Tesla: Never A Dull Moment
Summary
- Tesla had an incredibly interesting May. Between Musk's battle with Alameda County and California in general to his big payday, there's truly never a dull moment at Tesla.
- I discuss the Fremont gigafactory's controversial reopening, Musk's $775 million bonus, Model Y delivery time reduction, price cuts for other models, and potential pent-up demand for EVs.
- To provide a fresh take on to my valuation process, I employ a DuPont Decomposition method to assess Tesla's business and the trends thereof.
- I rate Tesla neutral until it reaches the $400s, at which point, I'd rate it a strong buy.
- Looking for a helping hand in the market? Members of Beating the Market get exclusive ideas and guidance to navigate any climate. Get started today »
Source: wraltechwire.com
Welcome Back
On 8th May, I reiterated my stance on Tesla (NASDAQ:TSLA) in the $700s and $800s with a neutral rating. In that article, I shared a detailed business analysis and estimated intrinsic value for Tesla. Since then, shelter-in-place orders have been eased, Tesla's Fremont factory has re-opened, and Musk somehow managed to land in hot water again.
In today's article, I will discuss some of the latest news regarding the company, analyze the momentum of Tesla's business fundamentals, and re-evaluate the company's fair value.
Elon Musk Remains A Brilliant Idiosyncratic Risk
I explained in the last article as to why Elon Musk represents a significant idiosyncratic risk for Tesla, and his recent actions surrounding the shutdown support my claim. I want to be clear that I support him, but I am also concerned that he may step on too many toes in pursuit of his visions. There is precedent here, and it generally does not end well for the bullish CEO, nor for the company from which they are removed.
We know that Musk has been a vocal critic of the shutdown, but his comments during Tesla's earnings call surely do Tesla's and his image no favors, regardless of how right he may or may not be. He termed the stay-at-home orders an unconstitutional infringement on people's freedoms, which was fine, but then in reply to a question regarding policy push for EV infrastructure, he went on a rant:
So, this is the time to think about the future, and also to ask, is it right to infringe upon people's rights, as what is happening right now. I think the people are going to be very angry about this and are very angry, because somebody should really -- if somebody wants to stay in their house, that's great. They should be allowed to stay in their house, and they should not be compelled to leave. But to say that they cannot leave their house, and they will be arrested if they do, this is fascist. This is not democratic. This is not freedom. Give people back their goddamn freedom.
Now, it is unequivocal that Musk's personality and intellect have driven Tesla to great heights in the same way that Uber's (UBER) Travis Kalanick and Apple's (AAPL) Steve Jobs drove their respective companies to great heights.
However, should he continue to act erratically, whether justified or not, the board may have its hand forced in removing him, which would be damaging to all involved.
Fremont GigaFactory's Controversial Reopening
In mid-May, Musk challenged local authorities to arrest him and re-opened Tesla's Fremont factory on May 11th in violation of regional shelter-in-place order. According to sources, Tesla and the Alameda county were already close to reaching an agreement to allow the factory to re-open on May 18th. Thus, Musk's hastiness is a cause for concern and raises several questions in my mind. Is Tesla under financial stress? Are order cancellations ratcheting up due to the global recession?
Now, America was founded on disobedience of illegitimate tyranny, so I could understand if he simply found the orders to be wrongfully emplaced, but to strain relations with the government that aids in regulating one of Tesla's largest factories seems... somewhat reckless.
My point is that Tesla's greatest risk may not lie in the growing market and opportunity ahead of it. It may lie in Musk's actions gone too far, resulting in his removal as CEO.
Such a scenario would be devastating to shareholders, of which I am one.
Powers That Be Side With Musk... This Time
During that time, Elon Musk threatened local authorities by saying that he would move the gigafactory to Texas/Nevada (Note: Namechecking Texas indicates Cybertruck gigafactory will be set up in the lone star state). Soon enough, President Donald Trump and California Governor Gavin Newsome came to Musk's support and let the plant reopen.
Source: twitter.com
Tesla seems to have left the whole fiasco behind after recently dropping its lawsuit against Alameda County.
Musk has yet again averted damaging Tesla through his erratic (relative to the average CEO) actions. This same personality and drive are what makes Tesla great, but it should be balanced and tempered, such that it does not result in Musk's removal as CEO.
Such an event would almost certainly send the stock down dramatically.
Musk's Bonus Pay Attracts Shareholder Litigation
For a change, Musk is not to be blamed for the new litigation against Tesla, but he is still at the epicenter of the issue. As you may know, Tesla's board of directors approved a $56 billion performance-based compensation plan for Musk in 2018. Last Thursday, the first tranche of the award was triggered when Tesla's average market capitalization stayed above $100 billion on a six-month and thirty-day basis, along with the satisfaction of other requirements related to revenues and profitability. So, Musk got an option to purchase 1.69 million shares at a strike price of $350, which translated to a net payout of $775 million (at a stock price of ~$805).
