Innovative Business Model
Tesla was one of the first car companies to sell high-end/high-performance electric vehicles. This is an alternative energy company that sells electric vehicles, batteries, & solar panels. They essentially have two different businesses under one corporate umbrella: Solarcity (Manufacturer of solar panels) merged with the parent company Tesla (electric vehicle manufacturer) in November of 2016. The company was founded by Martin Eberhard and Marc Tarpenningan. Later it was acquired by Elon Musk in 2003.
Over the years this company has developed a cult-like investor following that refuses to acknowledge traditional investing principles. This is without a doubt one of the most innovative companies of the 21st century. That said, no stock is worth an infinite amount of money. Everything comes back down to cash flow. Tesla has almost a half a trillion-dollar valuation, yet they haven’t even generated a billion dollars in earnings within a year. They have tens of billions in sales, but they barely generate a profit because they haven’t been able to increase their margins. The automobile industry is known for having brutally competitive margins.
Recently I’ve heard the argument that Tesla is more than a car company. I’m not going to disagree with that statement. That said, I’m not willing to pay 1,000 times earnings for a company that only grew top-line sales 14% last year. Facebook is only valued at 700 Billion, and yet it grew revenue by 26%. They also did 18 Billion in profit, and have a massive amount of cash on their balance sheet. At some point, it doesn’t matter what industry the company is in. What I start to think in terms of is other companies that deliver better numbers, that I can buy at lower multiples. It’s an invalid argument across the board.
Better overall execution: Tesla is separating itself from the competition. They are years ahead of the competition, in terms of EV+ self-driving cars. That said, they have limited pricing power. Consumers still have several EV options.
Increasing demand from Asia: In Asia, the demand for electric vehicles is growing at a much faster pace than in the rest of the world. In general, they have a much larger population, & the average yearly salary for the average Chinese citizen is rising quickly. So there is a growing demand for luxury vehicles. Not just luxury vehicles, but also Eco-Friendly cars. We
believe the country may eventually implement strict laws that attempt to eliminate Air pollution. Air pollution is becoming a huge issue in China.
Low industry margins: For several years, Tesla’s gross margin has remained in a continuous range of 20-30%. In the coming years, they estimate gross margins will eventually surpass 30%. Frankly, they can’t afford to continue down this trend. The only thing keeping Tesla in business is its ability to sell equity at significant market premiums. The automotive industry is known for brutally low margins. Hence why almost all American car companies have gone bankrupt. Tesla is far ahead of its competition, but to reach mass penetration they have to sell vehicles at an affordable price.
Automobile industry margins over the past 4 quarters.
Increased competition: The electric vehicle industry is relatively new in comparison to the traditional gasoline automobile. In the past, they were far less efficient & there were no high-performance electric vehicles. Since Tesla unveiled the first mass-production high-performance EV several competitors(BMW, Mercedes, Audi & many others) have come up with their own similar models. However, most of them are hybrids, not fully electric. Over time as the industry itself grows it is likely the other companies will get more competitive with Tesla. This could be a major concern because many of these other companies have far more capital, resources, expertise, & brand name recognition. In all fairness though, Tesla is becoming very popular with consumers.
Outstanding debt: Our main concern with Tesla is that they are incurring billions in debt in order to accelerate the pace of their growth. Thus far, they’ve been able to make ongoing payments. However they’re still yet to pay the larger sum of the debt they’ve incurred, & most likely they’ll take on more debt in the future. Previously they’ve been able to raise money at very low-interest rates, but this trend is changing because the fed plans to continually raise rates over the coming years. The majority of Tesla’s current debt is fixed-rate loans, meaning the interest rate they pay every year won’t change over the duration of the loan. The current debt isn’t our main concern. Our concern is that higher rates will reduce their ability to raise more capital in the future. This could possibly cause Tesla to one day file for bankruptcy. As an investor, I would consider this to be the most obvious inherent risk at the moment.
Production capacity: One of the biggest issues with Electric Vehicles is the lack of production capacity. Traditionally lithium batteries were used to power smaller objects. Powering an object the size of a car obviously requires a lot more batteries than a laptop. Tesla built the Gigafactory to attempt to solve this problem. In the future, Tesla may possibly still have difficulty scaling production & meeting demand. They need to build more gigafactories. The issue is that they are extremely expensive. The most recent one that they built cost billions of dollars, & the company had to explore various financing options to complete the project. Tesla is burning through a lot of cash because they are in an extremely capital-intensive business.
Foreign relations: Tesla has a lot of exposure to foreign markets. Almost 50% of their revenue comes from other countries. Our global trade relationship under the Trump administration is still very uncertain. This is an ongoing concern to continually monitor. The administration has taken a very tough stance against countries like China. 15% of revenue in 2016 came from China,
specifically. If we implement a border tax, Tesla could certainly be harmed by this.
Revenue last year was 24 Billion. This year they are anticipating to do roughly 26-28 Billion. That’s only 16% growth from last year. The previous year their revenue only grew 14%. This is extremely low growth considering that they have one of the highest earnings multiples out of any public company. The Automobile industry is historically known for having super low margins. Tesla has had negative margins since the company was formed. That was true until recently. This year they will do a few hundred million in profit. These margins are expected to increase, but the best-case scenario isn’t good enough to justify the valuation.
Let’s say that Tesla is more than a car company like everybody insists. Right now they have a 20% gross margin. Gross margin is sales minus the direct cost of manufacturing the product. This is only a small fraction of company expenses. A decently well-run tech company could do 20% net margin (sales minus all expenses). Let’s pretend like Tesla could sustain a 50% sales growth rate every year. It’s an unrealistic expectation, considering they grew less than 20% these past 2 years. Additionally all of the physical supply chain constraints they have. Even in this highly optimistic scenario, it would still take Tesla 10 years to generate half a trillion in real profit. The current reality doesn’t come anywhere close to this theoretical scenario. No matter which way you slice it, you can’t argue that Tesla stock is undervalued.
Overall from a pure valuation perspective, our outlook on Tesla is bearish. That said we’ve been bearish for several years now. In the past, I bought put options in 2017. This idea was profitable, but the risk didn’t justify the returns. The options implied volatility started to grow as a result of increased shorting amongst hedge funds. That made this idea unfeasible, within my strategy. Tesla is without a doubt one of the most interesting companies of the 21st century, but that statement has already been priced into the stock. It’s better to either stay away from this idea altogether or keep the exposure extremely small.