Telsa Inc — Is the stock worth $7000 or $295?

Company Overview

Over the years, electric vehicle (‘EV’) maker Tesla has evolved into a dynamic technology innovator. It has transformed the EV market much the same way as Amazon changed the retail landscape and Netflix revolutionized entertainment. Tesla is the market leader in battery-powered electric car sales in the United States, owning around 60% of market share. The company’s flagship Model 3 accounts for about half of the U.S. EV market.

Over the years, Tesla has shifted from developing niche products for affluent buyers to making more affordable EVs for the masses. The firm’s three-pronged business model approach of direct sales, servicing, and charging its EVs sets it apart from other carmakers. Tesla, which is touted as the clean energy revolutionary automaker, is much more than just a car manufacturer. The firm also makes different kinds of technology like self-driving software, charging stations and battery development, et al. The technology titan has also made inroads into solar and energy storage business.

  1. Strong Foothold in a Niche Market. Although electric cars occupy a small portion of the global automobile market, Tesla has acquired a substantial market share within this niche segment. With Model 3 sedan being its flagship vehicle, Tesla has established itself as a leader in the EV segment. Strong performance and impressive design of the firm’s products are ramping up sales volumes. Rising Model 3 delivery, which forms a major chunk of the automaker’s overall deliveries, is aiding the company’s top-line. Revenues are likely to rise further as it expects to make good progress on Model 3 going forward. Along with Model 3, Model Y is also set to boost Tesla’s prospects, going forward. Notably, the deliveries of the latest Model Y began in March — significantly ahead of schedule — and contributed to the company’s profits.
  2. Increase in vehicle deliveries. In full-year 2019, Tesla delivered 367,500 vehicles, reflecting an increase of 50%, year over year. For full-year 2020, the company expects vehicle deliveries to exceed 500,000 units. The firm’s first-quarter 2020 deliveries remained robust despite coronavirus woes. Higher volumes should enable Tesla to achieve cost and production efficiencies, thereby strengthening margins. Along with increasing automotive revenues, the firm’s energy generation and storage revenues are also boosting Tesla’s prospects. Notably, both solar and storage deployments will be up at least 50% in 2020
  3. International Expansion. With China being the biggest EV market, Tesla’s ambitious plans to start production in the country bode well. Robust production levels from the new Gigafactory in Shanghai bode well for its future growth. The Shanghai factory is ramping up well and commands a higher market share in the Chinese EV market. The plant is operating at full capacity and will continue to generate solid revenues for the firm. Accelerated production from Gigafactory 4 in Berlin will also add to the top-line, going forward. Tesla’s focus on the expansion of the product portfolio and development of self-driving capability is commendable.
  1. High R&D and SG&A costs. The company’s high R&D and SG&A costs may clip the margins, going forward. Both R&D and SG&A expenses had increased in 2015, 2016, 2017 and 2018. Though the company displayed operational efficiency this year, it is yet to be seen if it can continue the trend amid high spending plans and new launches. Tesla is investing heavily to increase production capacity, boost Model 3 sales, launch Model Y, construct Gigafactories and enhance Supercharger infrastructure. These initiatives are likely to strain the near-term financial prospects of the firm.
  2. Growing Capital Expenditure. Capital expenses in the first quarter of 2020 increased both yearly and sequentially and the trend is expected to continue, thereby marring cash flow and profit levels. And of course, Tesla’s profitability and deliveries might take a temporary hit in the upcoming quarter as stores in many of its markets were/are shuttered due to coronavirus pandemic. To this end, the company has refrained from providing any profitability forecast. While Models 3 and Y are aiding the company’s growth, production and margins for Models S and X are on the decline. Ebbing demand for Model S/X is denting the profits of the firm.

Regardless of the reasons listed above, Tesla is being bought for it’s story, innovation and the work ethic of Elon Musk — Tesla’s CEO. This is why there’s a great divergence between stock price and valuations.

ARK Investment’s research and modelling identifies and outlines a fundamental growth analysis of Telsa stock via three key independent variables, which are critical to understanding Tesla’s potential:

  • Gross Margins — Will Tesla’s cost of manufacturing vehicles continue to fall in line with Wright’s Law?[1], which says, that the cost of production declines as volumes grow due to economies of scale and experience curve effects.
  • Capital Efficiency — What is Tesla’s cost per unit to build new production capacity?[2]
  • Autonomous Capability — Can Tesla launch a fully autonomous taxi service successfully?

Ark Investment’s bull case implies that Tesla will maintain its roughly 18% market share and that a substantial percentage of its fleet will generate high-margin robotaxi platform fees.

My understanding is that Auto manufacturers have much lower gross margins, usually in the 10 to 20 per cent range than technology companies. The German automakers have gross margins of 20 per cent or a little lower while the American tech giants all have gross margins near 40 per cent or higher.

