Tesla: One Of My Favorite Companies Became Fundamentally Overvalued

Summary

• While in the midst of a strong period of production growth, current expansions will fall short of generating enough income to justify today’s value, even if demand exceeds production.
• With a host of new competitive threats entering the EV market in the coming years, Tesla will face strong competition that will eat away at its vehicle demand.
• Tesla’s peers in the autonomous driving field have received valuations that are dramatically lower than Tesla’s own, representing a clear disconnect between the company and its market.
• Recent value growth has come from value spikes that result from overhyped news reactions and has created the disconnect that Tesla experiences with reality versus its valuation.

Barring my latest article, I have been quite vocal about how Tesla (NASDAQ:TSLA) was unfairly ridiculed by financial analysts as nothing more than a money-burning corporation, destined to fail, lacking any path to profitability. I often touted its future growth as a reason to invest and a means to justify the company’s weak financial past. With the future at the forefront of Tesla’s valuation, the company was due for a spike in its value upon realizing their goals. This year has been plenty quite exciting, with the introduction of the all-important Model Y and ramping vehicle production at Gigafactory Shanghai, but at what point has excitement surpassed the reality of the electrifying company? I think that this has happened long ago. While I do still believe in the company’s long-term vision, I cannot see how these goals are able to justify such an astronomical valuation. Through a brief discussion of the company’s goals, I will provide reasoning as to why I believe the company is fundamentally overvalued.

Growth Analysis

This is where Tesla shines. Objectively, Tesla is undergoing some incredible growth projects that will see rapid expansion in the company’s production capabilities. With three new facilities in different stages of construction, one in Shanghai, China, another in Berlin, Germany, and a final one in Austin, Texas, the company is making massive pushes to produce more vehicles. With new production capabilities comes greater revenue for the company, assuming they can sell their vehicles, and therefore understanding the scale of this production ramp is quite important.

Looking at Tesla’s established production facilities, located in Fremont, California and Sparks, Nevada, is a good place to begin. While I am aware of Gigafactory 2, located in Buffalo, New York, this is a facility focusing on the production of Tesla Energy products and isn’t relevant for this analysis. Looking first at Fremont, Tesla has made the final investments needed to maximize the capacity of the production facility. Targeting an annual production rate of 590,000 vehicles by the end of 2020, or early in 2021, the NUMMI factory is returning to, and exceeding, its former glory. The change of ownership in 2010 from Toyota (TM) to Tesla saw many raise doubts about Tesla’s ability to make good on its promise to complete such a transition. However, ten years later, the young auto manufacturer has done just that and has proved its doubters wrong.

Tesla’s Nevada Gigafactory is a bit of a different story. Building the facility from the ground up, Tesla broke ground on the facility in June 2014 out of necessity to increase the available battery supply. Opting to build the factory in phases, Tesla was able to begin operations with future expansions to be completed as Tesla’s battery demand grew. Tesla states that the Gigafactory is in fact just 30% complete currently and, once completed, will be the largest building in the world, by both footprint and volume. While all of this sounds great, what matters more is what this means for production growth at the facility.

The factory’s main purpose is to supply Tesla with the batteries it needs for its mass-market vehicles. Fairly recently, we got a look at what future expansion for the Gigafactory may look like when Tesla and Panasonic (OTCPK:PCRFY) deem it economically viable. For those familiar with the infamous octagon that Tesla has used for press photos of their Gigafactory, the shape may seem familiar. However, current plans have only secured a further 10% increase in production as both companies work on efficiency first. While Tesla’s Battery Day brought some exciting news, much of this includes plans for future expansion and is still reflected by the current Gigafactory layout and expansion plans. As the factory grows, it will likely do so in direct correlation with Tesla’s automotive production growth.

Source: Electrek

On the other side of the world, Tesla’s Shanghai Gigafactory has been ramping production quite steadily. Back in September of 2019, my prediction of Tesla reaching a production rate of 250,000 Model 3s per year by the end of Q1 2021 was far from being widely accepted. However, according to Tesla’s third quarter report, I underestimated the company, as production rates are now at 250,000 Model 3s per year, or 5,000 per week. Some local reports indicate that Tesla has even exceeded this, with 5,600 vehicles produced weekly.

