Tesla’s Moment Of Truth Is Approaching
Tesla (TSLA) is an extraordinarily innovative company that has achieved amazing results in several sectors in a relatively short time frame. Let’s face it, if it weren’t for Tesla, EVs would still be limited to the likes of the Leaf and the Prius. The company also has achieved some remarkable feats in power generation and energy storage. Tesla is a company that looks to the future and shows us that things could be done smarter, more efficiently, and better than the current status quo can offer. But despite Tesla’s drive to continuously move forward and push the envelope on what’s possible, the company remains plagued by numerous problems.
It is easy to write these off as mere transient issues that will easily be offset and eclipsed by the company’s amazing products and stunning growth. However, Tesla is a publicly traded company with a fiduciary duty to its shareholders. Therefore, any significant issues facing the company that could cause the share price to decline significantly should be carefully examined, especially for anyone thinking of investing in the stock.
I have been bullish on Tesla for a long time, have been long its stock for most of the time throughout the last five years, and I continue to think that Tesla will be worth significantly more five years from now. But in the short term, there are some clear concerns that could cause some volatility to transpire in Tesla’s shares.
The stock is trading right around crucial technical support at roughly $300. The most recent decline comes on the back of a scathing Goldman Sachs’ downgrade. Moreover, the stock is technically in bear market territory as Tesla is off by well over 20% from recent highs. There’s an increasing number of fundamental elements weighing on Tesla’s share price, and the all-important Model 3 production appears to be hitting numerous speed bumps. In addition to all these developments, the company will announce delivery numbers for Q1 in the first week of April.
So, will $300 hold, will the stock rebound and move higher from here, or are Tesla shares headed for a breakdown instead? And what about longer term? Is there any hope for the company at all, and why in the world is Tesla worth $50 billion?
Model 3 Rampup
The Model 3 Rampup is likely one of the most important production efforts ever. It is certainly the most crucial manufacturing process in Tesla’s history as a company. A true EV, affordable, capable, and stylish, the likes of which have never been seen before. However, the rollout process has been anything but smooth, plagued by various problems and numerous delays.
Going by the company’s own original estimates, Tesla should be cranking out Model 3s at around 10,000 units per week by now. Even the drastically revised estimates call for about 2,500 units by now. What’s Tesla producing right now? While the true number remains a mystery, going by Bloomberg’s Model 3 tracker, the company is averaging around 750 Model 3 vehicles per week right now. This is drastically lower than even some of the most bearish estimates and suggests the company is on track to produce just 8,000 Model 3s this quarter.
Tesla was originally shooting for 500,000 Model 3s this year, but even with a constructive rampup from here, the company will likely only produce about 100,000. This is a huge difference, revenue-wise, performance-wise, confidence-wise, etc. But perhaps, most important is the increased pressure subpar production efforts of the Model 3 are inflicting on Tesla’s already fragile bottom line.
Tesla has managed to record just one profitable quarter in its near 10-year history as a publicly traded company. Moreover, the latest quarterly results have been showing massive losses, especially since the Model 3s troubled production process began. How much in losses? Well, nearly $1.3 billion in the last two quarters alone. What will the losses look like in Q1? Same ballpark, minus $500 million or worse. Why are the losses so great? Because the Model 3 production process is intended to be highly automated, efficient, and profitable, with an intermediate-term gross margin rate of 25%.
Unfortunately, so far, the production process has proven to be anything but highly efficient and profitable. And the longer Tesla continues to struggle with various “bottlenecks,” automation issues, and other problems associated with the Model 3 assembly, it will continue to burn through cash at an alarming pace. What’s Tesla’s gross margin on the Model 3 right now? Once again, the exact number remains a mystery, but judging by the company’s recent performance and estimates, gross margin on the Model 3 is close to zero, low single digits, or possibly even negative in a worst-case scenario.
When will Model 3 production improve to where the company is producing a profit, or is at least close to producing a profit on the vehicle? This too remains a mystery, but it must happen relatively soon if Tesla is to remain a viable business enterprise. My optimistic view is that the company will have most of the Model 3 issues figured out by the end of this year and will have a Model 3 gross margin close to 20% by early 2019.
Model S/X Sales
Another issue to consider is the apparent slowdown in Model S/X sales this quarter. Tesla said that it aims to deliver roughly 100,000 Model S/X vehicles this year, about the same as last year. The company also claimed that while demand remained strong for these vehicles, production capacity was constrained due to increased resources being diverted to the Model 3 vehicle.
