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Tesla Is Getting Bigger and Better

Tesla Motor (TSLA) is planning to construct the world’s largest battery factory. The company could produce more lithium ion batteries in a year than the total amount of batteries that were produced, around the world, in 2013. Moreover, the company could bring down the lithium ion battery costs by at least 30%, which could give a significant boost to its earnings.

The news was welcomed by investors and Tesla’s shares, which were already trading at lofty valuation levels, went even higher. In my previous article for GuruFocus, I mentioned that Tesla is laying foundations for solid growth in the coming years and therefore investors should not sell their Tesla shares. Since then, the company’s shares have been up more than 50% and are currently trading 63 times its 2015 earnings estimates, as per data compiled by Thomson Reuters. This is expensive even for a technology stock.

Tesla, however, is a disruptive technology stock. Therefore, its stock will likely continue to trade at extraordinary multiples of earnings; like 3D Systems (DDD), or the fuel cell makers such as Ballard Power (BLDP) or Plug Power (PLUG), or Amazon (AMZN).

The company’s recent quarterly results have shown that Tesla is heading in the right direction. The company has significantly reduced its losses while its revenues have more than doubled. In short, Tesla is getting bigger and better and as a result, its shares could continue going higher.

The Gigafactory

The planned 10 million square foot Gigafactory could be located in American Southwest, although no official word has come out yet. According to Los Angeles Times, Tesla is not going to build its factory at its stronghold – California – due to high real estate costs. Nevada, on the other hand, appears to be a likely candidate.

The facility, which could create around 6,500 jobs, will come with a price tag of between $4 billion and $5 billion. By 2020, it could be producing batteries for nearly 500,000 electric cars each year.

Tesla is also thinking about selling the batteries for homes, utilities, as well as commercial consumption.

Tesla founder Elon Musk believes that this facility would significantly improve the company’s ability as it moves forward with a plan to produce affordable electric vehicles in about three years. The business is eying significant reduction in costs of battery packs.

A battery manufacturing facility of this size and scale has never been constructed before. The project could propel the pace of innovation in batteries. The facility itself will likely go on to become a marvel of modern engineering.

Tesla will invest around $2 billion in the factory. To fund the project, the company has raised $2 billion through a convertibles debt offering at attractive rates. The remaining $3 billion will be raised by Tesla’s partner(s) through 2020. No official word on the name of the partner has come out yet but Panasonic, the primary supplier of lithium ion batteries to Tesla, appears as the most likely candidate.

According to a Stifel Nicolaus analyst, Tesla’s batteries will likely be able to store large amounts of renewable energy. Therefore, in the long term, Tesla could end up becoming a power storage company. If that happens, then one of the biggest beneficiaries will be Elon Musk’s SolarCity Corp. (SCTY), a supplier of solar power systems. The solar company could end up becoming a partner in the Gigafactory.

Solid Earnings

Last month, Tesla released its quarterly results that blew past analysts’ estimates.

The company’s loss shrank to $16.26 million from $89.93 million in the corresponding quarter last year. Adjusted earnings came in at $45.92 million, or $0.33 per share, which was much higher than market’s expectations of $0.21 per share. Meanwhile, its revenues doubled to $615.2 million from $306.3 million in the same quarter last year. Adjusted revenues were $761.34 million, $104.19 million higher than analysts’ estimates.

The company reported quarterly deliveries of 6,892 vehicles. The better performance is also reflected in the gross margin rate of 25.2%, which is in-line with estimates.

For the full year, Tesla’s losses shrank to $74.01 million from $396.21 million in 2012 while revenues climbed to $2.01 billion from just $413.26 million in the prior year. This was the first full year of Model S production. The company delivered 22,477 Model S in 2013.

The company has also given a forecast that supports its growth story. The company is eying significant uptake in production in 2014. The company will ramp up the production capacity of Model S and Model X. For Model X, Tesla will incur higher engineering and design expenditure which could cause an increase in overall R&D expenditure. The car is expected to be released later this year.

By the end of the year, Tesla will be producing 1,000 cars per week, a significant increase from the current levels of 600 cars per week. Meanwhile, production will increase to 7,400 units in the current quarter. For the full year, Tesla is eying more than 55% growth in Model S deliveries to 35,000 units.