In terms of development for the Model Y production lines in the facility, Tesla stated that they are currently building out the production capacity for the vehicle in Shanghai with all investments already completed. With the rapid progress shown with the Model 3, there is no reason to believe that Tesla will not complete full capacity construction before the end of Q3 2021. Upon reaching full capacity, this facility will add an additional 500,000 units to Tesla’s global output.

Tesla’s facility aimed to target the European market is located in Berlin, Germany. Beginning with Model Y production, the facility will eventually produce both Tesla’s Model 3 and Model Y with a combined total output of 500,000 vehicles per year -- just as Tesla’s Shanghai factory will. A publication from the local environmental agency indicates that the company expects production to begin in July 2021. However, the facility will likely take longer than Shanghai to ramp to full capacity, as Musk stated on Tesla’s Q3 earnings call that “because of the exponential nature of the spool up of manufacturing plant, especially one with new technology, it will start off very slow at first.” Pictured below is recent construction progress at the Berlin Gigafactory as of Tesla’s Q3 report, showing the rapid progress being made at the site.

Source: Tesla

Tesla’s Texas Gigafactory is still in its infant stage, as demonstrated by the photograph below, and has a bit of a twist on the format followed by the new facilities in Shanghai and Berlin. Tesla has slated the Austin facility as the production site for the company’s Cybertruck, alongside the Model Y, deviating from the typical Model 3 and Model Y format. The company will also eventually produce Model 3s and the Tesla Semi at the facility, but the company has not said exactly how many total vehicles they aim to produce at the site. The facility is not expected to be ready for production until May 1, 2021, though, just as with Berlin, investors should not expect a rapid production ramp.

Source: Tesla

All of these rising production figures will obviously correlate to stronger revenue generation for the company as well. However, the question remains: exactly how much will this improve by? Much of Tesla’s remains a question mark, which makes deriving the answer to this incredibly important question quite difficult. In the third quarter, Tesla produced 145,036 vehicles. Annualized, this would be 580,144 vehicles. The exact split between vehicles produced at Fremont and those in Shanghai is unknown, but it makes sense to reason that the majority are from Fremont. Following my previous predictions, in a year’s time, Tesla will increase its annual production rate from just over 580,000 to 1,090,000 from Fremont and Shanghai alone.

However, Tesla is not just working on these two facilities. With their Berlin and Austin Gigafactories working towards production as well, the company will likely see their output nearly quadruple within the next five years. While the production at Austin will likely be below the targeted 500,000 of other facilities, the greater revenue from higher sales prices of the Semi and Cybertruck will make up for the reduced volume. While this wouldn’t equate to an exact 4x multiplication of the revenue, it would likely come quite close. Unfortunately for the company, Tesla’s battery storage business is unlikely to see much growth in the near future as production is reserved mostly for vehicle production. Following the 4x multiplier laid out above, Tesla’s current annualized automotive revenue of $30.444 billion would see an increase to $121.776 and I would expect total revenue to remain somewhere in the ballpark of $120 billion to $160 billion at the end of 2026. However, keep in mind that this is under the assumption that Tesla will continue to sell every car that it manufactures -- far from a guarantee.

Basis of Tesla’s Value

Now that Tesla’s growth, which is what I believe to be its greatest competitive advantage, is out of the way, I can go on to discuss how the company is being valued. Tesla’s valuation has always been a bit speculative, as is the nature of any growth company, but now it seems that this speculation has become simply unjustifiable. Tesla’s current valuation, as I see it, is based on three major categories: production growth, autonomous vehicles, and their lead in the EV market creating strong demand. In a previous article, I detailed why Tesla’s position as the unquestionable leader of the EV market is coming to an end. This means that the company, which has seen demand exceed production practically since it began producing vehicles, may soon start to face more difficulty selling its vehicles. With demand already showing signs of weakness, especially in Europe where most of Tesla’s challengers are beginning their electric pushes, the future for Tesla looks far less secure.