To make it simple, it is the marginal cost of production, the cost of producing one more unit that’s the key divergence of profits between car companies and tech companies. When Ford makes a new car, it has to procure all the materials to make the car: the aluminium, the steel, the plastic, the copper wiring and also all the components made by its suppliers, like the wheels, the tires, the door locks, the electronics, the small motors that power the windows, the wipers, the list is almost endless. For an auto company, therefore, the marginal cost of production is heavily weighed down by the cost of raw materials and components sourced from other companies.

Now contrast, say, Microsoft. When it receives an order for its online Office Suite of applications, the cost of this one incremental “unit” is negligible, as the software is downloaded directly online by the buyer. All that Microsoft has to do on its end is ensure that it has a sufficient number of servers and enough capacity to service this new buyer.

Bulls argue that Tesla has far fewer parts because it does not have a traditional engine and that therefore it will eventually sharply reduce its cost of production (and improve its gross margin) as its volumes rise. Two, Tesla’s proprietary technology will eventually increase it’s gross margin to 30 per cent or higher. This will occur if Tesla’s battery advantage is sustainable and can command high pricing and if its mobility software develops quickly enough to become the industry leader. Indeed, even today before Level 5 autonomy, Tesla has been selling its software at $7,000 apiece at a margin of 90 per cent.

ARK Investment Management LLC

Tesla reported earnings per share of $1.24 in first-quarter 2020. This stemmed from higher-than-anticipated automotive revenues, which came in at $5.13 billion. The bottom line also compares favourably with the prior-year quarter’s loss of $2.90 per share.

During the reported quarter, net income attributable to common shareholders amounted to $16 million as against the net loss of $702 million recorded in the year-ago quarter.

Revenues increased to $5.98 billion from the $4.54 billion registered in first-quarter 2019.

During the first quarter, Tesla reported the delivery and production of 88,496 and 102,672 vehicles, reflecting a year-over-year increase of 33% and 40%, respectively.

Total automotive revenues surged 38% year over year to $5.13 billion in the reported quarter.

Energy generation and storage revenues decreased from $325 million in first-quarter 2019 to $293 million in the first quarter. Services and other revenues were up 13.6% year over year to $560 million.

Tesla’s first-quarter 2020 automotive gross margin was 25.5%, shrinking 538 basis points (bps) from first-quarter 2019.

Tesla had cash and cash equivalents of $8.1 billion as of Mar 31, 2020, compared with $6.3 billion as of Dec 31, 2019. This increase was mainly driven by a $2.3-billion capital increase.

Net cash used by operating activities amounted to $440 million in first-quarter 2020 compared with $640 million of net cash used in first-quarter 2019. Capital expenditure increased to $455 million from the year-ago quarter’s $280 million, mainly due to investments in the Gigafactory Shanghai and Model Y preparations in Fremont.

In first-quarter 2020, Tesla reported Model 3/Y production and deliveries of 87,282 and 76,266 units, reflecting a year-over-year increase of 39% and 50%, respectively. During the March-end quarter, the production rate of Model 3/Y continued to improve.

The Model S/X production and deliveries totalled 15,390 and 12,230 vehicles, up 9% and 1% year over year, respectively.

Tesla is making efforts to improve vehicle deliveries, sequentially and annually, with some expected fluctuations from seasonality. For full-year 2020, the company expects vehicle deliveries to exceed 500,000 units. However, amid the coronavirus-related setbacks, Tesla refrained from providing any profit or cash-flow forecast. The EV maker expects to ramp-up production of Model 3 in Shanghai and Model Y in Fremont through second-quarter 2020 and starts deliveries from both locations by 2021. Furthermore, deliveries for Tesla Semi are anticipated to begin in 2021.

Shares of Tesla have outperformed the industry over the past year. It has a first-mover advantage in the EV space with high range vehicles, superior technology, and software edge. Rising Model 3 delivery, which forms the bulk of Tesla’s overall deliveries, is aiding its top-line growth. Further, Model Y is also set to boost its prospects, going forward. Production ramp-up in Shanghai Gigafactory and upcoming product launches bode well for the firm. However, high R&D, SG&A costs and massive CAPEX may clip the margins. Tesla is investing heavily to increase production capacity, boost sales and construct Gigafactories, which are likely to strain its near-term prospects. Tesla’s elevated leverage of 53% also plays a risk. Waning margins for Model S/X is another concern. Thus, investors should wait for a better entry point at around $1200 or lower.

Referred Sources:

Tesla Q1 2020 Results, SeekingAlpha, ARK Investment Management LLC and predictions made by the Author’s understanding of the company.

Disclosures:

This report contains independent commentary to be used for informational purposes only. The analyst/author contributing to this report does not hold any shares of this stock. The analyst/author contributing to this report does not serve on the board of the company that issued this stock. Additionally, the analyst/author contributing to this report certify that the views expressed herein accurately reflect the analyst’s/author’s personal views as to the subject securities and issuers.

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Sai Penukonda

Sai Penukonda

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