International expansion has the potential to boost Tesla (TSLA, Financial)'s stock price. The company is set to launch its Model 3 in Europe and Asia Pacific in the first half of 2019, while the prospect of reduced import duties could catalyze sales in China.
It has acquired trucking companies as it seeks to reduce delivery times on its vehicles. This could help to maintain its momentum from the third quarter, where it was able to post positive free cash flow. Further free cash flow growth may help to reduce debt and improve its risk/reward ratio.
Having gained 6% in the last year versus a 3% rise for the S&P 500, the stock could offer investment potential.
International opportunities
Expansion into new regions has the potential to catalyze Tesla’s financial performance. It has launched a display fleet of Model 3 units in Europe, with consumers invited to view the vehicle in store. This is ahead of planned deliveries in the region in the first quarter of 2019, with a rollout due to take place across Asia Pacific by the end of the second quarter of 2019. This could help to maintain high demand for premium versions of the Model 3 prior to the release of a less-costly version. This could lead to growing sales as well as high margins.
The company’s sales in China could receive a boost from plans to accelerate the building of its manufacturing capacity in the market. This will help it to bypass duties and make the Model 3 more affordable for Chinese consumers. At the moment, it is subject to a 40% import duty. The company, though, intends to increase the level of localization through local sourcing and manufacturing. Given that the market for mid-sized premium sedans such as the Model 3 is larger in Europe and China than in North America, it represents a significant growth opportunity.
Demand growth
The company is seeking to overcome the logistical challenges it has faced while ramping up production of its models. It is acquiring trucking companies and also putting in place contracts with major haulers as it seeks to reduce shipping times to one month from a previous four to six weeks. This should allow it to maximize the number of vehicles it can ship prior to the planned 50% reduction in the $7,500 federal tax credit which is due to take place in 2019.
It may also allow the company to maximize sales in the fourth quarter as it seeks to maintain strong momentum after improved financial performance in the third quarter. It believes that demand for its Model 3 will grow as it gradually falls in price. The company has stated that its annualized run rate could more than double from 223,000, since key rival BMW ships around 500,000 units per year of its similarly priced 3-Series.
Potential threats
While Tesla has been able to increase production in recent years, its long-term debt has increased from $440 million in 2013 to $9.7 billion in the third quarter of the 2018 fiscal year. This is unsurprising, given the investment required to build an automaker with an international footprint in a relatively short space of time. It means, though, that the company’s long-term debt makes up around 215% of its net assets. Further investment is likely to be required as the company seeks to build a new truck and manufacturing plant in China, which could cause balance sheet risk to further rise.
The company’s third-quarter results, though, showed a swing to positive free cash flow. It generated $881 million in free cash flow during the quarter, with higher vehicle deliveries helping to push gross margin 520 basis points higher to 25.8% as it benefited from economies of scale. Tesla has also stated that it does not intend to further increase debt levels. Instead, it intends to pay down its debt in order to reduce balance sheet risk, with there being the potential for improving free cash flow to fund future investment in the business.
Outlook
The company’s international expansion in 2019 could boost its financial prospects. Alongside the prospect of increased sales in China, this could further increase free cash flow in future quarters. This may help to reduce debt, and also fund further expansion in terms of manufacturing capabilities.
Reduced delivery times may boost sales in the fourth quarter, while demand for the company’s Model 3 could be relatively high. It has generally been competitive versus rivals in terms of sales in existing markets, and the annualized run rate of deliveries has the potential to more than double from its current level according to the company. Therefore, having outperformed the S&P 500 in the last year, Tesla may offer further growth potential.