Tesla’s current production is clearly far below where the company hopes to be in five years' time, which raises a lot of uncertainties. Analyst concerns that the exclusivity associated with the brand will begin to fade as it becomes more mainstream are now more relevant than ever as the company aggressively builds out production. Additionally, the ‘cool factor’ of owning a Tesla, which alose comes partially from the exclusivity, will begin to fade as new EV offerings from other brands incorporate much of the same tech, which can even surpass Tesla’s own in some cases. The EV design cues that Tesla pioneered, starting with a large touch screen with a relatively minimalist interior, is also a component that many other companies are introducing in their own lineups. While Tesla’s previous demand relative to production was certainly impressive, demand will need to exceed today’s impressive numbers by a wide margin to match future production. It’s easy to look at the numbers and say that Tesla has strong demand today, but even if they double this demand in five years, the company will simply not come close to accounting for their dramatic rise in production. With rising competition, Tesla will simply be unable to maintain its current market share and, even as the market grows, will not be able to maintain demand that exceeds its production.

Source: Ford

Another recent article of mine detailed how I see the future of autonomous vehicles playing out, and while I don’t see Tesla as a leader in the market, it has the potential to serve as an important component. In that article, I likened the auto manufacturer’s distant future in the market to Waymo, which was recently valued at just $30 billion. While it is logical to point towards the lack of manufacturing power behind the Google (GOOGL) subsidiary as a contributing factor towards a lower valuation, General Motors’ (GM) owned Cruise Automation is valued at an even lower $19 billion. Both of these valuations demonstrate clear precedent for how an autonomous vehicle development program should be valued, but Tesla is far behind both of them. In terms of offering a ride-hailing service, Tesla will need to play catch up with both companies and its autonomous development program’s value should certainly not exceed Cruise’s $19 billion. Any strong growth company requires some healthy speculation to create a fair valuation of the company, as is part of the risk that comes with investing in one. However, speculation should not incur ignorance, and Tesla’s valuation points to one of lofty dreams with faulty ideology.

What’s Behind The Growth?

To reach such an inflated value, Tesla’s stock first had to climb over 400% from the start of this year, a time that feels all too far away in light of the global pandemic. To determine what caused such monstrous growth, it would help to remember where Tesla was nearly a full year ago. The best way to paint the full picture of the company’s standing at the time is to look at their 2019 full year report. In the company’s year summary, the company touts its ability to begin production at their Shanghai Gigafactory and a return to profitability in the second half of the year. At the time, Tesla had not produced any Model Y vehicles but promised that deliveries would begin soon. This promise was upheld, as the Model Y saw its first delivery on March 13 of 2020. While this was slightly ahead of Tesla’s initial production schedule, investors should have been expecting this result already, as per the company’s Q3 2019 report. At this stage, Tesla had already announced the Berlin Gigafactory and would announce plans for a second North American factory, to be revealed as the Austin Gigafactory, just three months later.

At this time, Tesla told investors to expect their Shanghai Gigafactory to reach full Phase 1 capacity by the end of 2020, as it did, and to see Model Y production ramp rapidly, as it did. The only thing that has happened this year that investors were not aware of before it began was the Austin Gigafactory. However, this shouldn’t have come as a surprise as Musk, as well as the company as a whole, had stated that the company required greater production capabilities to manufacture the Cybertruck and Semi. Essentially, by merely delivering on promises and fulfilling the bare minimum expectations held by investors, the company rose a jaw-dropping 400%.

However, Tesla has failed to deliver on some other, rather important, promises that the company has made. Both the Tesla Semi and Roadster are potentially quite lucrative for Tesla due to the high margins and sale prices of the vehicles, yet neither have yet made it to production. The Semi was expected to begin production at the start of 2020, then the end of 2020, and as of Q1 2020 it was 2021. This is all after the truck was originally slated to begin production in 2019. The Tesla Roadster, originally slated for a 2020 production date, is now expected to begin production in mid to late 2021. However, no negative ramifications have come from the company’s inability to deliver on these two vehicles that have the potential to deliver strong profits. Perhaps even more important is the message that this should be sending investors, that Tesla is still struggling to deliver on promises that it makes.

Source: Tesla

Perhaps an even greater blemish on the company’s reputation is their continued failure to meet autonomous driving goals. Their track record is, quite frankly, atrocious and the company’s current ‘full self-driving beta’ is arguably more of a driver hindrance than a driver-assist system. This terrible beta also comes almost a full year after Musk’s latest prediction of when Teslas would be capable of fully autonomous driving. While not only over ten months behind schedule, the capabilities do not come close to what Musk had said the vehicles would be capable of doing either. This is perhaps the largest stain on Tesla’s reputation as the industry often disregards the auto manufacturer's claims and it continues to fail to deliver on one of its biggest promises. However, these notable failures continue to have no effect on Tesla’s overall value as it just continues to climb higher.

