Tesla Could Fall To $35

May 29, 2019 8:00 AM ETTesla, Inc. (TSLA)225 Comments38 Likes
Maximilian Dorn profile picture
Maximilian Dorn
561 Followers

Summary

  • Vehicle production and deliveries are on the decline in 2019.
  • The company burned almost a billion dollars during the first quarter of 2019.
  • The recent capital raise will buy some time but only for about 10 months.
  • Tesla has to become and stay cash flow positive until the end of 2019.

Investment Thesis

Going into 2019, Tesla (NASDAQ:TSLA) reversed any positives trends that they showed during 2018. Both production and deliveries declined during the first quarter alongside a substantial cash burn. The most recent capital raise will buy the company some time, but they must get their costs under control sooner rather than later if they don't want to rely on the capital markets indefinitely. This is mostly a cost controlling issue and investors will be heavily reliant on transparency displayed by the company. This means that going forward, I believe it is vital to closely look at how the executives communicate with shareholders. Right now, the stock does not look attractive from a risk return perspective.

Model 3 production & deliveries showed very modest growth while Model S and X numbers declined

Tesla significantly ramped up both vehicle production and deliveries during 2018. Quarterly vehicle production increased 150% from 35k vehicles in Q1 to 86.5k in Q4. Simultaneously, deliveries increased as well, going from just under 30k in Q1 to almost 91k in Q4 which is more than a 200% increase.

Tesla production and deliveries

Source: modeled by me, data taken from filings of the company

However, during the first quarter of 2019, these numbers reversed. Not only did the growth not continue but also production and deliveries even declined rather significantly. The 31% decline in deliveries evidences weak demand for Tesla vehicles going into 2019.

Model 3 had a very good year in 2018. From 9.7k produced Model 3s in Q1 to 61.4k in Q4, a 530% increase. Model 3 deliveries went up by 670% from 8.2k in Q1 to 63.1k in Q4. This is especially uplifting to see because the performance of Model 3 will be a huge deciding factor in the future direction of the company.

model 3 production and deliveries

Source: modeled by me, data taken from filings of the company

Unfortunately, the growth story did not continue in 2019 with growth in the first quarter only being a meagerly 3%. Deliveries of Model 3 even declined by 19% which is especially worrisome considering the importance of Model 3 customer acceptance for the future prospects of the company.

model s and model x production and deliveries

Source: modeled by me, data taken from filings of the company

Model S and X fared even worse during the quarter. Production and deliveries were essentially cut in half within 3 months. This would have been fine if it was caused by consumers switching from the luxury models to the new Model 3. However, as evidenced by the weak Model 3 numbers, customers didn't buy Model 3s instead of the S and X, they simply chose to buy fewer Tesla vehicles altogether.

A major issue of Tesla has always been the production bottlenecks. After 2018, it looked like the company had finally overcome this issue and I believe that to still be the case even after this most recent quarter. Model S and X are built to order which means that the decline in production was not caused by the company's inability to produce a sufficient number of vehicles. Model 3 growth was weak but still growth, nonetheless.

Unfortunately, the fact that production has improved is of no use if demand is in decline. For all these past years, Tesla wasn't able to meet demand because production was slow. Ironically, now that production has been ramped up, it looks like the scale could tip to the other side, sufficient production but not enough demand.

Deliveries going forward

One month ago, Tesla confirmed guidance of 360-400k vehicle deliveries in 2019. I am very skeptical about this claim. Since they only delivered slightly more than 60k vehicles in the first quarter, they would need to deliver 100k vehicles in the next 3 quarters to even reach the lower end of this range. This would be a 66% increase from the first quarter and would even trump the delivery numbers of the best quarter of 2018. Considering that global demand for new vehicles is starting to show signs of a slowdown, I find it highly unlikely that Tesla will be able to not only evade a decrease in demand but also even increase their deliveries to unprecedented levels. For these reasons, I suspect that 2019 deliveries will rather fall into the 250-300k range.

They are back to burning cash

Source: modeled by me, data taken from filings of the company

Back in 2018, Tesla surprised a lot of investors when Elon Musk first announced that the company was going to be cash flow positive during Q3 and Q4. To an even bigger surprise to some people, the company actually delivered on this promise with rather impressive numbers. Tesla reported operating cash flow of $1.4 billion in Q3 and $1.2 billion in Q4.

Unfortunately, these changes didn't hold. Tesla fell back into old habits during the first quarter of 2019, burning yet again a very sizable amount of $950 million in negative free cash flow during that time. Volatility of this kind is not something you want to see here. Cash flows can be impacted by one-time effects but swings into the red of this severity and frequency are evidence that the company still has deeply rooted profitability issues. Ultimately, investors will want to see Tesla being able to maintain positive cash flows for extended periods of time instead of a change that only lasts 2 quarters and then immediately reverts back to a level that is just as bad as before.

Cash flow will be important if raising debt or equity becomes difficult

On May 2nd, Tesla announced that it would raise new capital through the issuance of both common stock and convertible debt. The next day, May 3rd, the company increased the planned amount to 3.1 million shares of common stock and $1.6 billion of convertible notes. The shares were offered at a price of $243 and the convertible notes carry a 2% coupon paid semiannually. The proceeds to the company totaled $2.3 billion excluding the option of the underwriters to purchase an additional 15% in both offerings which brings the total proceeds up to $2.7 billion.

