Tesla Motors (TSLA, Financial) is a large-cap corporation operating in the automobile industry. The company designs, manufactures and sells electric cars and has a wide presence throughout the world. Besides its automobile product line, it also develops and sells energy storage components to other manufacturers. With a workforce of more than 13,000 people and 50 subsidiaries based in different countries, the company has been operating for more than a decade and has successfully increased its market value more than 10-fold. The company is headquartered in Palo Alto, California.
Market cap: $30.96 billion
PE – forward 2016: 61
Valuation
PE – $122.5
EVA – $171
Price target – $150
Analysts: Usman Ayub, Soid Ahmad
Revenue insights
Tesla recorded net sales of $4,046 million in FY 2015, which was an increase of 26.5% compared to FY 2014. The major source of revenue for the company is the sale of its automobiles. More than 90% of Tesla's 2015 revenue was brought in by this segment, while the rest was generated by maintenance services, sale of EV power-train components, energy products, etc. Among its automobile sales, the company currently offers two fully electric vehicles -- Model S and Model X. Tesla delivered 50,580 EV units in 2015, a remarkable year over year growth of more than 50%, among which the majority of units were Model S, since Model X was released in the third quarter of 2015.
Geographically, Tesla currently generates around 50% of its total revenue from the U.S. market, down from 70% in FY 2013. This demonstrates implementation of the company's strategy toward operating in different geographies, and thus lowering its risk of being exposed to a single market.
Industry prospects
Since the company's main line of business is manufacturing and sale of motor vehicles, it will be affected by any developments in the global automobile market. According to research from Goldman Sachs, it’s expected that the number of car sales globally will experience a CAGR of 2.32% from 2015 to 2025. It is further forecasted that the growth in sale of vehicles in the emerging markets will dominate the sales growth in developed nations as per capita income in the developing countries rises.
Specifically, Tesla's operations are vulnerable to future trends in the electric vehicle industry. Navigant Research has predicted the market for light duty EV will grow from 2.6 million vehicle sales in 2015 to more than 6 million in 2024 globally. Future U.S. market for EV will significantly affect Tesla's operations. According to research firm Statista, sales of fully electric vehicles in the U.S. is projected to grow at a 32% CAGR from 2014 to 2018 and will reach 186,000 sold units by 2018.
One of the main factors that will be driving the sales growth is the reduced battery cost, as it makes up the majority of the total cost of an electric vehicle. According to Bloomberg New Energy Finance, the cost of lithium-ion battery packs is expected to decline from 2015 onwards at a slower rate, which will in turn increase demand for electric mobility.
According to the article "battery prices fell 35 percent last year and are on a trajectory to make unsubsidized electric vehicles as affordable as their gasoline counterparts in the next six years."
Besides declining EV costs, Southern California Edison received an approval from California Public Utilities Commission to implement its pilot plan of deploying 1,500 charging stations in California, while San Diego Gas and Electric is set to deploy 3,500 charging stations in the San Diego area.
To review, increasing charging stations, lower battery costs and automobile sales growth in the emerging markets will drive the demand for electric cars in the coming years, and Tesla will be able to benefit from this growth.
Thesis
Through our detailed analysis of the company, we have formulated a "Sell" opinion based on the following argument.
Tesla’s products are expensive and consumer consumption is set to shift toward value. The company's products will cost you an arm and a leg. Tesla has built up a phenomenal brand image and thus it adds this up when pricing its product. To top it off, being environmentally friendly means more premiums to be charged to the consumers. According to Deloitte, in the developed as well as the emerging markets, the majority of customers will be value oriented by 2020 in the automobile industry. Considering the fact that around 50% of Tesla's revenue is generated from the U.S., this leaves its future sales in a very vulnerable position amid shift of consumers’ preference toward conscious consumption.
Limited number of products is also one of Tesla’s weaknesses. When considering product diversification, Tesla's revenue generating ability significantly depends upon the demand for its Model X and Model S, with Model 3 currently scheduled for release in 2017. Although Tesla has started a new line of business by selling energy storage products under the brand name of Tesla Energy in late 2015, it will take some time before this new venture could bring in a significant portion of company's total revenue. With a record year of 17.5 million cars sold in 2015, there is a growing fear regarding the industry reaching its peak. If an auto recession is to take place in the coming years, Tesla will be completely vulnerable to its effects as it won't be able to rely on a different line of automobiles for meeting its business targets.