According to EVObsession.com, Tesla sold about 8,400 Model S and Model X vehicles in the U.S. in the first two months of this year. This is lower than last year’s figure of 8,800 Model S/X vehicles for the same time frame. Since about 60% of Tesla Model S/X sales come from the U.S., we can assume the company sold around 15,000 Model S/X vehicles in total in the first two months. By adding around 50% to account for March sales, this would give us approximately 22,500 Model S/X units for Q1. This is lower than last year’s 25,000 units and will make it very difficult for Tesla to achieve its target of 100,000 Model S/X vehicles this year.
This brings us to the recent Goldman Sachs downgrade. Tesla analysts at Goldman led by David Tamberrino recently reiterated their sell rating on Tesla with a $205 price target. The analysts expect Model 3 issues to drag out and call for just 7,000 Model 3 vehicles in Q1. Moreover, analysts predict lower Model S/X sales, a yoy decline of around 12%. Average consensus estimates are much rosier and call for nearly 14,000 Model 3s in Q1 and extremely robust sales of over 25,000 Model S/X sales in Q1.
The stock has gotten hammered since the note. Tesla is down eight out of nine trading days, with the price slumping by roughly 15% in this period alone. Furthermore, some investors could begin to lose a certain degree of confidence in the company, which could result in a further decline for Tesla’s share price. How much of a decline? Let’s look at the chart to get a better idea of where we are at and where we could be headed in Tesla’s stock.
TSLA is currently sitting at major support of $290-300. This is a crucial level, as the stock has bounced off this level several times, and has not breached this support since penetrating it to the upside about a year ago. The RSI, CCI, and full stochastic suggest that conditions are approaching oversold levels. However, if the stock falls through this crucial support, a significant leg lower is likely to materialize.
It’s Not All Bad, There’s Some Good News as Well
Tesla owners seem to be very pleased with the recent autopilot improvements. The common reaction appears to be that it feels much more natural and is very much akin to a human-like driving experience. Tesla remains at the cutting edge of AI. Therefore, it is not surprising that its self-driving program is yielding increasingly favorable results. Tesla also is one of the top destinations for IT specialists. Therefore, it is likely that the company will continue to be one of the predominant leaders in this space.
Model 3 Sales
There’s so much riding on the Model 3, and the production process could be a double-edged sword, so to say. Meaning that despite the discouraging Bloomberg estimates, they are still estimates. In addition, Tesla shut down Model 3 production for four days recently to make upgrades to the production process. Therefore, despite the overall “low number” of Model 3s produced this quarter, the actual production of the vehicle could be approaching Tesla’s revised target rate of 2,500 vehicles per week.
Does Tesla Deserve a $50 billion Valuation?
Whether Tesla’s stock is grossly overvalued or not remains a hot topic for debate. It depends on if you believe Tesla will ultimately make significant profits on its vehicles. It is often said that it is absurd that Tesla is valued at more than Ford (F). At first glance, this argument makes sense as Tesla sold about 100,000 vehicles in 2017 while Ford sold 6.6 million. Moreover, Tesla delivered just $11.7 billion in sales while Ford clocked in about $145 billion. Finally, Tesla lost nearly $2 billion while Ford reported a net income of about $7.6 billion.
Let’s look at the situation from a slightly different perspective, though. Ford’s average selling price for a car was just $22,000 in 2017. The company had a gross margin of 10%, and a profit margin of about 5%, indicating the company nets about $1,100 per vehicle.
We know that in the intermediate term, Tesla is shooting for a gross margin of 25% on the Model 3. With an average selling price of about $47,500 per vehicle, Tesla would have a gross profit of about $11,875 per vehicle to Ford’s $2,200. Moreover, if we assume Tesla can earn a net income of about 12.5%, (half of its gross margin per vehicle) Tesla would earn about $6,000 per a Model 3, or more than 5 times what Ford makes per a vehicle. This means Tesla could earn nearly as much as Ford by just selling 1 million Model 3s per year. This is not considering Model S/X sales, energy generation/storage, Tesla Semi, or any other future products.
By looking at the situation from this perspective, and by assuming that Tesla will be able to achieve its margin goals, it becomes very clear that Tesla has the potential to become enormously profitable within the next few years. Whether this actually happens remains to be seen, but this should give people an idea why the market is currently valuing Tesla at $50 billion. It is on the assumption that the company will become profitable and will be able to achieve target margin goals at some point in the next few years. Based on the underlying statistics, ultimately (within the next 3-5 years), Tesla could be valued at much more than $50 billion.
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Disclosure: I am/we are long TSLA.
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.