Tesla: Lithium Market Realities Point Towards Long Term Pain In Shares

Summary

• Tesla is currently valued at multiples that could make SaaS software companies blush. The stock currently assumes that the company will grow unimpeded for decades.
• The product produced is undoubtedly good, but the company currently appears to be priced for perfection with no margin for error at all, either internally or with its suppliers.
• In the current environment where high multiple peers are crashing, Tesla seems poised to follow suit eventually and the magnitude of the losses could be extreme.
• The reality and vulnerability of the lithium market provide little hope that Tesla realistically can hit its goal of 20 million vehicles by 2030.
• Current holders would be wise at a bare minimum to cash out their cost basis here.

Scott Olson/Getty Images News

I do not usually write bearish pieces, in general, I tend to keep to myself or simply ignore stocks that fit a bearish narrative for me, for Tesla (NASDAQ:TSLA), however, I simply cannot ignore what I see as the precarious position current valuations place individual investors in.

Overview

Tesla's run in the stock market to this point has been simply legendary. The stock has run from $62 a share in 2019 to over $1,199 as of 01/04/2022 clocking in a wealth-generating 1,490% return over the last 3-year period.

Data by YCharts

The reason behind this massive run-up in shares is not easily explained and appears to be quite complicated. The company is clearly operating at a high level. The product they produce is attractive, well-liked and is a driving force behind the EV trend sweeping the globe. This is only part of the story, however.

During this 3-year period of explosive share price growth, the company grew revenues from $24.57 billion in 2019 to a forecasted $51.32 billion in 2021. The company also grew gross profits from roughly $4 billion in 2019 to a forecast of over $15 billion in 2021.

During the same 3-year period, the company's market capitalization grew from $53 billion to $1.08 trillion or roughly 1,900% growth. Below I have put this into a bit of context.

• 2019-2021 revenue growth = 109%
• 2019-2021 gross profit growth = 275%
• 2019-2021 market cap growth = 1,900%

Clearly, the results of the business have been outstanding, however, these results in absolutely no way justify the explosive growth in the share price. It would appear that a full 1,625% of the share price growth has been due simply to multiple expansion.

While I can certainly see a case to be made that the EV market's prospects and therefore Tesla's are vastly increased from 2019, I cannot find any reason to believe that the market potential has somehow increased 1,625%.

One rather obvious explanation for this discrepancy in business results and the share price is the rise of the Reddit momentum trader. Individual investors have piled into the name in record numbers along with high growth ETFs like Cathy Wood's various ARK funds leading to extreme FOMO (fear of missing out).

The unfortunate reality as I see it is that even if Tesla continues growing like mad for years and years, it will not grow into its valuation until nearly a decade even under the rosiest of scenarios.

Below I will set forward a few valuation scenarios and then delve into the lithium logistics of how either of these scenarios could play out in the real world.

The Perfect Scenario

Below I will attempt to create a scenario under which Tesla could be considered nearly fairly valued today.

Under this scenario, I will use a 2023 revenue number of $93 billion per current analysts' projections as a starting point and continue to compound revenues at a 30% pace until 2030. I will also use a 15% net income margin which is a full 100% higher than the current rate and is unheard of in the auto industry today.

Also, at the end date of 2030, I will place a 25 PE ratio on the now mature company which is more than twice historic levels for automakers along with using a discount rate of 10%.

• 2030 revenue = $583 billion (assuming a 30% CAGR)
• 2030 net income = $87.5 billion (assuming 15% net income)
• 2030 market cap = $2.188 trillion
• 2022 discounted market cap = $1.02 trillion
• 2022 fair value $997.33

Verdict - 20% overvalued under this scenario.

So, this is what appears to be priced in for shares of Tesla at the current valuation, 30% revenue growth until at least 2030 along with a full doubling of its net income margin to 15% and even then, with Monday's gains in the books, make it overvalued by roughly 20%.

For the company to reach a revenue number of $583 billion primarily driven by the automotive segment, the company will need to produce and sell roughly 20 million cars if the price reduction plans of $30,000 per car are brought to fruition.

For some context, in 2021 the company, just this weekend announced that impressively it produced 936,000 vehicles in 2021 beating estimates by over 45,000 cars. While this is certainly good news in the short term, the difficult reality is that this feat is only roughly 4.65% of the 20 million goal by 2030. Getting production and importantly demand to reach 20 million vehicles in only an 8 year period would be a feat of historically immense proportion.

The market is currently pricing in at the current value that Tesla will equal the production and sales capacity of both Volkswagen (OTCPK:VWAGY) and Toyota (TM) combined in an 8-year period from today.

This looks like the textbook definition of priced to perfection...

More Realistic But Still Rosy Scenario

In this scenario, I will attempt to model a more realistic revenue and net income path while still using a very optimistic but not unlikely set of variables. I will model revenue growth off of the same 2023 estimated base of $93 billion growing at 30% in 2024, 25% in 2025, 22.5% in 2026 and 20% each year after.

Also, I will use a net income margin of 10% which is still 35% higher than current levels and equal to the most profitable vehicle maker in the world, Toyota Motors, while keeping a healthy 25 PE ratio and 10% discount rate.

