Tesla (NASDAQ:TSLA) bulls must be mystified. Why? Because the sentiment-driven nature of the company's stock price appreciation may be ending. This is something I've alluded to several times over the last couple of months in previous Tesla articles, but this past week's recent reaction to the company hitting its Model 3 production run rate goal is some of the most convincing evidence of this I have seen so far.
Over the last three months, the company has made some really aggressive promises to the investing public. Not only did Tesla allude that they would be cash flow positive for the remainder of the year this year, but they also promised that they would not need a capital raise (this year) and that they would be able to meet a production target of 5,000 Model 3 vehicles per week. While Tesla did meet this production goal, the stock sold off violently in the succeeding two days, pushing from highs of over $360 per share on Monday to closing on Tuesday at about $310 per share – a nearly 15% move lower on what was supposed to be good news.
So what gives?
So much pressure was put on Tesla hitting this arbitrary number over the last couple of months that everybody seemed to think it would be the end-all-be-all for the stock - that a positive result would prove bulls right, and a failure to meet the goal would vindicate bears. Instead, Tesla met the target and the stock moved lower.
After the number was posted at the beginning of the week this past week, it became clear that the market may actually be interested in how the company arrived at the number instead of just focusing on the number itself. This, looking below the surface at Tesla, if it becomes the market norm, would definitely work against the company, in my opinion. The first thing that we have to take a look at is the fact that the market may have already expected them to hit the number.
The 5,000 per week goal may have already been priced in. Although Reuters was out with a report last week claiming that they were having trouble making their production target, it did also note that the company was projected to be ramping up production to 4,200 vehicles per week:
Tesla Inc is not producing enough Model 3s per shift to reach the 5,000 per week target that Chief Executive Officer Elon Musk said it would reach by Saturday, three line workers at the company’s Fremont, California, assembly plant told Reuters this week.
The company was able to assemble and paint 210 Model 3s during the first of two 12-hour shifts on Wednesday, one worker told Reuters. On one of two Monday shifts, the company produced 305 of the vehicles, another worker told Reuters. The number of vehicles assembled per shift is displayed for line workers in the plant.
The company is running two 12-hour shifts per day every day this week on the Model 3, the two workers who provided the production figures said. If the company produces 300 Model 3 vehicles during all 14 shifts, it would produce 4,200 cars for the week.
This could have been enough to show the market that things were heading in the right direction. Similarly, I asked on this podcast whether or not this report could have actually been a purposeful leak from the company to set expectations low. After all, Elon Musk seemed to be in good spirits last week around the same time this was reported, as he Tweeted out a video that seemed to take a jab at short sellers.
Also, the fact that the company had erected a massive tent and an additional assembly line outside of its Fremont facility must’ve told people that more production was ultimately going to be coming (even if just a small amount).
(Photo Credit: The Straits Times)
After the fact, it was reported that this tent did help produce about 20% of the vehicles Tesla made to hit its goal. TechCrunch reported:
Tesla hit a key milestone in the second quarter, managing to hit a 5,000-per-week production target for its important Model 3 electric vehicle. Remarkably, about 20 percent of the 5,031 Model 3 vehicles made in the past seven days were produced on the company’s GA4, a hastily built general assembly line housed under a massive tent at its Fremont, Calif. factory.
This 20% figure seemed to elicit some concern as well, possibly causing an overall change in sentiment that could have caused Tesla's stock to sell off. For instance, The Street wrote an article called "Should Tesla Supporters Be Worried That Some Model 3s Were Assembled in a Tent?" which made common sense points regarding the quality of such vehicles built hastily, in a tent:
Meanwhile, should the thousands of Tesla lovers on the waitlist for the Model 3 think twice about driving a car assembled in a tent? Given recent reports of quality and safety issues, it may be reasonable for Model 3 buyers to give their builds a series of once-overs when they finally get them, Acevedo said.
"I think Tesla's been under the magnifying glass for quality issues. So when you have a highly publicized new take on producing vehicles, it makes perfect sense that those who are queued up for a Model 3 would be going through their new car with a bit more scrutiny," Acevedo added.
Moreover, the mainstream customers that Tesla is targeting with its first mass-market build may have far less patience with sloppy quality or warranty repairs, noted Abuelsamid.
Or, the stock plunge may have just been a classic "sell the news" event. Even many of the skeptics and the bears that I talked to going into this past week expected Tesla to hit the number – many of them expected the company to hit the number by taking away from other parts of the business and other parts of production, grinding the gears at the rest of the company and mis-allocating resources off of the Model 3 lines. This seems to be exactly what happened. And, the more interesting thing?
The market actually seems to care this time. It is my opinion that in the past, the market may not have really cared about how Tesla got to this number, but rather that they got to it at all. Tesla has pretty much been a company that has revolved around its story, and not its financials or details, since it has been public. This has fueled the stock on its run since the company's initial public offering.
To me, it seems that nobody has really given credence to the financials or the close details of any intricate inner workings of the business with the exception of a couple of journalists and short sellers. The problem is that the market didn’t seem to care about this angle on the company and shorts have been pretty much run over since the company's IPO. These are interesting times for Tesla, no doubt. After I made note, on a number of podcasts, of the fact that the mainstream media narrative surrounding the company has changed and the fact that the public doesn’t seem to be as enamored and in love with Elon Musk as it once was, I think that to see the market potentially looking “under the surface“ at what’s going on at the company behind the numbers is astonishing and should be concerning to the company and those who own Tesla stock.
