I have a Buy investment rating for Tesla, Inc.'s (NASDAQ:TSLA) shares.
I previously discussed TSLA's stock split and target price changes with my prior September 7, 2022 update for the company. In that article, I determined that "the implied upside (+13%) for TSLA's shares as per the consensus price target isn't very attractive" at that point in time. However, Tesla's shares have dropped by a substantial 33% following the publication of my earlier write-up, and this has prompted me to provide an update of my thoughts on Tesla with this latest article.
Specifically, I focus on Tesla's near-term stock price underperformance, its five-year or medium term growth prospects, and the stock's valuation in the current write-up.
TSLA's shares have underperformed in the past month or so. However, if one looks beyond the near-term headwinds, Tesla is expected to stay as a fast growing company in the coming five years based on the future CAGRs for its key financial metrics. Also, Tesla's valuations have returned to reasonably appealing levels considering its forward P/E multiple of 33.8 times now. After comparing TSLA's five-year outlook with its current valuations, I choose to upgrade my investment rating on TSLA from a Hold previously to a Buy now.
Tesla's recent share price performance has been poor in both absolute and relative terms. Since the company reported its Q3 2022 financial results on October 19, 2022 after trading hours, TSLA's stock price has fallen by -17.7%. In the same time frame, the broader stock market as represented by the S&P 500 rose by +9.0%.
TSLA's key headline metric, Q3 2022 earnings per share or EPS of $1.05 came in +5% above the sell-side analysts' consensus forecast of $1.00. But the company's above-expectations third quarter bottom line was not the key metric that investors focused on, as seen with Tesla's stock price performance following its results announcement.
Instead, Tesla's automotive gross profit margin was the metric that really mattered for investors.
Adjusting for Zero Emission Vehicle or ZEV credits, the non-GAAP adjusted automotive gross profit margin for TSLA contracted by -200 basis points from 28.8% in Q3 2021 to 26.8% for Q3 2022. Tesla's actual third quarter non-GAAP adjusted gross margin also turned out to be -0.6 percentage points lower than the analysts' consensus gross margin estimate of 27.4% based on data obtained from S&P Capital IQ.
Looking at TSLA's stock price performance since the earning's announcement, it is very clear that the company's third quarter automotive gross margin was a major disappointment for investors.
The two near-term catalysts that investors will be watching out for are stronger-than-expected vehicle demand as indicated by deliveries, and better-than-expected profitability at the gross margin level.
Tesla's stock has performed poorly in the last month or so. One major factor is TSLA's lower-than-expected automotive gross margin, which I highlighted in the preceding section. The other significant factor is the market's concerns about the company's ability to maintain a healthy pace of vehicle sales in a challenging economic environment. The company acknowledged at its most recent Q3 2022 earnings briefing that the Chinese and European economies are under pressure.
In the next section, I analyze if it is likely that Tesla can realize both of the above-mentioned catalysts in the short term.
My prediction is that Tesla's performance will be mixed in the short term, with a recovery in the company's automotive gross margin being negated by lower-than-expected vehicle deliveries.
On the negative side of things, TSLA's vehicle deliveries in the upcoming quarters might come in below expectations.
Tesla mentioned at its most recent quarterly investors call that the company's 2022 vehicle deliveries are expected to come in "just under 50% growth due to an increase in the cars in transit" as a result of "limits on outbound logistics capacity which we didn’t anticipate."
Apart from issues relating to logistics, other factors such as weak consumer demand in view of poor economic growth, and consumers holding off new purchases in anticipation of potential tax credits for 2023 are likely to result in weaker-than-expected vehicle deliveries for Tesla in Q4 2022.
On the positive side of things, I expect Tesla's automotive gross margin to improve in the fourth quarter of 2022 and beyond.
One key thing to note is that the Q3 2022 automotive gross margin for TSLA was hurt by "Austin and Berlin ramp costs" as per management's comments at the third quarter results briefing. It is noteworthy that Tesla guided that "the impact" of "Austin and Berlin ramp costs" going forward will be "less than what we saw in Q3." Also, one should have seen the worst of inflationary cost pressures again, and it is reasonable to take the view that raw material expenses should trend lower in the future.
Nevertheless, I think it is important for investors considering a potential investment in Tesla to look beyond the near term. I write about Tesla's intermediate term or five-year outlook in the next section.
In the next five years, Tesla is expected to continue delivering strong growth across all of its key financial metrics.
As per consensus data sourced from S&P Capital IQ, analysts estimate that TSLA's top line will grow by a +30% CAGR from $53.8 billion in fiscal 2021 to $201.7 billion for FY 2026. Over the same period, Tesla's normalized net income and free cash flow are projected to increase by CAGRs of +29% and +45% to $26.8 billion and $32.5 billion, respectively according to the sell-side's forecasts. TSLA also stressed at its recent Q3 2022 earnings call that the company will continue to "grow our vehicle production, sales deliveries by" a CAGR of +50% or higher in the long run.
There are a number of factors supporting the positive five-year and mid-term financial outlook for TSLA.
Firstly, the penetration rate of electric vehicles might increase at a much faster pace than what the market is currently expecting.
A September 14, 2022 research report (not publicly available) titled "Demand For EVs Outpacing Supply" published by Needham & Company highlighted that "the majority of automakers" are "targeting 100% of sales weighted to EVs by 2030 or 2035", while it noted that various industry forecasts point to US EV penetration rate only hitting the mid-40s to mid-50s percentage range by 2030.
In other words, analysts might be overly cautious in relation to their estimates of the expected penetration rate of EVs in the future, and there could be positive surprises ahead which will benefit the market leader, Tesla.
Secondly, Tesla's future top line expansion isn't just about executing on more one-off vehicle sales. It is worthy of note that revenue derived from TSLA's Services And Other segment surged by +84.0% YoY from $894 million in the third quarter of 2021 to $1,645 million in the most recent quarter.
Looking forward, supercharging revenue (key contributor for the Services And Other segment) is an area which holds significant growth potential. According to a Goldman Sachs (GS) research report (not publicly available) titled "Opening The Supercharger Network" issued on June 29, 2022, analysts from GS estimate that "the incremental (supercharging) revenue opportunity could be $1-$3 bn in a few years", if TSLA does "open up the (Supercharger) network to all EV drivers."
Thirdly, Tesla's future earnings per share or bottom line can grow as fast, if not even faster than its revenue, considering the positive effects of operating leverage and potential shareholder capital return.
In the third quarter of 2022, TSLA's operating costs increased by a mere +2.3% YoY as compared to a +55.9% jump in the company's revenue in YoY terms. This is a good illustration of how Tesla benefits from positive operating leverage.
Separately, Tesla's future EPS growth can be boosted by share repurchases. TSLA emphasized at its Q3 2022 results call that it can "do a buyback on the order of $5 billion to $10 billion, even in the downside scenario next year."
TSLA's shares are now rated as a Buy. Tesla's consensus forward next twelve months' normalized P/E multiple has derated to 33.8 times now as per S&P Capital IQ data, and this is just 9% above TSLA's three-year trough P/E ratio of 31.0 times. I think that Tesla's current P/E metric is reasonably attractive as compared to the company's five-year forward financial outlook, and this makes TSLA a Buy in my opinion.
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Those who believe that the pendulum will move in one direction forever or reside at an extreme forever eventually will lose huge sums. Those who understand the pendulum's behavior can benefit enormously. ~ Howard Marks
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.