Tesla (NASDAQ:NASDAQ:TSLA) is uniquely positioned to drive disruptive innovation in several markets including motor vehicles, electric grid, solar, production automation and artificial intelligence. Tesla is not just an innovative car company with stylish electric vehicles. TSLA trades at a significant premium with respect to car companies, but its valuation should be based on opportunities that leverage its technologies in new markets. TSLA's energy storage and growing recharging network provide EV differentiation and expands its addressable market into the electric utility grid.
TSLA is certainly not without risks, but its value drivers include utilities embracing distributed grid energy storage approaches, improved value proposition for EV customers, vertically integrated energy storage and solar production, design-for-manufacture automation processes, machine learning, and AI development through Tesla Vision. These factors enable TSLA to address new markets with leading performance metrics that in turn should drive a higher market valuation.
This report analyzes how TSLA is positioned in the EV, solar, energy storage and potentially, technology licensing markets. The report examines the competitive dynamics, market opportunities, financial metrics and risk factors. Through this analysis, a valuation model is constructed to substantiate a target price of over $500 a share.
The following data points and analysis will serve as the framework to assess TSLA's market opportunities. The demand for EVs is paramount and will focus on economics and value of EVs and what differentiates TSLA. Next, it's the utility market and spending on the distributed grid and energy storage. Solar, with the integration of the SolarCity acquisition, offers higher efficiency panels. In addition, a new market will emerge as TSLA generates intellectual property around design automation, self-driving vehicles and AI.
The market demand for EVs has been relegated to the affluent and environmentally conscious individual. The lack of recharging infrastructure, short driving ranges and comparatively expensive vehicles has limited market appeal. Despite these challenges, EVs have demonstrated strong growth on a global basis. EV production has a 56% compounded annual growth rate over the last four years
Figure 1 Global EV Sales
Despite the impressive growth in EV sales, their total sales still represent less than 1% of total light vehicle sales, essentially cars and pickup trucks. As EV costs decline and functionality in terms of driving range improve, the market for EV will expand dramatically. Some estimates suggest that EVs could represent 25% of the vehicle market in the next five years.
Being first is not without risks and companies don't create significant value until the infrastructure to grow is in place. Just look on how long it took for the value of Amazon (NASDAQ:AMZN) to be recognized from its IPO in 1998. The following chart offers a comparison of total internal combustion engines vehicles to battery electric vehicles. BEVs don't appear to register on the graph. The question is - is there enough market demand and incentives to persuade potential buyers into EVs?
Figure 2 Total Global Vehicles to Battery EVs
Source: International Organization of Motor Vehicle Manufacturers (OICA)
Metrics associated with product functionality, economic savings, and feasibility in terms of vehicle attractiveness were used to evaluate potential market demand for EVs. Financial viability and constraints are discussed in the financial performance section.
Two crucial considerations for EVs is their driving range and recharging network available. The refueling infrastructure in the US is huge and that is a major factor in considering a lifestyle change such as EVs. In 2012, the US Census Bureau estimated 114,533 gas stations. Most of these stations are also convenience stores where milk and coffee can be purchased.
For EVs, the recharging network is an important consideration and in some locations may prohibit even consideration of an EV. To ameliorate some of these concerns, TSLA has expanded the EV driving range and established 790 Supercharger locations in the US covering 97% of the US population within 150 miles.
TSLA has a substantial lead in producing an EV with a driving range over 300 miles. So for convenience-conscious drivers, how far the vehicle can travel before refueling is a major consideration. The following graph shows how TSLA compares to other EVs and hybrid vehicles.
TSLA ranks close to the average sedan in miles driven on a tank of gas versus other EVs. The Nissan Leaf and Chevy Volt are not designed for extended battery operations and driving range depicts only EV range. Reaching 300 miles on an EV charge is a substantial competitive advantage because the energy density of the storage system lends itself to differentiation and expansion into the distributed grid market.