• 2030 revenue = $384 billion
• 2030 net income = $38.4 billion
• 2030 market cap = $959.7 billion
• 2022 discounted market cap = $447.38 billion
• 2022 fair value $437.44

Verdict - 64% overvalued under this scenario.

While this scenario is certainly more achievable for the company, even this scenario likely will require Tesla to accomplish what is a Herculean task of growing vehicle production 1,400% to 12.8 million at $30,000 per car under the current price reduction plan in 8 years.

What is disappointing is that under this just slightly less than perfect scenario, Elon Musk would likely be forever enshrined in the industrial hall of fame for what would be a monumental achievement, yet the stock price would likely languish for nearly a decade at best.

Lithium Required To Hit A 20 Million Vehicle Target By 2030

First, before I dive in, let me state that making vehicles is both incredibly hard and incredibly complex. It requires huge factories working in concert along with a military-level supply chain across the globe. With EVs, the lithium component, in my opinion, is the most complex and the factor most out of the company's control.

Regarding the company's current lithium demands, it certainly appears that Tesla's supply chain is one geopolitical event from being broken. In November, Tesla signed a 5-year deal with Ganfeng Lithium Co. of China beginning in 2022 to supply the majority of the company's needs through 2027. In addition, the company has signed various other deals with other miners across the globe, including various junior mining companies in its attempt to secure the materials needed for its ambitious growth plans.

I do not think I am going out on a limb by saying that relying on a Chinese miner for a material that could be considered a key national resource along with a hodgepodge of others including junior miners, is primed for massive potential disruption given that China is in the middle of transformative geopolitical disputes with the USA.

Each Tesla requires roughly 22 pounds of finished lithium metal per vehicle, equating to a ton of lithium metal needed to produce just 90 vehicles, 1 pound of lithium metal requires 5.3lbs of LCE. Building a million EV's requires roughly 60,000 tons of lithium LCE. 20 million vehicles per year would require roughly 1.2 million tons of lithium LCE to be produced, just for Tesla.

For context, roughly 360,000 tons were mined in 2019 in the entire world. Ganfeng Lithium reportedly mined 90,000 tons during 2020 and while plans are in place to boost this to 200,000 tons by 2025, this is woefully short of the amount that Tesla needs to reach its goal.

The typical time it takes to build new lithium production capacity is 5 to 10 years historically, now thankfully the lithium industry has been planning capacity increases for many years, however, they appear to be nowhere near the levels needed to supply the penetration predicted by both Tesla and other EV competitors.

Source: Benchmark Minerals

By the year 2030, based on industry projections, roughly 1.5 million tons of lithium LCE will be produced in the world, total. This is a full 2 million tons short of projected demand. Tesla alone would be projected to require roughly 80% of the entire world's supply of lithium if it is to hit its target production. It is perhaps reasonable to expect that this target of production can be raised a bit, however raising it by 133% is a bridge too far for me.

If Tesla were able to achieve my "Rosy" scenario of 12.8 million vehicles produced in 2030, the math in the lithium realm also seems much more doable. 768,000 tons of lithium would be needed under this scenario for Tesla which works out to roughly half of the projected production. Total world demand would still outpace supply by nearly 100% however any little bit closer we can get increases the chances for success and innovation.

The current Lithium supply chain relies on areas of the world that are geopolitically risky such as Latin America, China, etc. Australia is also a major (and stable) supplier of the base metal, however, it relies on China to process this currently as well.

Recent elections in Latin America have led many to believe it is only a matter of time before governments begin to nationalize lithium production and thus take away the potential for rapid supply increases by way of private capital investment needed to bridge the demand gap.

In my opinion, the current 20 million vehicle estimate is nearly totally reliant on the efficiency and ingenuity of others outside of Tesla, specifically lithium miners in questionable jurisdictions, which is not a good place to be if you are long the stock.

Bottom Line

Tesla is an amazing company and I have owned shares in the past; however, the current price of the stock does not leave any room whatsoever for even the slightest of hiccups. Only assuming flawless execution of what are near impossible goals and vast logistical challenges, many that are out of the company's control, is the stock considered fairly valued today, leaving basically no upside at all for current shareholders.

The true bottom line here is that we all know that Tesla is likely significantly overvalued but for some reason, we appear to just ignore it. With the meltdown in prices of other high-flying companies in late 2021 and with rates likely set to rise significantly in 2022, I am left to wonder when the shoe will drop for Tesla. The unfortunate thing is that if the stock does come crashing down, small individual investors will likely be disproportionally affected given the company's meme status and vast following.

To be 100% clear, I am not short the stock, options or any other trading vehicle in Tesla nor do I currently have any plans to be. The market and general populace have for whatever reason chosen to ignore fundamentals in this specific stock and I have no desire to fight it.

If I currently were sitting on large gains in the name, at a bare minimum I would sell my cost basis and play this stock with house money.

Thank you for reading and I look forward to your comments below, good luck to all!

Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such 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 am not a licensed financial advisor. This is not a solicitation to buy or sell a specific security nor is it to be construed as investment advice, please contact your licensed financial and tax advisor for advice to your specific situation. This article is an opinion piece only and should not be construed as fact or be represented as such, please perform your own due diligence prior to investing in this or any equity.”