Wednesday, May 29, 2019

Tesla Is Melting




Long/short equity, value, special situations, Growth
Tesla's stock has been cut in half since the company's highs of last year.
Tesla is now trading at 1.5 times sales and at about 30 times forward EPS estimates.
Tesla is also trading around critical technical support, suggesting a rebound (possibly supported by a short squeeze) is likely.
Many of the issues plaguing the company may be transitory, and Tesla's China project appears to be on point.
Ultimately, shares are likely to rebound here and trade substantially higher, especially long term.
 
 
 

Tesla 
(TSLA) is now 50% below its high of around $380 late last year. Things were looking great for Tesla at one point; demand was through the roof, profitability was higher than anticipated, and the future looked bright.
However, things appear much different for Tesla just 6 months after its peak. Tesla is now facing profitability issues, demand concerns, increased competition, as well as cash burn, and even possible liquidity issues at this point.
While some concerns regarding Tesla should not be underestimated, the current atmosphere surrounding the company appears to be almost panic-like. Yet, panic is likely the last thing you should consider if you are a shareholder right now.

Source: StockCharts.com

The stock is now firmly trading in the “buy zone” ($180-200), I recommended as an attractive long-term buying opportunity in this 
"Tesla: Breaks Down" 
article 1 month ago.
Despite several short-term difficulties, Tesla remains a leading, high-growth company with enormous long-term potential.
Moreover, with the recent price slide, Tesla’s valuation is starting to look far more attractive 
(roughly 30 times forward estimates) 
relative to other growth companies.
Ultimately, the current slowdown in demand will likely prove to be transient in nature, and Tesla’s profitability is likely to bounce back in the second half of the year.
Also, the overwhelming amount of negative press surrounding the company has caused the stock to get severely beaten down technically, right around critical support.
Tesla represents a compelling buying opportunity at current, deeply oversold levels, and I expect the stock to be much higher 1-year from now (given that general marks conditions don't deteriorate).

Tesla: Burning Cash, Again

Just when you thought it was over, back-to-back profitable quarters in 2018. Tesla had an atrocious Q1 in 20
19. Remarkably, the company lost 
more than $700 million.

Source: Author's material
However, Tesla was hit by various transitory factors, and profitability is likely to recover in the second half. In Q1, many of Tesla’s Model 3s were shipped to Europe, which likely weighed some on operating costs.
Nevertheless, Tesla’s real problem was that the company delivered far fewer Model 3 vehicles than anticipated. This was the leading factor behind Tesla’s lower than expected revenues and much higher than expected losses in the quarter.
Naturally, the fear on the street now is that this will continue, that Tesla has achieved high market penetration in certain areas, especially in the U.S., and demand for Tesla's essential Model 3 vehicle may die down.

High Market Saturation

The Model 3 may have temporarily highly saturated the North American market. Sales of Tesla’s Model 3s and other vehicles are down notably from the highs in 2018. Nevertheless, the Model 3 was by far the best-selling car in California revenue-wise in Q1 of this year.
Image Source
Ultimately, this current “Model 3 glut” in the U.S. is likely a normal phenomenon. There was an extremely high initial demand for the vehicle leading up to and into its launch. Now, many consumers who wanted a model 3 have one.
Time is required for digestion of incredibly high inflow of Model 3s into the U.S. market. I believe the current slide in demand is a transitory phenomenon, and demand for the Model 3 should pick back up once the original models work their way through the auto system.
Relatively high demand in the U.S. should return, and combined with increasing shipments to Europe and Asia, Tesla’s production should have no problem satisfying demand.