Figure 3 EV Driving Range - Miles
A second consideration for some buyers is vehicle performance. A key metric for EVs is top speed and acceleration. The following graph compares TSLA with respect to vehicle acceleration across a spectrum of vehicles, from the average sedan to Formula 1 racecars. While the two leading hybrid vehicles Chevy Volt and Nissan Leaf compare slightly better than the average car, TSLA compares closer to the performance of a Formula 1 racecar.
Figure 4 EV Performance - 0-to-60 MPH Acceleration
In addition to performance and vehicle range, economics plays a key role in evaluating the attractiveness of an EV. There are several parameters to measure the economic attractiveness of EVs including costs associated with energy maintenance and insurance. The following chart compares EV energy and maintenance costs to cars and pickup trucks.
Figure 5 EV Economic Benefits
Source: AAA, Tesla reports
Clearly, TSLA offers substantial benefits in terms of energy and maintenance savings. TSLA provides EVs with less maintenance costs with extended warranties. While tires may wear similarly across vehicles, EVs save on brake replacement. The fact that there is an order of magnitude less moving parts in an EV extends substantially vehicle life in comparison to ICE vehicles.
Aside from energy and maintenance, vehicle insurance costs prove to be cheaper with EVs. One avenue TSLA is exploring is to bundle the EV, maintenance and insurance into a package at a significant discount.
In essence, the EV offers substantial savings, better performance and longer vehicle life in comparison to ICE vehicles. These factors together with a visible recharging network should drive EV demand. TSLA is solidly positioned as the leader in the space with requisite recharging infrastructure and is vertically integrated to benefit across the energy and vehicle markets.
One element for EVs that requires further improvement is charging time. While most gas stations can fill a vehicle in less than ten minutes, EVs require longer charge duration of 30 minutes or more. However, at home charging offers convenience and can enhance customer experience by not having to go to a gas or recharging station at all. TSLA is building the network infrastructure to improve charge times and for home systems.
Hybrid EVs have been the leading sellers with the Nissan (OTCPK:NSANY) Leaf and Chevy Volt (GM) at the lead. The primary drivers of the hybrid success have been acceptable price points and reliance on the ICE infrastructure. Without adequate recharging networks, people have hesitancy in migrating to EVs.
However, this changes as the footprint of recharging stations grows and EV vehicle prices are at par with conventional vehicles. The challenges associated with hybrids such as ineffective fuel savings in stop and go city traffic, inadequate acceleration, and no battery power at fast speeds begin to limit hybrid desirability.
The energy storage market is perhaps the most interesting TSLA segment. Energy storage is the Holy Grail for the utility industry. Energy storage is a nascent opportunity for TSLA and with its lead in energy density in battery packs this market could represent one of its largest segments.
According to the Elision Electric Institute, US investor-owned utilities are projected to spend over $90 billion in 2017 in capital expenditures. Over 25% of the CapEx is targeted toward distribution or the last mile of electric transport. Transmission refers to the large high voltage structures that carry the electricity from the point of generation to substations in the local market.
Not only does the utility distribution network need an upgrade to support the influx of renewable energy generation to the grid, but also without local energy storage, the network is substantially inefficient. Energy storage is crucial to protecting the vulnerability of the grid and to more effectively manage supply with demand.
Figure 6 US Utility CapEx Spending
Source: Edison Electric Institute
Energy storage has the potential to represent a $12 billion market for TSLA in five years. The ability to provide the network infrastructure to support energy storage and local distribution with EV recharging stations provides TSLA with a competitive advantage.
Electric energy has become more important than oil. To illustrate the importance of electric the following chart shows the US demand of electric and oil on a per capita basis. Improving vehicle energy efficiencies have enabled the US to reduce the per capita demand for oil. However, the growing use of electric continues to outpace the demand for oil. Initiated energy conservation measures have begun to mitigate electric demand. LED lighting can reduce lighting energy usage by 50% or more. In addition, solar and wind have enabled some facilities to mitigate energy demand.