Throughout 2018, the company's (now former) chairman and CEO Elon Musk kept emphasizing that Tesla would not need to raise additional capital in 2018. These statements were met with doubt but were upheld in the end. Mr. Musk intelligently did not extend this promise until 2019. This new capital increase is quite sizable, being about 10% of the company's total capital. Apart from dilution by the issuance of common stock, the debt pile will be increased by about $1.8 billion. Considering the degree to which Tesla is already leveraged, I personally dislike the size of the debt issuance. However, I am glad about the fact that they elected to at least raise a portion of the total amount as equity. Dilution is an issue, but I believe that the increased risk brought on by taking on additional debt trumps the dilution problem by far.

Tesla's leverage ratios are quite bad

Thanks to the equity raise, the company's debt to equity ratio even decreased slightly despite the $1.8 billion debt increase. Regardless, with liabilities 4.5 times the size of the equity and interest-bearing debt 2.5 times the size of equity, the company is tremendously leveraged.

Source: modeled by me, data taken from filings of the company

As stated previously, I like the fact that they didn't raise the entire amount in debt, but I would much rather see them addressing the already existing debt pile instead of having to celebrate an $860 million equity raise next to $1.84 billion in new debt. People have expressed that raising debt beats running out of cash any day and while that is obviously true, I don't see any positives in that situation because "not going bankrupt" is hardly what I would call successful. Elon Musk stated just a few days ago that the proceeds from this capital raise will only keep Tesla afloat for another 10 months if they continue to burn cash at the rate of the first quarter.

Valuation

Tesla's stock price has to decline rather significantly over the past weeks and currently sits at $190 per share which is half of its 52-week high of $387.

Tesla Peers

Source: modeled by me, data taken from Yahoo Finance

Tesla has always traded at much higher multiples than other car manufacturers due to the company's superior growth numbers and innovation. Now, with growth slowing and competitors releasing their own electric vehicles, there is the possibility that investors start pricing Tesla like every other car company. If Tesla keeps missing targets, doesn't deliver on promises and can't keep up the growth pace on top of still struggling to achieve profitability, there is little reason to pay such a high premium for the stock. The table below shows the market cap as well as the share price of Tesla if it was valued at the average multiples of competitors.

Tesla Valuation

Source: modeled by me

It is surely possible that Tesla will be able to overcome its obstacles, but right now, it seems likely that won't be able to deliver on most of their promises. For this reason, a repricing of the shares to levels of competitors is a decently possible scenario. Should this happen, I estimate that the share price could plunge to $35 which is about a fifth of the current trading price. This estimate is also in line with Morgan Stanley's most recent bear case target of $10.

Risks and challenges

  • Global demand for new vehicles shows signs of a slowdown but is ultimately uncertain. Vehicle purchases are difficult to forecast and could move in a different direction than anticipated
  • Trade war and tariffs could develop in a way that negatively impacts Tesla even further
  • Interest rate risk: Bonds of Tesla have taken a dive lately and could drop in value even further which, in turn, means that the company will have to pay a lot more on their debt in the future. This will negatively impact the bottom line by taking a bigger cut out of operating earnings.

Conclusion

Approaching the end of the first half of 2019, Tesla looks significantly worse than it did at the end of 2018. The decrease in both production, as well as deliveries, is disconcerting to say the least. Additionally, the out of control cash burn suggests that the company does not have its costs under control at all. Given that global vehicle demand could slow down in the coming months and years, Tesla will have to find a way to become and more importantly stay cash-flow-positive even during demand fluctuations. Even though they were successful in raising new capital up until now, Tesla cannot rely on cash injections forever because one day investors might refuse to supply fresh capital or at least demand a higher return which will put more pressure on the company.

Furthermore, the potential of the share price to decline to the estimate poses a significant risk. In the event of a decline to $35 per share, investors would lose 80% of their money. Overall, the downside potential just appears to be substantially greater and more likely than any of the upside. For these reasons, I believe that Tesla is not an attractive purchase at the moment despite the recent significant decline in valuation.

Disclaimer

This is neither an offer nor a recommendation to buy or sell securities. The points presented in this article are estimates and opinions of the author and may or may not correctly indicate the future.

I am not a financial advisor and this report is not to be considered financial advice. Please always conduct your own research and consult a financial advisor before making any investment decisions.

This article was written by

Maximilian Dorn profile picture
561 Followers
I am a private investor who focuses on dividend income and capital preservation. My investment decisions are heavily focused on valuation by which I determine whether a stock is under- or overvalued. I hold a bacherlor's degree in economics and management with a specialization in finance from Ulm University, Germany. Currently I am enrolled in a master's program.
Follow

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.

To ensure this doesn’t happen in the future, please enable Javascript and cookies in your browser.
Is this happening to you frequently? Please report it on our feedback forum.
If you have an ad-blocker enabled you may be blocked from proceeding. Please disable your ad-blocker and refresh.