Tesla 2025: Batteries Not Included

Summary

• Tesla's valuation implies tremendous growth.
• Growth in EVs will be constrained by many factors including adoption and subsidies.
• We examine a model of unrestrained growth, i.e. growth restrained only by raw material availability.
• Even in this Valhalla world, Tesla appears extremely expensive.

Tesla's (NASDAQ:TSLA) valuation appears stretched even under extremely optimistic scenarios. The bulls have to pray for multiple miracles.

Tesla currently trades at 8X 2016 revenues. I am using revenues here as profitability is a long elusive goal for the car maker. Yet with the Model 3 on track for production in July and a rapid ramp up expected in to year-end, the bulls are hoping that this is the start of the profit cycle.

The Gigafactory:

Underpinning the first stage of the Tesla expansion is the Gigafactory in Nevada. Currently operating at 14% of capacity, this factory will supply batteries for Tesla cars. The Gigafactory is so huge that it single handedly exceeded all the of the world's lithium-ion battery capacity in 2013.

It will produce 35 GWH of batteries internally (solar and EV) annually at peak capacity. That translates into approximately 5.833 metric tons (MT) of lithium annually, or about 31.04 MT of lithium carbonate (LCE).

Global Lithium Production:

There are plenty of good estimates out there. I have looked at them and complied my own set which I consider slightly more optimistic than the average. Below is the actual and forecast global production of lithium carbonate till 2023.

Source: USGS and Author's estimates

This forecast, if realized, will be a 11.2% compounded annual growth rate from 2015-2023. That is a very impressive number. Beyond 2023 all forecasts show a tapering of growth due to the fact that the easy deposits have been hit, the law of large numbers and the fact that it is hard to get further growth without investing massive amounts in the dictatorial regime of Bolivia, home to 70% of global lithium reserves. Here are couple of such forecasts. First from Global Lithium LLC.

And second from Sanford Bernstein and US Global Investors.

In both cases you can see that 2025 numbers are barely above the 2023 numbers used in my forecast. However, for my analysis I have used more optimistic numbers.

A model to estimate how many cars can Tesla produce in 2025 and 2030:

A recurring argument has been that Tesla can "grow" into this extreme valuation. To examine the validity of that we created a model whereby Tesla's car production was essentially only limited by how much lithium it could use in the market. We ignored other very strong limitations such as adoption speed, phasing out (or failure to scale up) of government subsidies, cobalt availability or capital availability for expansion. The rationale for this model was to put an upper limit to the bull case and see if valuations even made sense then.

The assumptions were

1) Continued growth of lithium supply at 10% per annum between 2023 and 2030. This is against the consensus which expects a tapering of growth.

2) Growth of all other lithium uses at 5% per annum from 2017 onwards. This is likely very conservative as solar gets cheaper and demand for energy storage increases, lithium battery demand for energy storage is likely to explode. The Gigafactory itself plans being a significant source of demand for this kind of use.

3) Tesla is able to access 50% of all lithium supply remaining between 2017-2019, 40% between 2020-2022, and 30% from 2023 onwards. There are currently multiple plug-in EV manufacturers. As you an see from the chart below, Tesla's share is really small in the US and even smaller when you take into account global sales.

Source: Inside EVs

This market share is set to rise due to Model 3, but many competitors are on the scene and another 10-15 new electric cars are set to hit the market. We would like to point out here that hybrids, which are likely to see their sales expand in this time period tremendously as well, use about 1/12th to half as much lithium as pure EVs. So for Tesla to corner 30% of this market long term will require a lots of luck and possibly locking in very long-term contracts right now.

Based on these very optimistic assumptions, Tesla should be able to manufacture over 1 million EVs in 2025, a whole eight years from now, and double that in 2030. Please take a moment to note that in 2030 58% of global lithium supply is dedicated to EVs.

How much money can Tesla make on these?

Model 3 is likely to be another loss-making endeavor in 2017 and 2018. See here for a breakdown by Seeking Alpha author EnerTuition. UBS expects an operating loss per car of $2,800 but expects a breakeven if Tesla can upsell people to the $41,000 price point. Fiat's CEO recently said that the metrics do not work for plug-ins and he can get better car (better than Model 3 ) out in 12 months if the metrics worked. Still, longer term we are going to give the benefit of the doubt to Elon Musk.

We will assume that the price of a new Tesla, partially due to technology, partially due to (very limited) economies of scale, falls to $25,000 by 2025 and Tesla is able to churn out an after tax profit of 5% on this. This again is fairly optimistic as GM (GM) and Ford (F) manage net margins in this range but they have much larger scale than Tesla.