Tesla is using external funds excessively. Tesla is a cash devouring machine. The company relies heavily on the issuance of common and preferred stock as well as its ability to take on more debt for meeting its cash requirements. Considering the fact that the company failed to post a net profit figure for the last 13 years demonstrates the bitter reality that Tesla has been poorly investing external funds provided by its shareholders. Except for 2013, the company has only posted operating cash outflows for the last five years, which supports our above argument even further. Furthermore, Tesla recently was involved in a forward integration as it is planning to acquire SolarCity (SCTY, Financial), a provider of renewable solar energy for residential and commercial customers. In our point of view, the transaction is not a smart move since both companies are cash hungry businesses with negative cash flows, providing batteries for SolarCity's products at a lower price will aggravate margins and cash flow position of Tesla. Since the deal is being financed through a share issue, it will further dilute EPS as the company has already issued shares for financing its Model 3 plan.
GM's Bolt EV is more price efficient than Tesla's Model 3: Tesla is completely focused toward the availability of its new line of electric car, Model 3, in 2017. With a starting price tag of $35,000, the car reaches 215 miles of range per charge. On the other hand, Tesla's competitor GM (GM, Financial) is looking forward to ship its new line of all-electric automobile, Chevrolet Bolt EV. The starting price tag on Bolt EV is $30,000, estimated to cover more than 200 miles of range per charge and is expected to be made available at the end of 2016. When compared to the Model 3, not only does the Chevy Bolt give value for money as far as the mileage is concerned, but it will help GM in achieving first mover advantage, which will significantly hurt Model 3's sales after launch.
Poor inventory control and high OPEX will put pressure on earnings. In FY 2015 closing inventory went up from $953 million to $1.28 billion, a year over year increase of 34%. Tesla's direct competitor Nissan (NSANY) was able to lower its closing inventory levels by 3%, from $1.31 trillion to $1.27 trillion. Not only is it a sign of poor inventory management from Tesla, but also indicative of future write-offs, which will negatively impact earnings. Furthermore, the company's OPEX is growing at a faster rate compared to its sales revenue. In 2015, the company's SG&A expense grew by 54% while its sales grew by 26%. In the coming years, we can expect further growth in OPEX as Model S pre launch advertisement campaigns intensify, thus placing pressure on growth in future earnings.
Potential acquisition of SolarCity doesn’t bode well for the company. Tesla Motors recently announced it would acquire SolarCity. On the surface, the rationale is the vertical integration related to the combination of two businesses, which could prove beneficial for SolarCity in the competitive solar market. But there are many caveats that come with the deal if it goes through.
First, both Tesla and SolarCity are cash hungry businesses. Tesla is ramping up Model 3 production. SolarCity hasn’t been able to generate positive cash flow for the past four quarters. The same holds true for Tesla. If Tesla provides batteries for SolarCity’s products at a low price, it’s going to hurt its margin and cash flow. Tesla is financing the deal by issuing more shares. The company has already raised cash for its Model 3 plans. Now, further dilution to EPS will put pressure on the stock price. Looking at SolarCity, a rate hike by the Fed in the future will further affect the margin of the company on financing residential and commercial projects, not to mention the competition from other solar power providers at home and abroad.
Overall, the deal doesn’t seem to be a good one, at least from a short-term perspective. Cash burn will increase and EPS for Tesla will go down affecting the stock price negatively. Tesla is already trading at a value not justified by conventional valuation techniques. Therefore, risk-averse investors should steer away from Tesla, while risk-seeking investors can gain from shorting Tesla Motors now.
Valuation
Economic value added approach also reveals a price around $171. Assumptions include:
- Earnings are expected to grow at CAGR of 30% during 2015 to 2020. Three percent growth is assumed in perpetuity.
- CAPM is used to calculate the cost of equity. Increase in capital is assumed to increase the cost of equity going forward.
- NASDAQ composite is used as a proxy for the return on market.
The valuation sheet demonstrates that the stock is overvalued and is currently worth $171.1 based on the above assumptions. As a going concern the model also indicates that Telsa will be able to post 4.9% per annum growth in residual earning, which needs to be compared with the implied growth in residual earnings based on current market price of the stock.
Verdict
In conclusion, if Tesla's acquisition deal with SolarCity were to close, it will not bode well with the company as the new share issue will dilute future EPS. Also keeping in mind the operational inefficiencies related to inadequate inventory management, higher OPEX than its rivals, overvalued products compared to its competitor, poor product diversification and significant downside demonstrated by our valuation model, we believe Tesla's current market price is in excess of its intrinsic value.
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