Back to the Model 3 number. It simply seems to me that the market is aware of the fact that Elon Musk pretty much had to pull out all stops and throw a major hail Mary to reach this 5,000 car per week goal for the Model 3. After all, Reuters reported on Tuesday of this week that Musk himself was at the factory "barking" at employees who were expected to work 12-hour shifts. There were some other ugly details of this Reuters report that pretty much dissected the consequences of Tesla hitting its goal:
1. It compromised Model S production.
“They were borrowing people from our line all day to cover their (Model 3) breaks so the line would continue to move,” said a Model S worker on Sunday.
“They’ve been throwing Model 3s ahead of the S to get painted to try to assure that they make their goal of 5,000,” the worker said. “The paint department can’t handle the volume.”
Because of the focus on the Model 3, the S line was about 800 cars behind schedule to enter the paint shop, the worker said.
2. It made employees feel as though they were at risk for injury because they were working so much.
But the worker told to expect longer shifts warned that pushing assembly-line workers too hard could backfire.
“He (Musk) is going to go through an awful lot of people because people are going to start getting hurt left and right,” by the fast-moving assembly line, the worker said.
“There’s only so fast a person can move.”
3. It put pressure on employees and risked burning them out.
“The manager and supervisor are verbally going around and saying: ‘If you don’t come in, you’ll be written up’,” one of the workers told Reuters last week.
Some employees are worried the frenetic pace plus long hours could burn out workers. One employee said they were told to keep working until they met their daily production mark, not when their shifts ended.
“They said starting tomorrow be prepared to work up to 12 hours,” said the Model S employee on Monday. “It’s going to be basically 12 hours from now on and I’ve got a feeling it’s going to be six days a week.”
4. It threatened the company's annual production goal rate.
Any potential disruption of the Model S and X lines could threaten Tesla’s target of building 100,000 of those vehicles in 2018. Tesla built 49,489 of those cars in the first half of this year.
Tesla said there had been no disruption to S and X productivity and noted it also built 1,913 of those vehicles during the last week of the quarter along with its Model 3s. A spokesperson also said workers from the S and X line had volunteered to help out on the 3 line.
Perhaps the market on Monday and Tuesday was asking "What good is it hitting a run rate of 5,000 Model 3s per week when it grinds the gears to a halt at all other parts of the company?"
The end doesn’t seem to justify the means. Rather than working on a calculated and intricate plan to reasonably ramp up Model 3 production to these levels over the course of time (or do the unthinkable and scale back some of the company's estimates instead of rushing to meet them), Tesla, not unlike in Spaceballs, shifted from light speed to ludicrous speed immediately and the market may not have liked the fact that they inefficiently overshot their mark.
Now, as the company has slammed to a halt and put some of its Model 3 production on hold for the July 4 holiday, Elon Musk, playing the role of Dark Helmet himself, likely flew the length of the ship and crashed head first into the front control panel as the stock dropped nearly 50 points from highs in the span of two days.
The market may have realized that the way that Tesla achieved their goal was inefficient and could actually be doing more harm than good. If the market continues to keep this attitude with its outlook on Tesla there is a very real possibility that the only thing that may help the stock recover is careful and calculated vision, along with a conservative guiding hand to gradually help steer this company in the right direction.
Whether or not you think Elon Musk, who is eccentric to say the least, is capable of this remains to be seen. I certainly think it would be a challenge for him personally. If the market starts to lose confidence in the Tesla story and starts to focus on the financials – after all, we have the Model Y and the Semi to look forward to - there are going to be a lot of very difficult questions that the company is going to have to answer with regard to its finances, how it will pay for capital expenditures necessary to grow in the future, and how it is going to meet its short term financing needs.
I put this chart out on Twitter today, which shows one slice of Tesla's financial issues. It shows that its accounts payable is just about to exceed the amount of cash that the company had on hand at the end of the quarter last quarter.
Some would argue that these cash levels at the end of the quarter are optimistic, but even if we just take it at face value, it’s just another angle to examine a company that appears to be in a tight financial position. The amount of time that the market is going to extend Elon Musk to live up to his promises and turn a consistent profit is not never ending – although to shorts, it certainly has felt that it that way. As David Einhorn famously said, “All bubbles eventually pop – at least they used to".
Going forward, how is this going to change things for Tesla investors? In my opinion, it is going to be more difficult for the company to deliver news that is concrete enough to allow the stock to maintain its current valuation near $55 billion. As I said on a recent podcast, getting the valuation to $55 billion with no real consistent cash flow was the easy part. Now, the company putting its head down and trying to execute effectively enough to start to bridge that gap between actual financial value and the assigned market value is going to be the challenging part.
If the market can only be satisfied by the creation of real value and the market wants to see this gap begin to bridge, the downward pressure on the stock price could easily continue. After all, if the company can’t do enough to make itself worth the $55 billion that the market has assigned to it, the only other option is for the price to correct by moving lower.
Although it may be a long while down the road still, this market is not going to give Tesla a never-ending stream of confidence for decades to come. There are simply too many difficult questions on the line and too much at stake with too many people watching for this to happen. Lest we forget that the stock market is, in my opinion, at the tail end of a decade-long bull market, where we are 10 years into a credit cycle and interest rates are moving higher (slowly).
Should Tesla need to raise capital, which I predict that they will, it is going to continue to come on more and more unfavorable terms to the company and shareholders going forward. If the market continues to look at the company with the skepticism that it looked at the Model 3 production target with, a rude awakening could continue for Elon Musk and Tesla shareholders.
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Disclosure: I am/we are short TSLA. 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.