The current battery supply issues could continue to hurt the company throughout the first half of 2014. But Tesla is eying significant improvements in the second half.

As mentioned earlier, its gross margins of 25% were in-line with expectations. These would improve to 28% by the final quarter of 2014.

Disclosure: This article was written by Sarfaraz A. Khan, with valuable contribution from Gohar Yousuf, research assistant at Half Bridge Business Review. Neither Sarfaraz A. Khan, nor Gohar Yousuf have any positions in the stock(s) mentioned in this article.

About the author:

Sarfaraz A. Khan
Sarfaraz A. Khan is a capital market analyst and finance writer. His specialty lies in energy stocks. He also covers consumer goods, services sector, technology stocks, emerging markets and ETFs. His work appears on TheStreet, Seeking Alpha, Motley Fool and GuruFocus.

Visit Sarfaraz A. Khan's Website


Rating: 3.0/5 (2 votes)

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Comments

batbeer2
Batbeer2 premium member - 4 months ago

Hi Sarfaraz,

Thanks for the article.

>> Tesla, however, is a disruptive technology stock. Therefore, its stock will likely continue to trade at extraordinary multiples of earnings;

What exactly is disruptive about Tesla? Is there anything unique about their production proces or technology?

With a forward p/e of 60, I can see how they have access to cheaper capital than almost anyone else on the planet. With this, they can indeed build a mega battery factory at a very low cost of capital (implied << 0.5% interst rate). If they pay their emplyess with that "currency", then they also have some of the cheapest labor on the planet.

Other than the fact that their cost of capital is lower that anyone else's, I wonder what is so disruptive about that factory?

At the end of the day, distributing thousands of batteries accross the US and possibly the globe is a nontrivial component of cost, especially if the batteries themselves get cheaper.

AlbertaSunwapta
AlbertaSunwapta - 4 months ago

Isn't a current model Tesla about $70,000? I'd want to know what would be the price of the cheapest model they could produce? If they are going to stick to a high margin product, how big is that market and how long until competition arrives?...

P.S. I wish I'd bought a few shares a while ago. Now though...

ecotycoon
Ecotycoon premium member - 4 months ago

The strategy of tesla is start with high margin and decrease overtime to more affortable car, the strategy is really good, the product awesome, management outstanting, Although at the present price it look like a really risky bet, i may well be wrong....

weaponzero
Weaponzero - 4 months ago

@ Batbeer2 -

The factory that they are building will be powered by 100% solar and wind which will be on site. But the most important thing about the factory is the economies of scale. The raw materials for a battery is around 60-70$ per kwh. So a 200 mile mid-size EV battery of say 50kwh has a material cost of 3 - 3.5k. But due to poor economies of scale, that 50kwh will cost you about 20-25k minimum today. This factory can cut the cost of manufacturing the batteries in half getting the cost to around 10-12k.

They don't need to distribute batteries all over the country, they just load them up on the train and ship them to their car factory in California. And maybe to their partners (Toyota and Mercedes)

@AlbertaSunwapta - The Model E will have a sticker price of 35k and profit margin of 18% according to Tesla.

sersoylu
Sersoylu - 4 months ago

If there is one CEO out there that fits the "quality manager" mantra of Buffett, that must be Tesla's Owner and CEO. Elon Musk is simply an incredible human being. If he started an ice cream company in the north pole, I'd still seriously review it. Tesla's valuation, on the other hand, is quite an overshoot, which is a different matter altogether.

batbeer2
Batbeer2 premium member - 4 months ago

>> So a 200 mile mid-size EV battery of say 50kwh has a material cost of 3 - 3.5k. But due to poor economies of scale, that 50kwh will cost you about 20-25k minimum today. This factory can cut the cost of manufacturing the batteries in half getting the cost to around 10-12k.

Interesting.

If you break down the cost of a house/hamburger/smartphone to the raw materials, that cost is typically an order of magnitude less than the cost of the end product. It's not a safe bet that this will drive down the price of houses/hamburges/smartphones within a couple of years.

At these prices, I think you need evidence that there's some kind of competitive advantage. What is it?