However, this award has instigated Richard Tornetta (a Tesla shareholder) to file a litigation against Musk, challenging the incentive plan. In the lawsuit, he has alleged that Tesla's board violated its fiduciary duties by approving an excessive compensation plan for Musk.
Reading The Tea Leaves Of Tesla's Production
In an effort to be completely transparent, I stated in my last article that Tesla would have no issues with demand due to their persistent backlog of orders. However, recent price cuts have put that theory under intense scrutiny.
The coronavirus pandemic has severely hit all automakers, and Tesla is not immune (according to early signs). So, you might ask, what are these early signs? Price cuts and a drastic reduction in delivery times.
According to data from Electrek, Tesla has cut prices across all its models save the Model Y. Here's a summary of the deep price cuts:
Model | Old Price | New Price | Price Cut |
Model 3 | $39990 | $37990 | $2000 |
Model S Long Range Plus | $79990 | $74990 | $5000 |
Model X | $84990 | $79990 | $5000 |
Source: electrek.co
Historically, Tesla has shown no demand issues, but price cuts worth thousands of dollars are a strong signal of demand fall-off. I am inclined to agree with Electrek's view on the price drop.
Source: electrek.co
Model-Y: No Price Cut, Yet Delivery Time Reduction Is... Concerning
Source: electrek.co
After Tesla resumed production at the Fremont factory earlier this month, Electrek reported on Tesla updating Model 3 & Model Y delivery timelines.
According to Electrek, the automaker changed the delivery timeline for the new Model 3 orders from 4-8 weeks to 4-6 weeks.
Since Tesla had just started delivering previously reserved vehicles before the shutdown, the Model Y didn’t have a delivery timeline. However, after Tesla restarted production, it was set to 8-12 weeks for new orders. And just two weeks later, Tesla drastically reduced the Model Y delivery timeline for new orders to only 4 to 8 weeks.
We know that Tesla had amassed Model Y reservations orders for over a year and had a huge backlog, so how is Tesla able to deliver the Model Y so soon. Well, there could be a few possible reasons for the reduction in Model Y delivery timelines:
- Order cancellations are leading to a smaller backlog.
- Drop off in new orders (demand).
- Huge Ramp up in Model Y production.
I read about Tesla ramping up its Model Y production capabilities at Fremont during the shutdown. Still, it's hard to imagine they could fulfill a year-long backlog and satisfy new orders in such a short space of time. Hence, I believe the shorter delivery times are a result of a mix of all the three reasons that I put forward.
Here's Electrek's view on Model Y demand drop-off due to the current crisis:
Source: electrek.co
More Bad News
Source: www.electrive.com
BloombergNEF [BNEF] forecasts that the worldwide EV vehicle sales will contract to 1.7 million by 18% in 2020. However, the research firm maintained its long-term projection that EVs will comprise of nearly 50 million (i.e., 60%) of global vehicle sales by 2040.
Points Of Optimism For Shareholders
According to an article published on CNBC, Tesla is set to have a much better 2021 with global EV sales topping 3 million vehicles.
A new report by Cairn Energy Research Advisors, a research firm focused on the battery and EV industries, predicts a surge in electric vehicle sales in 2021 as countries around the world push new programs to encourage consumers to buy battery-powered vehicles. Cairn estimates global sales of EVs in 2021 will jump 36% and top 3 million vehicles for the first time ever.
“There’s pent-up demand for electric vehicles,” said Sam Jaffe, managing director of Cairn Energy Research Advisors. “We will see a combination of factors make 2021 an inflection point for the sale of electric vehicles.” Jaffe believes the two biggest factors that will spark demand for electric vehicles are the markets in Europe and China.
Tesla's Shanghai Gigafactory is operational, and I expect Tesla to win significant market share in China - the largest EV market in the world.
Now, I already covered a detailed analysis of Tesla's financials in my previous research note, and we haven't had a new earnings report since then. So, I would like to analyze the momentum of Tesla's business fundamentals using the DuPont Decomposition.
Assessing Tesla's Business Momentum Via DuPont
The return on equity is a measure of the profitability of a business in relation to the equity. For Tesla, we will study its Return on Equity (performance measure) over the last eight quarters to decipher business momentum trends and its drivers. Here's the chart for Tesla's Return on Equity (ROE):
Source: Author
In the figure above, you can notice the stark improvement from a negative ROE in June-18 & Mar-19 to consistently positive quarterly ROE over the last three quarters. This exemplifies Tesla turning into a profitable business over the previous nine months or so. Tesla's ROE is low, but the long-term ROE trend looks positive (upward). However, over the last three quarters, the return on equity has come down from 2.4% to 0.2%, which technically means Tesla's business is losing momentum. Let's perform a DuPont Analysis to understand the exact driver(s) of Tesla's ROE.