Figure 7 US Energy Demand per Person
One of the biggest utility trends is the migration from centralized distribution to a distributed grid where more generation is pushed to the network edge. To effectively interface with the electric grid, energy storage and visibility into generation and demand are required. Strategically, the integrated and distributed grid is the foundation of the US economy for both service and manufacturing industries. The distributed grid also is required to improve our national security from intrusion and manipulation of the grid.
The solar market is one of the fastest-growing technologies driven from the lower panel costs and improving operational efficiency. Solar costs are at par with grid pricing in most states even without tax incentives. The average price per watt for a solar photovoltaic (PV) module has declined from an inflation-adjusted $50 a watt in 1980 to less than $1.25 per watt in 2016 according to Green Tech Media. Some research on solar can be found on Green Econometrics.
TSLA acquired SolarCity in 2016 and announced that its new solar panels product could produce power for about $0.55 per watt. TSLA's price point reflects panel costs benefiting from solar PV panels with improved efficiency and produced through its new facility in Buffalo, NY, with technology acquired through SolarCity's acquisition of Silevo in 2014. In-house production should enable TSLA to operate more competitively in the solar market, but the solar market is plagued with bankruptcies and falling prices.
While solar is certainly an attractive market to address, solar PV panels have become commoditized as prices continue to decline. TSLA has taken steps to improve product performance and focus more on direct sales and away from lease financing. The opportunity is combining solar with energy storage - that is the key differentiator.
Design for manufacturing, automated production processes of EVs and energy storage, autonomous driving vehicles, and AI data and software provide a tremendous opportunity for TSLA. The curation and cultivation of crucial IP could enable TSLA to open new markets. There also is increasing IP content into each EV. The licensing of technology around Tesla Vision autonomous driving and design for manufacturing processes have the potential to generate $2 billion in revenues in five years.
To evaluate the competitive landscape, it may help to compare some performance metrics with respect to competing EV players. There are more than a dozen vehicle manufacturers offering some form of EV. Major manufacturers are expected to ramp production of EVs with the market for EVs amounting to 25% of the industry.
TSLA is significantly smaller than the major manufacturers and is constrained by CapEx spending to improve production and sales. Not only is spending required to build EVs but also the recharging network and retail and service facilities.
In comparison to leading vehicle manufacturers, TSLA was able to achieve gross margins of 22.2% for Q4 2016 on a non-GAAP basis after adjusting to exclude stock-based compensation and zero emission vehicle ZEV credits. That puts TSLA near the top of the gross margin ranking. However, Q3 2016 adjusted gross margin were 25%, a decline of 280 basis points. TSLA expects gross margins to remain in the 20% to 25% range.
Figure 8 Vehicle Manufacturer Gross Margins
Source: Company reports,
While low cost structure is a competitive advantage, production ramping is key to mitigate high costs. TSLA is developing the Model 3 with a more simplified wiring structure and more automated production to lower costs.
Figure 9 Revenues per Employee
Source: Company reports
In comparing revenue per employee basis, TSLA does not command a leading position. Part of the explanation is the additional 5,000 employees that came with the SolarCity acquisition. To improve its competitive position, TSLA needs to scale Model 3 production and energy storage battery packs. With increasing production volume unit costs should decline. Gross margin expansion may become more tenuous for TSLA as legacy manufacturers introduce more EVs and hybrids.
Most of the production progress will depend on design-for-manufacturing implementation and faster line speed. Elon Musk indicated on the conference call that production is only as fast as the slowest activity in the production process. Which is like driving on a single lane road, you're only as fast as the slowest car in front of you. These costs are all front-end loaded and small changes in tooling or dies can dramatically impact the performance of the quarter.
Execution is fundamental in achieving strong financial performance. The bulk of sales remain in the US. The challenge is going to be penetration of China, the largest EV market led by competing EV company BYD (NYSE:BYD). Shenzhen-based BYD is also vertically integrated with producing rechargeable battery systems and solar PVs. In 2016, TSLA was able triple sales in China while the EU market saw a decline.
