This year about 15.5 million new automobiles will be sold in the U.S., according to Edmunds, with an average transaction price of around $31,000. The vast majority of these sales will be for traditional gas-powered vehicles, with a tiny fraction being for electric cars. Two of the most popular electric cars are General Motors' (NYSE:GM) Chevy Volt, which sold 23,461 units in 2012, and the Nissan Leaf, which sold just 9,800 units in 2012.
But the big story in the world of electric cars is Tesla Motors (NASDAQ:TSLA). Founded by Elon Musk, co-founder of PayPal, Tesla recently announced that the company would turn its first ever profit in the first quarter of this year. This comes on quarterly sales of about 4,750 units of the Model S, a full size luxury sports sedan that sells for $62,400 after a $7,500 tax credit. For comparison the Chevy Volt sells for about $32,000 after the tax credit, while the Nissan Leaf sells for as low as $21,000 after the tax credit.
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The Problem with Electric Cars
Eventually we will all be driving electric cars. At some point in the future oil production will be unable to keep up with demand and gas prices will rise to levels which make driving a traditional car unaffordable for most people. But this is most likely a ways off, and until that time electric cars simply offer a less convenient alternative.
The biggest issue with many is the time it takes to charge the battery. While filling a car with gas takes a few minutes, charging an electric car takes at least a few hours. And then there's the issue of battery degradation. All batteries slowly degrade as they are used, holding less and less of a charge as they age. Eventually they need to be replaced, and for electric cars this could cost $15,000 or more. This effectively negates any fuel savings.
But It Will Get Better
Over time battery technology will improve and electric cars will become a more feasible option for many. The Nissan Leaf is already selling at a price point lower than the average transaction price, and as electric cars increase in convenience compared to gas-powered cars the market should grow.
But right now the market is tiny, and it makes very little sense for the big car companies to push electric cars when there are no sales to be made. Tesla is trying to create a market, and to some degree they are succeeding. But what happens when that market becomes big enough that the big car companies start to get in on the act? Tesla won't be able to compete.
A History Lesson
Between 1896 and 1930 there were over 1,800 automobile manufacturers in the U.S. Today there are three major companies and a couple dozen minor companies. Many of these now-defunct companies existed when the automobile was not yet mainstream, much like the situation the electric car finds itself in today. Many of them were innovative, much like people claim Tesla is today. But manufacturing automobiles is an extremely capital intensive business, and scale matters much more than in other industries. The industry consolidated, with the big three driving most of the smaller companies out of business.
There is no reason to believe that Tesla has any sort of competitive advantage. It sells a very niche product, and when the market for electric cars grows it will be cars like the Nissan Leaf which sell well, not the $60,000 Tesla Model S. If Tesla remains an independent company, it simply won't have the scale to compete in mainstream markets, relegating them to the much smaller high-end market in which they'll face increasing competition from larger and more experienced companies.
And yet the stock market seems to think that Tesla has a big future ahead of it. The company has a market cap of about $4.8 billion on just $413 million in annual sales. Tesla spent a full 57% of revenue on capital expenditures in 2012. Although on paper the company may be profitable, this quarter the free cash flow is likely to remain soundly negative. Is there a chance that Tesla becomes a roaring success? Sure. Is it likely? No.
What About GM and Nissan?
Since the new GM emerged from the government bailouts during the financial crisis the company briefly reclaimed its crown as the world's No. 1 auto maker. Although it's now lost that title to Toyota, GM has continued to see sales rise each year: $152 billion in 2012 compared to just $104 billion in 2010.
From an investment perspective I'm not a huge fan of GM, or any car maker for that matter. Automobile manufacturing is a capital-intensive business, as can be seen from GM's $9 billion in capital expenditures in 2012. And while EPS came in at $2.92 in 2012, suggesting a P/E ratio of less than 10, this number was highly distorted by one-time items. A massive tax benefit and a goodwill write-off covered up sub-par performance, so GM doesn't look too attractive after all.
Nissan is a bit smaller than GM, with about $94 billion in revenue in fiscal 2012, and trades at a P/E ratio of about 12.4. The forward P/E ratio is a much lower 6.7, and analysts expect about 10% annual earnings growth going forward. Although the Nissan Leaf has seen low sales so far, in March 2013 the Leaf beat the Chevy Volt in sales with 2,236 units. This blows past the Leaf's best previous month and could be the result of a lowered price point. Selling at around $20,000 is a big advantage, and we'll have to see if these higher sales hold up. Although the Leaf represents an insignificant part of Nissan's revenue, it could see significant growth in the future.
The Bottom Line
If you're going to bet on the electric car your bet should be placed on one of the big car companies. GM's Chevy Volt sales tripled in 2012 from 2011, and with an onboard gas generator the Volt's range is far higher than strictly electric cars like the Model S. This, in my view, is more innovative than anything Tesla has put out. It bridges the gap between gas and electric and is much more palatable to the average American driver. At best Tesla will be a niche car maker, and at worst it will eventually go broke. Either way, investing in Tesla is a mistake.