The DuPont Analysis breaks the Return on Equity (ROE) into four ratios:
Profit Margin: Net Income/Net Sales
Asset Turnover: Net Sales/Average Total Assets
Capital Structure Leverage: Average Total Assets/Average Common Shareholder Equity
Interest Leverage: Net Income/ (Net Income + Interest Exp*(1-Tax Rate))
The multiplication of profit margin (1) and asset turnover (2) is known as Return on Assets (another measure of profitability). The multiplication of all four ratios is the Return on Equity (ROE).
An ideal company should have the following trends:
Source: Author
So, how does Tesla stack up? Is Tesla an "ideal company"?
Source: Author
As you can see in the chart above, Tesla's profit margin trend is almost similar to its ROE; hence, on the first look, it seems like the primary driver of ROE. The asset turnover ratio is range-bound (14-24%), and its long-term trend is flat. The capital structure leverage is consistently dropping (i.e., either the sales are going down, or total assets are increasing).
In Tesla's case, we know that sales have been going up, and the company has been expanding its production capacity aggressively by opening up additional gigafactories. Of course, manufacturing plants are long-term assets, and thus we can expect Tesla's capital structure leverage to trend downwards in the near term (even though it is not ideal). The interest leverage in following an ideal company with a long-term trendline heading lower.
In summary, the trends in profit margin and interest leverage ratios of Tesla are similar to an ideal company. However, a flat trend in asset turnover and declining capital leverage ratios mean that Tesla is not an ideal company. Hence, the momentum study of Tesla's business fundamentals suggests investors should stay away from the company in the near-term.
Data Table used for Tesla DuPont Analysis:
Source: YCharts
If you'd like to further understand DuPont Analysis in detail, see this video.
Re-Evaluating Tesla's Fair Value Using The LASV Model
In my previous article on Tesla, I explained the working of my proprietary valuation model. Here are the assumptions I will be utilizing for re-valuing Tesla.
- I will continue to utilize a conservative free cash flow margin of 5%, which translates to free cash flow per share of $6.54.In the previous article, I assumed a top-line (also FCF per share) growth rate of 25%.
- However, in today's article, we discussed new sales forecasts for EVs during this year and next (-18% in 2020 & +36% in 2021). Assuming these forecasts turn into reality for Tesla too, then the FCF CAGR growth rate for Tesla drops to 20.85%.
Supporting growth rate calculations:
Fiscal Year | FCF per share | Growth Rate |
2020 | 6.54 | -18% |
2021 | 5.36 | 36% |
2022 | 7.29 | 25% |
2023 | 9.12 | 25% |
2024 | 11.40 | 25% |
2025 | 14.24 | 25% |
2026 | 17.81 | 25% |
2027 | 22.26 | 25% |
2028 | 27.82 | 25% |
2029 | 34.78 | 25% |
2030 | 43.47 | 25% |
Ten-year CAGR Growth: | 20.85% |
New Assumptions:
Assumption | Value |
Free cash flow per share | $6.54 |
Free cash flow per share growth rate | 20.85% |
Terminal growth rate | 2% |
Years of elevated growth | 10 |
Total years to stimulate | 100 |
Discount Rate (Our "Next Best Alternative") | 9.8% |
Source: L.A. Stevens Valuation Model
Using the above assumptions (factoring in the impact of COVID-19), I determined that Tesla's fair value is $337.89, i.e., the stock is currently "Overvalued" by 147.12%. Unfortunately, DCF models are far, far from perfect, as we can see here.
But that's why there are multiple valuation angles from which the L.A. Stevens Valuation Model assesses a stock's buy worthiness!
But this does not account for the fact that in the year 2029 or 2030, the stock will trade at an elevated multiple (i.e., price to free cash flow). That is, its growth will in all likelihood not hit 2% by 2030. It will likely be higher (perhaps something like 7-12%); therefore, we must assume a price to free cash flow per share multiple by which we can create a 2030 price target; with which we can create a CAGR for the next ten years (using today's share price as the beginning value).
That is, we take today's free cash flow per share, grow it at the assumed growth rate (in the chart above), then apply an "assumed price to free cash flow multiple" to achieve a target 2030 price target.
Just to remind you that we are extremely conservative with our assumptions, which provides us a considerable margin of safety.
So let's check out the results if one were to buy today at about $850:
Source: L.A. Stevens Valuation Model
Hence, if one were to invest in Tesla at $850 for ten years, then he/she can expect an annualized growth rate of about 4.56% on their investment amount, which is well below our "hurdle rate," i.e., the 90-year annualized performance of SPY (9.8%).