Figure 10 US and International Sales
Source: Company reports
TSLA's revenue growth in Q4 2016 increased 71% from Q4 2015; however, Q4 2016 was down 9% sequentially from Q3. TSLA was able to mitigate operating losses, but still a loss of $674 million for 2016.
A current ratio of 1.1 is troublesome. Negative cash flows and high debt levels also weigh negatively on liquidity concerns.
With negative operating margins and cash flows, coverage of capital spending is of particular concern. Capital spending is required to expand production and develop the network infrastructure to achieve sales goals.
Fixed assets to equity have improved going from 314% in 2015 to 126% in 2016. Long-term debt to capitalization improved slightly from 77% in 2015 to 68% in 2016. These high ratios demonstrate the capital-intensive nature of the business.
Return on Investment
Free cash flow to stockholder equity improved from negative 178% in 2015 to negative 21% in 2016. Return on invested capital moved into positive territory, which was mainly attributable to higher depreciation expense. ROIC went from negative 8.4% in 2015 to 2.4% in 2016.
Sales to total assets are lower on the SolarCity acquisition with the ratio declining from 0.5 in 2015 to 0.2 in 2016. There was some improvement in CapEx to total assets with the ratio at 6% in 2016 versus 20% in 2015.
R&D declined as a percent of sales from 18.8% in Q4 2015 to 14.1% in 2016. R&D expenses remain high even for a technology company. SG&A to sales ratio edged up slightly from 22.8% in 2015 to 25.6% in 2016; however, they retreated from 28.5% in Q4 2015 to 26.2% in Q4 2016.
The following table provides a review of TSLA's financial performance.
There are several risks that have the potential to create havoc for TSLA. Among the risks are high debt level, variances in international sales, long lead-time on component supplies, high cash burn rate, negative cash flows, and expanding competition. The timing on production equipment availability could substantially delay production and delivery. Larger competitors could implement predatory pricing to force margins down. International expansion is costly and incurs long shipping times. Revenue is not recognized until the customer signs for delivery from which timing can impact quarterly revenue performance.
The large players are dedicated to expanding the EV market. With improved and enhanced competitive EVs entering the market, pricing pressure and lack of differentiation could commoditize the EV market. A secondary offering is imminent, which could limit stock appreciation. In addition, the market is waiting for proof that TSLA can meet production levels on the Model 3. The market is not standing still. Legacy car makers continue to introduce new EVs and hybrids at competitive prices and BYD is growing market share in China.
To construct a valuation model for TSLA, a select group of automotive and technology companies was assembled. It would not be appropriate just to compare TSLA to other car companies. Clearly, TSLA is unique with multiple opportunities to expand revenues and cash flows.
Figure 11 Peer Group Market Capitalization
Figure 11 Peer Group Valuation: Price/Sales Ratio
Using the average price/sales ratio of this peer group and estimated revenues, margins and cash flows, a valuation for TSLA was constructed. The valuation model disaggregates TSLA's five-year projected revenues into market segments and assigns cash flows and market multiples to derive stock valuation. While EV and energy storage command the largest portion of value, technology leads with the highest multiple contribution.
Based on this valuation model, a price target of $552 per share was established. The bottom line is that these new market opportunities that offer substantial upside are not reflected in the current stock price. The energy storage market has the potential to reach over $12 billion in revenue and offer higher margins than EVs. The technology portion of the business could even be as large.
TSLA Valuation Model
The valuation model is predicated upon TSLA's ability to execute on its business model in terms of operating margins and market penetration into the electric utility market, developing the requisite engineering and production automation technologies to create IP, and optimizing solar PV efficiencies. There is also a concern over TSLA's high leverage and negative sustainable growth rate. In addition, capital is key. In addition, TSLA's need to raise capital in a secondary offering will add dilution and could significantly limit stock appreciation in the near term.
This article was written by
Disclosure: I/we 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.