With a price-to-book at 30x the industry standard, Tesla (NASDAQ:TSLA) looks expensive in a market already considered by many to be overvalued (the market might actually have already reset at a baseline, though). More worrisome is the simple fact that TSLA is in the automaker industry, which is facing a potential disaster - please read this article first to understand the danger any automaker or dealership faces in the current lease market. However, TSLA is likely the best choice for exposure in the auto industry because of several key factors that make it "recession-proof" (at least in respect to the auto industry bubble).
The main issue most automakers will face in the coming bubble is handling the increasing amount of defaults on leases. Tesla started leasing its vehicles only two years ago, effectively throwing its hat into the automaker bubble ring. From the viewpoint that Tesla is a luxury car maker, this is to expected, as approximately half of the luxury cars leaving dealership lots are released on leases.
Tesla offers leases through its partner for this program, US Bank, which, according to Musk, has a lower cost of capital. This translates to up to a 25% reduction on lease payments for a Model S. The lease can also be waived within the first three months if the car is returned, a typical marketing tactic that increases the number of leases (i.e., letting you take the puppy home before buying him).
The leasing process was created to be easy, with as little paperwork as possible, and can be performed online. The car will be delivered to a nearby dealership or even a home or business. The lease is easily upgraded, which is important as we will later see in this article.
In the electric vehicle (EV) industry, approximately 75% of vehicles are obtained through leases. This should put this industry at particularly high risk in the event of a cascade of lease defaults. Putting together EVs and luxury cars, then, Tesla should be especially vulnerable, right?
Will TSLA Crash with the Auto Industry?
No. Although Tesla does not release information on the percentage of cars released under leases, Tesla's lease rate is estimated to be under 40%. Thus, Tesla is the black sheep of both the EV industry and the luxury vehicle industry in terms of lease rate.
With motor vehicles falling in the US, generous leases should boost sales for automakers:
The leasing program that began in 2014 has in part kept TSLA's revenue growth in-line:
However, TSLA's debt-to-equity ratio stands at 2.9, nearly 3 times that of the automaker industry. Being so, a surge of defaults could hurt TSLA more than its peers. But besides its low lease rate, TSLA has some other bubble-proof armor in its closet.
The best argument for holding TSLA during a questionable period in the automaker industry is that TSLA is not an auto stock but a tech stock. Much like Apple (NASDAQ:AAPL), Tesla attracts early adopters, possesses a brand-loyal base, allows energy rebate discounts, and has the highest retention value in the EV market. These four aspects work synergistically to push TSLA forward in spite of declining consumer sentiment in the vehicle market.
One reason is that earlier adopters prefer to upgrade when the newest version of their addiction of choice hits the market. Just as early adopters in Apple's market are defined as those who ditch their old iPhones for the newest version (even if it offers nothing truly novel), early adopters in Tesla's market should be willing to ditch their current Tesla for the newest one.
Tesla Draws Early Adopters
Discarding a car for the newest version is much more of a financial burden than doing the same for a smartphone. The leasing system provides a reasonable solution for Tesla owners. Lease owners can easily place themselves in a system that allows them to gain the latest Tesla version at a significant discount.
In addition, early adopters of Tesla are exposed to a larger impetus for switching vehicles immediately upon release: EV range upgrade. Whereas upgrading to the newest iPhone will not bring you tangible benefits, upgrading to the newest Tesla, which certainly contains an improved EV battery, will save you time. As the EV industry progresses, so does the EV range on batteries, allowing you to drive longer distances on a single charge.
Telsa's leases also account for federal energy rebates and are therefore quite attractive relative to other luxury vehicle leases. Thus, Tesla's lease program should attract luxury car purchasers with tighter budgets; many will be organically converted into brand loyalists or early adopters. In fact, the Tesla lease pricing carves out a nice price niche: above that of its EV competitors' but below that of non-EV luxury automakers'.
Tesla Leases Trigger More Leases
Still, the retention value of a Tesla is not like that of an iPhone, making trade-ins appealing. Compared to most automakers, Telsa produces vehicles with high retention values. The result is a brand of used cars that can be logically sold back instead of being driven-to-death, a common phenomenon for cars that lose the majority of their value by the end of a three-year lease.
Tesla was at the top in terms of retention value when the leasing program was offered and still holds that position. In fact, Elon Musk himself guaranteed that the Model S can be resold for at least 50% of its value after a 3-year lease. The math works out: 83.1^3 = 57.2%:
This works into a system in which Tesla owners (or soon-to-be owners) can easily justify the purchase in spite of actual need: each purchase results in an investment of over 50% of the next purchase. Tesla is in an interesting position in comparison to luxury automakers and its EV competitors: The traditional luxury vehicle industry offers little reason to buy another car at the end of a lease; the EV industry offers little in monetary value at the end of lease (e.g., the Cadillac ELR in the chart above loses 80% of its value at the end of a three-year lease).
Despite Tesla exposing itself to the risks of vehicle leasing, it should easily weather the automaker bubble. The estimate 40% exposure versus 50% (luxury vehicles) and 75% makes it the least risky option in the non-gas vehicle sector. But in addition, Tesla's leasing program works in a way in which one lease fuels another, increasing customer retention.
Tesla's lease system is perhaps one of the few that make sense in the current market. Most leases act as a way to move product quickly in expectation of future cash flows and appeal to lower income brackets. While Tesla's leases also aim at future cash flows and can attract drivers who view Tesla vehicles as expensive, they also have the side advantages of increasing customer retention and therefore brand loyalty.
Overall, Tesla's risk-reward profile looks rather strong. The leases lost via defaults will be outweighed by an extended customer life value. Should a wave of defaults hit the automaker market, Tesla will be one of the few automakers already positioned to "ride it out."
Whether TSLA is correctly valued at 30x price-to-book is another question, one hard to answer, in fact, due having so many negative values on the balance sheet (thereby leading to negative valuations). But I think in the long-term, we will look back at the TSLA prices of today and see the stock price as low. If you want to hold TSLA but are concerned about the lease-related issues surrounding the auto industry, feel confident in knowing that TSLA will likely be the least affected stock in the industry.
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