Therefore, I reiterate my neutral stance on Tesla and suggest investors hold the stock if they own it. However, prospective investors should make long-term investments only in the $400s if they wish to generate market-beating returns.
Conclusion
In this article, we discussed the latest news surrounding Tesla and analyzed the momentum of Tesla's business fundamentals. The last three quarters have been profitable, but we could see a slowdown in the ROE trend with lower Asset turnover ratio and profit margin. Sales decline due to an economic downturn could severely impact Tesla in the near term. The stock remains overpriced, and low expected returns do not warrant an investment at these elevated levels. Long-term investors should hold the stock, while prospective buyers should wait for a better entry point.
Key takeaway: I reiterate a neutral rating on Tesla.
As always, thanks for reading; remember to follow for more, and happy investing!
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This article was written by
These mostly include businesses in consumer discretionary, FinTech, and software.
Here is a snapshot of my performance over the last half decade or so: https://www.tipranks.com/experts/bloggers/louis-stevens
Some credentials of mine: U.S. Army Officer in Reserve, Political Science Florida Atlantic, MBA University of Florida, inventor of the L.A. Stevens Valuation Model.
Analyst’s Disclosure: I am/we are long 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.
Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.
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Comments (171)
with the person using the "First Principle Thinking",any use of those OLD "assumption and model" will lead to wrong prediction.For example, the author here, did NOT use the information on the progress of TESLA's effort to become the "Best in Manufacture".This NEW goal of becoming the "Best in Manufacture" (plus all the advantage TESLA has now) is the KEY for TESLA's future, it relates to many crucial things used in analysis.
"Tesla quietly acquired automated manufacturing firm to design factories"electrek.co/...This is the type of info to help us to do evaluation for future TESLA.
SBC is inevitably a cost to the shareholders via dilution.
Since Tesla’s FCF is of no benefit to shareholders, how it be used as a valuation measure? Or do you see the nature of Tesla’s FCF fundamentally changing going forward?
However that can be more or less depending on economies of scale for a company.
Tesla has terrible economies of scale and that's why never profit no matter how much revenues increase. 2014 revenues: 3.2 bn Expenses+interest: 3.49 bn
2019 revenues 24.58 bn Expenses+interest: 25.25 bnCash flow increase to be expected in line with change of revenues - expenses.
In Tesla case about 0%.And profits are needed for positive cash flow which will be difficult to achieve with recent $2000 price cuts.
Situations are different in 2014 and 2019 for Tesla2014: Expenses and interest used to fund
Model 3 Development
Gigafactory2019: Expenses and interest used to fund
China Factory,
German Factory,
Model Y Launch,
Semi,
Roadster,
Energy and SolarIn 2020: Add these to the list
Texas Factory
Cyber TruckIf Tesla decide not to expand at their pace, expenses will go down, but so will growth. Based on the shareprice, shareholders will expect investment in top-line growth.
cost of revenue: 20.5 bn
Selling/Gen/Marketing: 2.65 bn
Research and development 1.34 bn.1,34 bn is really low especially for a 164 bn company and has to be more if Tesla doesn't want to be caught up in technology soon. mobileeye plans tobotaxis in 2022 at initial price $ 15.000 and expects price $ 5000 eventually.www.youtube.com/...
In May Sweden is 69 while Norway is at 8.How can they pay their delivery staff if only 2 model 3 per week are delivered? Maybe Tesla wants to concentrate on bigger markets only.
Looks like they have given up on Norway.
Previously their best market in Europe. In most other European countries sales appear to be not much different from February.
It is frustrating that the Author won’t answer my question but not unexpected.
Elon's 775m bonus more than that!
This leads to a current price of $1000 at $9B * 40 / 210m / 1.1^3. * .8
So with a 20% that they fail and 80% that they succeed they are undervalued slightly.
You’re long! Good for you! 💰
You get it! Tired of hearing “never made a profit” for the last 10 yrs.
But that’s all the shorts got left.
And you can’t make it to the top without stepping on toes. (Elon does that well)!
Gates, Zuch, Jobs, Bezos have all had their feet in the fire 🔥
He’s in good company.
Musk is just a little more intelligent than all of them ? but certainly more intelligent than Zuck
Good point! But I think it will be closer to 1000. And that’s conservative. I wouldn’t bet against him. As many shorts found out the hard way.
"But Musk must hold the shares for five years before selling, so if the SP is back down to $350 or below by then, as I expect, his profit will be zero."Can he borrow against those shares or use them as collateral to scam a bank?
"Can he borrow against those shares or use them as collateral to scam a bank?"Not if he had to borrow to buy them in the first place! AFAIK.