In the month leading up to the company’s Q4 2019 report, the company’s value grew by nearly 40%, with better-than-expected deliveries being the only major piece of news to boost the stock. In the week after the report, Tesla grew another 29%. This was almost 70% growth from essentially one piece of good information -- Tesla was able to deliver more cars than people thought they would be.

An equity raise in February saw the company’s value climb by nearly 5%, less than a month after Tesla CEO Elon Musk stated that the company would not raise any more equity capital raises on the company’s 2019 Q4 earnings call. The company had closed at $153 per share the day before the equity raise was announced, having risen over 100% in the two months leading up to the announcement. Usually, an equity raise isn’t too far out of the ordinary for a growth company like Tesla, but, coming less than a month after the CEO said it would be unnecessary to do so again and after such a dramatic climb in value, it seems like the company was trying to take advantage of their value at the time. Because of this, it seemed illogical to many, myself included, that Tesla’s value would then climb as a result. Strange, unjustified, rises like these have not been uncommon for the company during this historic run and should have raised several questions.

Tesla’s most recent accomplishment was its addition to the S&P 500. In this case, the news is rather positive and serves as a clear vote of confidence for the company’s success. While a brief price hike is normal for companies recently listed to the S&P 500, as many investment vehicles tracking the index will buy shares to account for the new development, this has been overblown again by Tesla. Traditionally, this brief hike doesn’t surpass 7% and will effectively be completely negated within 20 days, demonstrating a fairly steady downturn after the first three days. Therefore, the more than 28% rise in the five days of trading after the news broke seems like a bit of an overreaction and the lack of a correction furthers this line of thought. This is one of the clearest examples of how Tesla does not behave like any other company, without any justification to do so. At the very least, the company should see a short-term drop in value from this current spike. Again, positive news about Tesla has garnered excitement and led to value inflation. While some of this is due to a recent analyst upgrade, the stock had still risen 20% before the news broke without any signs of corrections on the horizon. As I see it, Tesla’s run-up has been largely illogical and without much or, in some cases, any reason. There is no reason Tesla should’ve risen 70% in the first month and a half of 2020 and sustained growth has pushed Tesla’s value further from the bounds of reality.

Source: McKinsey & Company

Peer Comparison

For a while, comparisons of other automotive companies used to frustrate me. Tesla just wasn’t like other manufacturers. However, General Motors is starting to become more of a viable comparison to Tesla than it ever has been in the past. To combat Tesla’s future ‘robotaxi’ plans, General Motors has Cruise Automation. In fact, I anticipate that Cruise Automation will even end up being the superior service. To oppose Tesla’s supercharger network, General Motors has partnerships with multiple EV charging networks. To challenge Tesla’s Autopilot, General Motors, again, has Tesla beat with both Cruise Automation and Super Cruise. To match Tesla’s vertically integrated battery tech and powertrain manufacturing, General Motors has Ultium. Perhaps Tesla’s only lead over a company like General Motors is in its energy business, yet General Motors’ plans to license their proprietary Ultium battery tech to other manufacturers has the potential to more than make up for that as well.

However, General Motors is not a speculative bet. They are a proven automotive powerhouse that posts consistently strong sales and revenue, especially when compared to Tesla. Even with lowered sales from the Coronavirus pandemic, General Motors posted revenue of $35.5 billion for the third quarter of 2020. Annualized, this would represent $142 billion, or on the higher end of Tesla’s potential revenue in five years if they’re able to maintain demand that exceeds production. While I do expect General Motors to have a successful transition to EVs, they do also still have plenty of time to create a compelling EV as demand for gas-powered vehicles remains far stronger than that for EVs. However, with a value of just over $60 billion, the proven automotive giant lags far behind Tesla. Holding every single one of the same distinctions as Tesla, with the exception of their energy business, General Motors is a far more secure bet with proven revenue streams and a history of delivering on their promises. Now, unless Tesla’s energy business is worth upwards of $350 billion, or about 85% of the total company, their value just doesn’t make sense.