- Solar energy isn't cheaper than some of the alternatives.

- Labor in the US isn't cheaper than some of the alternatives.

- I'll grant you stocks and bonds in the US are more expensive than some of the alternatives. This means Tesla, as a seller of debt and equity, can build a factory cheaper by selling some (convertible) debt. That may not be a durable advantage though.

harshals
Harshals - 4 months ago

Its funny folks ask what is disruptive about Tesla. Let me list a few:

a) First All Electric Car with range of 260 Miles which means my electricity bill if I charge at home is around $30 per month

b) Free Recharging and Free Maintainance of my Car. Zero Oil changes for about 20 years.

c) Gross Margins of 30% which can rise more.

d) Design wise you can create as many different Models on top of the Battery Pack Base

e) Clean Energy and you can just stop begging Middle East for Fuel for oh forever !!

f) All new way of selling directly to consumers with petty things like 17 inch display which can have software updates on the fly while some cars still figure out how to make bluetooth technology work.

g) Deliver from Factory to Any other country door step in the world which takes away the middle man which dont add much value to the process anyways

h) The Model X is 70K and The Model Z will be 30K and we will just see 350,000 selling the very first year in 2018.

batbeer2
Batbeer2 premium member - 4 months ago

I can understand why the car is special. I'm trying to understand why investors believe the company is. By buying the shares, you are buying the company, not the car.

There is a difference. Back in the sixties, Aerospatiale built the first supersonic passenger airliner. It was both disruptive and a huge hit. I dare say that buying Aerospatiale shares at 100x earnings or for that matter 10x earnings wouldn't have worked out very well in the long run.

The point here being that even companies without durable competitive advantages can produce disruptive products.

Elon Musk seems to me to be a bit like Howard Hughes or maybe Nicola Tesla. Both were serial disruptors. Investing in their ventures didn't always work out very well though.

TannorP
TannorP premium member - 4 months ago
One could argue the true disruptive technology is the direct sales to consumers much like the GEICO model and it can be seen as a threat to other automotive manufactures and dealers, as New Jersey recently banned the method. The batteries and solar on the other hand are not all that disruptive as other companies are utilizing the technology and will simply copy, but the design and elegance of the car is different for a solar vehicle. Yes you get better mileage then ever before but it is Moore’s law playing out, we will continue to utilize solar more efficiently in terms of KWh used regardless if is Tesla, BMW or GE.



Examining the moat I don’t think there is much of one beyond Elon Musk and the brand of Tesla, I do not see it being durable over 20-30 years with margins more than likely depressing as competition encroaches. 

Batbeer has a very good point about Nicola Tesla and Howards Huges, we could add in Edison as well. The stock as a currency is one of their best competitive advantages for the time being as Batbeer has explained.



I am surprised there is not a lot more talk about the direct sales model and the middle man being cut out. This is a huge factor in both the pricing and gross margins Tesla has. It is a cool company with a short-term advantage, the valuation may be justified but not to me, way too much risk of permanent capital impairment.

EDIT: The letter by Elon Musk to New Jersey provides better understanding. [www.gurufocus.com]

Random thoughts, Cheers.
dwhitney
Dwhitney premium member - 4 months ago

Quote from the Fairfax Annual Letter to Shareholders: "Tesla Motors, for example, sold 22,477 cars in 2013 but commands a market cap of $31 billion, while Fiat, which we like, sold 4.4 million cars but has a market cap of only $14 billion."

Prognostications about share price movments against Tesla would be stupid to make, but these numbers definitely make Fiat look pretty appetizing.

AlbertaSunwapta
AlbertaSunwapta - 4 months ago

Intrinsic value calculations anyone? :-)

TannorP
TannorP premium member - 4 months ago

^ lol back of the envelope with YR1 to 5 [70% Revenue Growth] YR 6 to 10 [40% revenue growth] 2% terminal value. Shares count remains the same, debt level remains same, 10% discount.

Initial cash-flow = This year EBITDA (I know ridiculous for an automotive company, or any other for that matter)

Pretty much as liberal as it gets and we get an intrinsic value of $263.50, looks like the market is pretty optimistic . . .

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