Based on this Tesla could make about $2.6 billion in after tax profit in 2030. Assuming it trades at a 10-12 price to earnings ratio like other auto manufacturers, Tesla's market cap would be about half of where it stands today. But that figure is also very overstated. It ignores the amount of capital expenditures and R&D spending Tesla will have to do to get to these numbers. Based on Tesla's spending history, we estimate a conservative $25-$30 billion in additional spending to reach the figures above. This will likely be mostly debt as internal cash flows are nowhere near suffice to finance this. For those doubting these figures, remember, Tesla will spend a total of $7 billion in 2016 and 2017 in capital expenditures and R&D to get to the 500,000 unit mark. It will be impossible to reach that kind of net margins with so much debt.

Alternatively, even doubling the number of cars made (using 60% of available lithium) and ignoring the capital expenditures required to get there, would make Tesla a break even investment after 13 years.

Q&A:

I am going to use the next part to try answer some questions that are likely to come up.

1) Can Lithium supply grow faster than this?

It is possible but highly unlikely as mining is incredibly capital intensive and the trio of countries holding 90% of the world reserves (Bolivia, Chile and Argentina) hardly incite the warm fuzzies you require to make billions of investment. Even 10% post 2023 appears to be a challenge but I am an optimist at heart.

2) What if battery technology improves?

We are counting on it. Batteries are not chip processors. There is no Moore's Law here. We can expect 5%-7% annual gains in lithium batteries.

Source: Bloomberg

By 2025 that would mean a car that could go 750 miles on a single charge with the same amount of lithium that we currently use per car. We expect car manufacturers to use it to counter range anxiety rather than reduce amount of lithium per EV.

3) What about breakthroughs in battery technology?

The time from the lab to mass commercialization is at least a decade in most cases. We don't see anything on the horizon that would radically change our outlook. While Tesla might be following the Talladega Nights slogan,

the reality is that if a radical technology comes out after Tesla has invested in multiple factories with the current technology, that capital could be stranded. In other words, a first mover disadvantage.

4) What could make these forecasts very optimistic?

A lot can go wrong for Tesla.

• There are multitude of competitors with much better manufacturing capabilities and the financial wherewithal to fund a long-term battle on the EV front. All the major car manufacturers like Ford, General Motors, Toyota (TM) etc., are profitable and should they decide to battle Tesla on price, they will definitely win.
• EV sales depend on subsidies and as recently shown in Denmark, EV sales fell off a cliff when subsidies were removed.
• States have gone from funding EV growth to taxing them. Five States including California, passed taxes targeting EVs this year.
• 60% of Cobalt used in EVs is mined from the Democratic Republic of Congo would need to be ramped up to meet supply and could prove a limiting point.
• Solar will be cheaper than fossil fuels by 2020 even without subsidies. The market for solar energy storage is much much larger than that for EVs and could prove to be a big competitor for lithium.
• The capital expenditures required to make it from 500,000 to 2,000,000 units will require access to capital markets as under no scenario can Tesla fund this from profits.
• The field of dreams mentality could prove wrong. If Tesla builds it, they may not come.

5) What could work in favor for Tesla?

• Extremely high oil prices could give it the impetus it needs to price its cars better.
• Tesla could sell a smaller car with a much smaller battery, hence more units, but that would require it to make the transition to a less-performing car model successfully. The whole selling point of Tesla is that no performance is sacrificed. Transitioning away from that could prove challenging.
• Tesla could be acquired by a firm more silly than today's investors.
• Tesla could adopt this slogan and make the limiting factor someone else's headache when they cannot get enough lithium.

Conclusion:

Tesla remains extremely expensive even after accounting for remarkable future growth. One can tweak this model the way one see fit but barring near-term profitability which we see as extremely unlikely, adding higher numbers to the 2025 production would require even more capital expenditures earlier. Tesla remains an incredible bubble whichever way we slice it, but unlike the Amazon bubble which have steered clear off until our bubble burst catalysts materialize, we are playing this one using ratio spreads.

I/We are long 1X TSLA Jan 19, 2018 - 240 Strike Puts

I/We are short 2X TSLA Jan 19, 2018 - 200 Strike Puts

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Analyst’s 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.

I/We are long  1X TSLA Jan 19, 2018 - 240 Strike Puts I/We are short 2X TSLA Jan 19, 2018 - 200 Strike Puts