Its well known in the market how good stories sell well. People love to dream and imagine all the wonderful possibilities that could be. Investors are no different, and are willing to pay a premium for hope of a bright future plus they tend to ignore any storm clouds of danger in such stocks. Its human psychology and its manifested itself in many forms throughout time from the Tulip Mania of the 1600s to the Dotcom Bubble in the late 1990s.
Investors of today are no different. Everyone wants the next "big" thing and if its sexy, it sells.
A Pure Story Stock
While there are many on the street that think Tesla (NASDAQ:TSLA) is a sound company with incredible fundamentals, the simple truth is that Tesla is a pure story stock. It has a cult like following centered on a leader that has had tremendous accomplishments in a very short period of time. This following, which consists of investors and analysts alike, enables the company to carry a valuation that is far in excess of its competition on almost every metric. And with this higher valuation comes an ability to literally print money by issuing new shares at these inflated valuations to fund their operations. Even when the results go a bit astray, the story is so good that investors are willing to overlook the problems and focus on the future dreams instead.
What makes this story so much better is Tesla has morphed into more than just an automotive manufacturer and has now become a one stop shop for rooftop solar power, battery producer, and electric car maker. The dreams are big. The story is sexy. And the investors are paying a huge inflated premium to own a piece of this story.
The Real World Discounts Recession
While TSLA is able to have the investment community ignore the economics involved in business cycles, other auto companies such as Ford (NYSE:F) and General Motors (NYSE:GM) are not so lucky. Both F and GM are valued at levels that factor in an imminent recession with forward 2017 PEs sporting 6.7x and 5.5x respectively. The market has discounted the prices for the whole auto manufacturing sector on the basis that we have already hit "peak" auto sales in this expansionary cycle, and the future recession will take auto sales substantially lower. The prices of these real world auto manufactures are discounting that likely probability.
When Paths Collide, Dreamers Face Reality
Even the best most wonderful of dreams is eventually ended by waking up. While most investors in TSLA would prefer to have the company continue to be funded by an ever-increasing pool of new investors paying higher and higher prices, the reality is that this dream is unlikely to come true. TSLA has so far been able to extend the dream by coming up with new and creative ideas to get bigger and better, but eventually they have to execute against the promises they've made. And make no mistake, they will face real competition on every front.
TSLA operates primarily in an industry that will compete hard for market share in the areas where money is made. It is one thing for TSLA to sell a beautiful high-end sports car, it is quite another to sell a mainstream everyday vehicle to the masses. Not only do they have to produce it at a price point that is profitable, they also have to market it against competition that has far superior balance sheets. These competitors have networks of dealers, suppliers, politicians, and bankers that will not simply walk away from a serious fight.
If we look at the prices for GM and F, we see analysts are predicting US car sales have topped out and the total pie of cars sold will get smaller. In order for Musk to deliver on his promises, TSLA will have to gain a significant market share from rivals in a market that is shrinking. In good times that would be a challenge, but in tough times you can bet that F, GM, the other auto players, and their respective allies will fight for every dollar of revenue and profit.
Under The Hood
Lets look at some fundamental facts of all three companies highlighted in this story.
- Price: $228.23
- Market Cap: $33B
- Automotive Net Cash: $0 (excludes Finance subsidiary)
- Earnings Estimates: -$0.84 (2016) $1.71 (2017)
- 2017 PE: 130x
- Total Est 2016 Revenues: $8B
- Total Est 2016 Automotive Units Sold: 75 thousand
- Price: $12.38
- Market Cap: $50B
- Automotive Net Cash: $14B (excludes Finance subsidiary)
- Earnings Estimates: $1.88 (2016) $1.86 (2017)
- 2017 PE: 6.7x
- Total Est 2016 Revenues: $140B
- Total Est 2016 Automotive Units Sold: 7 million
- Price: $31.90
- Market Cap: $50B
- Automotive Net Cash: $20B (excludes Finance subsidiary)
- Earnings Estimates: $5.85 (2016) $5.77 (2017)
- 2017 PE: 5.5x
- Total Est 2016 Revenues: $159B
- Total Est 2016 Automotive Units Sold: 9.5 million
Analysis Of The Stats
When looking under the hood, several issues should be noticed. First TSLA should produce 75 thousand cars, while F and GM should produce 7 and 9.5 million. This fact should not be overlooked. TSLA has very little experience in "mass producing" millions of cars and this is a very big risk investors often overlook. Compared to F or GM, TSLA is not even close to having the infrastructure built out to compete in a serious way.
Second, TSLA carries a market cap of almost 60% of its bigger brothers. If you look at the almost every metric, this simply doesn't make any sense. TSLA burns cash, has no cash cushion against bad times, and relies on the generosity of the market to fund their stock sales at ever increasing price levels. Meanwhile F and GM have $14B and $20B to cushion their cash burn in the event of recession. Stated another way, the investors in TSLA don't anticipate anything bad happening in the future, while F and GM investors are braced for Armageddon.
Finally, in order for TSLA to earn its market cap it must take a lot of market share from others to justify its valuation. Their sales of $8B are roughly 1/20th of each of the other 2 players. While many of their supporters believe they have some secret sauce that will thrust them past the other major automakers, the truth is that all the producers have products that will compete. There is no moat to shield them from competition, and as they enter the big boy mass market, they will find out just how tough it is to compete with very established competitors.
Recession Possibilities Ahead?
GM and F continue to price in a recession and if one does develop, then it could be argued their stocks have already taken the haircut. Trading at mid-single digit PEs now will certainly cushion the blow later because they are trading at roughly 1/3 of the rest of the market. While we would expect the earnings to fall in a recession, the key question will be how far the earnings actually drop. We are confident both GM and F have anticipated this likelihood, thus we believe the market will be pleasantly surprised when the worst comes and these two companies demonstrate how they've changed.
TSLA on the other hand will face a hard reality if recession hits. They will have to compete for market share in a much tougher mass market segment in a much tougher macro environment. The fact that investors rely on a high valuation to fund their operational model only adds risks to the execution challenges. If a recession does hit and the market drops along with it, any unraveling of the go to market strategy for funding could cause a massive loss in share price. It could create a death spiral where more and more shares have to be issued to fund operations, thus depressing the stock with each successive issue. Essentially the opposite of what we have witnessed during the current market levitation.
Tesla is a story stock that is headed down a path towards true competition with some serious market competitors. While investors like to dream of what could be in the future, sometimes it is best they take a hard look at the future reality. Both F and GM are signaling that the auto market is at a top. In addition both companies are well positioned to weather the storm ahead. TSLA is reliant on a funding model that could be a disaster for current shareholders if times get tough. We suggest investors in TSLA wake up from their dreams before reality finally sets in.
Disclosure: I am/we are long GM, F.
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.