like Toyota (NYSE:TM) and Mercedes Benz (OTCPK:DDAIF) have turned to Tesla to supply electric engines and parts for their RAV4 EV and B-Class EV resulting in almost $4 million in revenue this quarter alone.

Obama and the DOE announced a goal to putting 1 million electric vehicles on the road by 2015/2016, paying a $7500 Electric Vehicle Credit to those who buy electric cars. This has gained the attention of both consumers and auto manufacturers. The average price for electric and plug in hybrid cars is $36,922 from $41,102 a year ago, showing that many of the new manufacturers are aiming towards the lower end of the hybrid and electric market. Just recently Porsche (PAH3), Mercedes and BMW (OTCPK:BAMXF) have entered into the electric car market. BMW has released the i3 which is priced at $41,000 and can travel between 80 - 100 miles per charge. Though it is not even close the capabilities of Tesla, it might attract to a broader range of shoppers. BMW is also unveiling the i8, which is supposed to take the world by storm though it is priced at over $200,000. The release of new electric vehicles shows that other manufacturers are interested and see vast profit potential -- the only thing is that Tesla is here first.

Tesla has captured the hearts of investors, critics, and consumers alike with the Model S, capturing the high end electric vehicle market -- but Tesla is not stopping there. Elon Musk confirmed that Tesla has plans to create a $30,000 - $40,000 EV called the Gen 3, within the next few years attempting to expand their consumer base -- but they are not waiting until then. Tesla has unveiled multiple plans to attract and keep consumers:

1) The first is an offer to buy purchased cars back within 3 years for 43% of the purchase price. This seems like a losing proposition, as their gross margin was 22% in the most recent quarter. If they sell a Model S at $70,000 (hypothetically) it costs them $55,000 to make, leaving them with a $15,000 gross profit. If you take in 10% depreciation per year, Tesla will loose roughly $6000. This service is more for the secondary market than for investors - it will keep Tesla's Model S at a premium against other electric vehicles, though the implication for investors are not yet known.

2) Battery swap is a service in which Tesla is pioneering 90 second recharging by switching the battery in the vehicle. Tesla has not released many details, except that they will charge their customers for this service.

3) Supercharger is a FREE service in which Tesla will recharge half your car's battery in 20 minutes (the fastest in the world). According to Tesla's website, all the stations will eventually be powered by solar panel canopies, as to maximize cost efficiency. At the current point in time there are 16 stations, with plans to expand to cover 80% of the US population by 2014. In my opinion this could be the downfall of Tesla. On their website they state "Incredibly fast. Always free.", meaning they have guaranteed they will never charge to recharge a Model S (All 85 kWh and some 60 kWh). Supporting 100,000's of Teslas across the world seems like an expensive proposition.

The average price paid in the US for a kWh (Kilowatt-hour) is 12 cents. Tesla's basic Model S is 60 kWh which means it takes 30 kWh to charge it half way (or $3.60), though it could cost up to $10.20 to completely recharge a 85 kWh battery for the premium model. This could be a money pit for Tesla (plus the cost of land, taxes, etc.).

If Tesla manages to sell 500,000 cars (compared to 20,000 - 30,000 this year), the upkeep could be tremendous (millions every day). Tesla is currently manufacturing roughly 500 cars a week and is still losing money: in the most recent quarter Tesla made $26 Million in net income, while receiving $51 Million in Zero Emission Vehicle (ZEV) credits.

Competition is increasing, costs are rising, and valuations are flying. The market is currently valuing their potential at $17 Billion (market cap is $17.75 Billion and there is a $700 Million shareholder equity) -- is it justified? I believe that with Tesla's current policies it is not, but the potential is there. I would like to create a hypothetical scenario:

Tesla sells 500,000 vehicles within the next five years, of both Model S, Model X, and Gen 3 EV vehicles and obtains $3 Billion (based on $30 million profit on the sale of 5000 vehicles in the last quarter, though the actual number should be lower due to the lower margin Gen 3 vehicles). At the current ratio they would have to sell approximately 2.8 million vehicles to justify the market's value, while the current production rate of 500 vehicles a week means it would take them more than 15 years to meet the breakeven point. The costs don't even include Tesla's planned expansion of the 'supercharger' network, retail locations, service locations, or even the buy back program.

I would like to propose a solution. Tesla has already promised that it will never charge to recharge a Model S at a supercharger station, but it never said anything about the Model X or Gen 3 vehicles. If it were to sell 100,000 of these vehicles, the cash flow generated through these stations could generate billions. Using the same calculations as before (12 cents per kWh) it would take the following to fully charge different vehicles:

1) Model S/X 60 kWh - $7.20 - 208 Miles per charge

2) Model S/X 85 kWh - $10.20 - 265 Miles per charge

Tesla could offer to charge your car for $15 - paying around 5.5 cents per mile (compared to a 50 MPG hybrid car at $3.60 a gallon which is over 7 cents a mile). Consider a 12 car 'supercharger' station, taking 30 cars an hour, generating $450. Now consider they install 100 of these stations across the country, for both Tesla and other electric cars (that use Tesla batteries), and fill the station half of the day (12 hours) -- that would generate over $500,000 a day, or $190,000,000 a year. If they received half 60 kWh and half 85 kWh, the average charge would cost them $8.70, or would generate 58% gross margins (if they were to fully charge the cars). Operating profit would be well over $110,000,000 a year (in just the USA), and there is the opportunity to also add retail stores and restaurants to the charging stations as well (and the opportunity to bring the cost down to under 10 cents with solar panels).

At the current point in time, I believe that Tesla is incredibly overvalued. Larger competitors are entering the game, bringing with them brand names and billions of dollars. If Tesla can gain a competitive edge, like a national supercharging station, they can gain customers due to their size while earning perpetual income. I wouldn't short the stock, as management can take the company ahead of the competition if you give them a year or two (look what they did in a single year), but would watch for future announcements. Even if Tesla expands and creates a national network, the potential does not end there. They can make billions by selling cars and energy (through charging stations) across the world. With Tesla's technology anything is possible - the question is what they do with it...

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.