After its surprise profit in third-quarter 2018, many fans of Tesla Inc. (TSLA, Financial) began to boast that the electric car company was in the clear. Many were confident that Tesla was finally on the road to the sustainable profitability long promised by CEO Elon Musk.
Those hopes have been dashed in recent days thanks to a host of negative announcements from the company. Far from turning the corner, Tesla looks as vulnerable as ever. Indeed, it appears the growth narrative, which has withstood numerous hits in recent months, has finally begun to crack under the strain of a harsh reality.
Elon Musk sends a sobering email
The first bad news hit on Jan. 18. In an email to all Tesla staff (which was later made public), Musk offered a solemn outlook for the coming quarters. The big headline grabber was the announcement that Tesla would be downsizing 7% of its workforce, the second major staff culling in 12 months. But the really bad news had to do with profitability. According to Musk, Tesla is likely to report a profit for fourth-quarter 2018, but that it will be smaller than the blowout earnings beat of the prior quarter. A lower profit sounds even worse when one recognizes that Tesla sold more vehicles in the fourth quarter than in the third, confirming the company’s margins have been falling.
Musk’s outlook for early 2019 is even more sobering. He warned that first-quarter 2019 might not be profitable at all:
“This quarter, as with Q3, shipment of higher priced Model 3 variants (this time to Europe and Asia) will hopefully allow us, with great difficulty, effort and some luck, to target a tiny profit.”
All of this flies in the face of the Tesla growth story, which expects massive growth on both top and bottom lines for years to come. It is that expectation that keeps the share price where it is and the market capitalization around $50 billion.
More analysts get skeptical
As we discussed in a recent research note, a number of analysts have grown increasingly wary of Tesla’s prospects in 2019. On Jan. 23, another analyst joined the chorus of negativity, with RBC slashing its price target from $290 to $245, downgrading from a “hold” rating to “sell” on the grounds that profit may have already peaked for the company’s current product lineup:
“It’s not that we don’t believe Tesla can grow over time, our model shows solid LT growth. But the current valuation already considers overly lofty expectations. For instance, let’s assume 1mm [Model 3] units @$55k ASP, 12 percent EBIT margins, no interest/equity raise all by 2025. This is undoubtedly solid earnings, but at a more ‘mature’ 15x P/E, the discounted back value is ~$195, meaning even in an optimistic case at least 1/3rd of today’s price is an ‘Elon premium’.”
RBC has come to the realization Tesla’s share price anticipates huge growth, but that such growth looks highly unlikely. As RBC concludes, even healthy growth over the next several years cannot justify the current share price.
With another analyst added to the bear camp, Tesla now has more “sell” recommendations than “buy” recommendations. That is an ominous sign as the company faces increasing pressure in 2019.
Production cuts could cut deep
Wednesday’s bad news did not end with RBC’s downgrade. According to a new investigative report by Lora Kolodny for CNBC, Tesla has cut production of its Model S and Model X vehicles:
“Deep cuts occurred in its sales, delivery and Model S and Model X production teams, according to current and newly laid off workers. These people also said that Tesla has suspended night time production of its Model S sedans and Model X SUVs at its Fremont, California car plant.”
Despite Musk’s repeated claims throughout 2018 that Model S and Model X production was being kept stable due to constraints, it is now quite clear demand is the real problem. Whether these models are losing sales due to cannibalization by the lower-priced Model 3 sedan, secular decline in interest for an aging product or competition from new luxury electric vehicles, is not wholly clear as yet. From what we can glean so far, all three factors appear to be having an impact.
This is a big problem for Tesla. While the Model 3 sells in significantly greater volume than Tesla’s two higher-end models, it is a much lower-margin product. Losing Model S and Model X sales will apply further negative pressure to an already strained growth story.
Meanwhile, overall demand appears to be far lower for the Model 3 than the company had projected, with margins likely to come under continuous pressure as it switches to a lower-price product mix, federal tax credits continue to phase out over the course of the year and competitors enter the market in unprecedented numbers.
The Tesla growth story is facing ever increasing strain. It is impossible to say if this will be the final turning point. Tesla has faced similar crises of confidence before only to regain market trust. The third-quarter profit helped dispel many dark clouds - for a time, at least.
This time does seem different, though. Tesla’s wiggle room is diminishing as the exciting future becomes the disappointing present. There are precious few levers Tesla can pull to get out of its current mess. European and Chinese Model 3 sales may help for a time, but the breathing room they offer will do nothing to change the underlying story of deteriorating fundamentals.
Disclosure: Short TSLA via long-dated put options.
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