Is Tesla the future of Transportation or just market insanity?
A 276.5% annual return isn't something you see everyday, specially in the automobile Industry. YetTesla Motors (NASDAQ: TSLA) not only has managed to almost triple its market capitalization in one year (currently $13.83B): some of its most optimistic supporters consider this is just the beginning, as they see Tesla as the future of transportation. But, objectively speaking, does Tesla really represents the future of transportation or it is yet another story of market insanity?
We have to start by admitting that Tesla isn't a normal auto stock. It does not have to deal with strong unions, due to the small size of the company. It enjoys tax credits for the time being, at least until the company manages to sell 200,000 electric cars (after that, the tax credits are expected to decrease). Finally, because its product is quite attractive and new to most consumers, it doesn't need to invest heavily on advertising for the time being. Notice, however, that all these apparently strong competitive advantages are not scalable: as Tesla continues increasing production, it will lose most of the advantages I mentioned earlier, from enjoying tax credits to having low marketing budget. Well, Tesla is increasing production steadily: in the first quarter of 2013, the Model S electric sports sedan outsold by wide margins the Mercedes S Class, the BMW 7 Series and the Audi A8. At first glance, this looks great, but considering Tesla's main advantages are not scalable, it also brings worries.
Well, even if Tesla is about to lose some significant benefits, in theory everything should be all right if the car manufacturer enjoys economies of scale. As production increases and fixed costs get more diluted, Tesla could use its higher margins to offset the negative effect of having no more tax credits. But will Tesla be able to increase its margins? So far the current gross margin without credits is a mere 2.3%, although Tesla CEO Elon Musk has stated that his goal is to achieve a 25% gross margin for Tesla's high-end cars without the inclusion of regularly credits. This is higher than BMW's 19% overall gross margins and I personally have no idea how Tesla will be able to achieve this in the next years, as the guidance looks pretty high.
The bear case
The bear case, presented by Mark B. Spiegel, generously assumes that Tesla will indeed achieve a 25% gross margin for its high-end cars. If by 2018 Tesla sells 80,000 high-end vehicles at an average price of $85,000 per unit and 200,000 Gen 3 cars (with a 15% profit margin) at an average price of $45,000 per unit, the company would be worth $15.8 billion (revenue) times a 1.3x BMW-like valuation multiple, that is $18.6 billion. Notice that this is a very optimistic scenario!
Now, you have a $18.6 billion enterprise value for 2018, so discount it back by 15% a year and you get a present value of roughly speaking $9.2 billion, which divided by the total number of outstanding shares, gives a $73/share estimate, well below the current $ 125 share price. Therefore, even under a very optimistic scenario, we find that Tesla is grossly overvalued. As a matter of fact, it is so overvalued, that as Jae Jung from Old School Value wisely puts it, it makes no sense to check the fundamentals of the stock or to even try to value it. Tesla is a purely story stock at the moment.
The bull case
To my way of thinking, the bull case is quite emotional. First of all, nobody knows the potential market size. Some estimates suggest that the sales of all types of electric vehicles could be as high as 20% of the total U.S. auto market by 2020, but there are more optimistic ones. Considering that Tesla is probably the only electric auto maker stock that is prepared for such a massive increase in demand, it makes sense to be long now. After all, Tesla is the only well-established electric car maker so far.
The other reason for being long Tesla is because both the increasing media coverage and the fact that it will join the NASDAQ-100 Equal Weighted Index will cause a further increase in demand for shares. Many ETFs are or will soon be long Tesla, including the Clean Edge Green Energy Index Fund and the PowerShares WilderHill Clean Energy Portfolio. So, even if the current stock price is way above the value that fundamentals dictate, an almost guaranteed further increase in demand for the next months makes this a buy.
The bottom line