Overvalued

To determine Tesla’s current financial viability, I’d like to annualize the company’s third quarter net income to achieve an annual net income of $3.496 billion. This reflects the company’s current operations better than last year’s net income due to growth in both production volume and efficiencies. At the time of writing this article, Tesla’s P/E ratio is 147, compared to General Motors’ of just over 7 (using 2019 adjusted income). For those that argue in favor of Tesla being more than just an automotive company, the data does not get any more favorable. The S&P 500 has a historical average P/E ratio of just under 16, while current market conditions have brought it up to just under 36. Annualizing Tesla’s third quarter revenue brings a figure of $25.2 billion and would provide Tesla with a price to sales ratio (“PSR”) of 20.5. The average PSR on the NASDAQ, where Tesla is traded, is currently 3.91, again, far below where Tesla resides.

It is not a sustainable practice to value a company based on what their profit could be in five years' time and this is a dangerous precedent to set. While it is more than acceptable to take into account growth potential, this does not need to entail a P/E ratio of 147 or a PSR of 20.5. Instead, a PSR of 4.75, or a P/E ratio of 35 would suffice. Of course, a large portion of Tesla’s value is associated with the company’s growth and emerging technologies, which is why I utilized a PSR and P/E ratio so far above the average. While my imposed target P/E ratio for Tesla would still fall slightly under current averages, Tesla’s business has been affected far less by the ongoing pandemic than many other companies so it has no reason to fall under this current exception.

To achieve each of my target values, an approximate 76% drop in the company’s value would need to take place first, or the company could raise profits by over 325% and revenues by nearly 330%. With such large increases required to make this work, Tesla’s current value doesn’t even reflect where it’ll be in five years (based on expectations of low demand and expansion plans discussed above). In its current state, Tesla’s plans for future expansion and other business ventures simply fail to justify the company’s astronomical valuation.

Perhaps one of the greatest reasons that Tesla has become so overvalued is its shareholder base. Popular among inexperienced, young investors, Tesla’s stock is artificially inflated to represent the overexcitement that is often generated by the strong fanbase of the company. CEO Elon Musk’s charisma is often identified as the root of this and his large public figure is instrumental in this cycle. Tesla knows this, which is likely why they offered their stock split. This move made their shares more attainable to the casual investor and allowed these investors to continue to pump up their value. Looking at Tesla’s shareholder base, 56% of shares are owned by individuals with no major stakes on their own. Compared to Apple (AAPL), which has 39.2% of their shares held by amateur investors, and General Motors, which has just 11.8%, it is apparent that insiders and professionals are staying away from Tesla at a disproportionate level compared to its peers. To fill this hole, Tesla’s incredibly loyal fanbase more than suffices. Even still, Apple has, arguably, an even larger fanbase than Tesla, yet it still maintains a better ratio of amateurs to professionals. This source of value inflation cannot last and the hype will die out eventually, leaving Tesla with nothing else to justify its incredible valuation.

Investor Takeaway

In its current state, it’s hard to get excited about Tesla. I’m sure there are many people like me, who see a company with great growth prospects, but can’t look past its disproportionate value. It’s a pretty strange position to be in, but reality is often disappointing. With the company rising towards new heights, it is becoming more detached from its true value than it ever has been before. While it is currently riding on waves of excitement, this momentum cannot last and I would therefore recommend taking a short position in the company.

Since I’ve last written about the company, Tesla’s days to cover has fallen from 1.3 to .8 which allows for great flexibility to exit a short position if need be. Additionally, listed as a general collateral stock, Tesla’s borrowing fees remain among the lowest on the market at just .30%. Because of both of these factors, Tesla is a fundamentally less risky short position than most other companies on the market and will allow for minimal losses if the short thesis proves incorrect. What remains key is determining when exactly the hype around Tesla will die out. I would be lying if I said that there was a concrete way to determine this. The Elon Musk fandom is unlikely to dissolve overnight, but a greater sense of reality could set in among Tesla’s investors. With the arrival of a strong catalyst, Tesla’s momentum could easily begin to reverse. Whether this is a sign of weak demand, further production delays, or another issue surrounding the company’s fundamentals, I believe that a major correction is on the horizon. While I believe signs of dramatically weakening demand are inevitable within the next three years, I believe that this first major correction will come within the next six months. Investors should watch closely for this catalyst and as the floor is ripped out from underneath Tesla, their weak fundamentals will do nothing to slow their fall.

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.