Production Remains Solid

Tesla is stably producing around 6K Model 3s by now. Even if we do not factor in continuous increases in production and leave production constant at 6K per week, Tesla should construct 312,000 Model 3s over the next 12 months.
Source: Bloomberg.com
The median price for the Model 3 remains relatively high and was around $50K per vehicle in the last quarter according to research. However, even if we lower the ASP to $45K per Model 3 vehicle next year, Tesla’s Model 3 segment's revenues will be around $14 billion.
It is likely that the company could produce at least 20% gross margin on the vehicles (Tesla’s Model 3 gross margin was over 20% for 3 out of the last 4 quarters).
This will give Tesla a gross profit of around $2.8 billion over the next 4 quarters. The Model 3 segment delivered roughly $10.1 billion in revenues, and $1.88 billion in gross profit over the last 4 quarters.
This represents about a 49% YoY rise in Model 3 segment gross profit. Tesla’s more profitable Model S/X segment should provide substantial revenues as well over the next 12 months.
However, with increased competition hitting the market, primarily directed at the Model X vehicle, along with some cannibalization in the Model S segment, sales are likely to come in light.
I’m expecting just 80K Model S/X units to be sold over the next 12 months. There is increased competition from Jaguar’s I-PACE, Audi’s e-tron, and other EVs that appear to be encroaching on Tesla’s market share, possibly temporarily.
Nevertheless, Tesla automobile’s performance, technology, and other competitive advantages should enable the company to sustain its market share successfully long term.
Moreover, many consumers may begin to choose Tesla vehicles as increased competition will likely attract an enormous amount of interest in the 100% performance EV sector. This is still a relatively small segment of the giant auto industry, but it will likely become huge in the future.
With an average price tag of around $100K for a Model S/X vehicle, Tesla should deliver roughly $8 billion in revenues from this segment (my estimates). If we use a typical 27% gross profit margin in this segment, Tesla should deliver about $2.16 billion in gross profit over the next 12 months.

Tesla’s Profitability Potential

Tesla’s secondary businesses essentially cancel each other out profitability wise, as services continuously bleeds cash, while leasing and energy generation and storage continue to be profitable.
With an estimated gross profit of $2.16 billion from Model S/X segment and an estimated gross profit of $2.8 billion from the Model 3 segment, Tesla should deliver around $4.96 billion in gross profit over the next 12 months.
This exceeds the company’s operating costs over the past year, which were $4.285 billion. Additionally, operating costs were abnormally high due to Model 3 ramp up and other transitory issues last year.
Operating costs are also in a downward trend, and the company is continuously implementing methods to lower costs, a trend that is likely to continue going forward.
Elon Musk is likely the type of person that can micromanage costs extremely effectively if it is considered a priority for him. Right now, it appears to be the number one priority for the company.
Therefore, even with relatively low, somewhat even stagnant production projections, Tesla could deliver around $5 billion in gross profit over the next year.
Simultaneously, the company may be looking at lower operating costs YoY as well. If the current trend of lower costs and cost cutting continues, Tesla could conceivably lower operating costs to roughly $4 billion (modest 6.6% YoY decrease).
$5 billion in gross profits and $4 billion in operating costs would provide Tesla with a very healthy $1 billion operating income. However, interest expenses and other non-operating costs would likely lower Tesla’s net income to about $300-500 million over the next 4 quarters.
This would equate to roughly $1.69-2.80 in EPS over the next 12 months, translating to a forward P/E ratio of 68-112. This certainly is not cheap, but please keep in mind, this is with relatively conservative projections, especially in the Model 3 segment (essentially presuming no production/demand growth).

Tesla Could be Huge 

in 

China and 

in 

Asia in General

 

Also, it is important to mention that Tesla’s production, sales, and earnings should increase once the Chinese Gigafactory is functional later this year/2020.
Despite the trade dispute with China, Tesla should still build its factory in Shanghai, likely on favorable terms, and as scheduled. In fact, the company is showing enormous progress in the production process already.
Realistically, Tesla could very well surprise investors to the upside, especially in the second half of the year. I used relatively modest estimates in this article, but I believe Tesla could surprise to the upside profitability wise, possibly delivering $5 or more in EPS over the next 12 months. This kind of profitability would put Tesla at a 38 forward P/E multiple.
(Current consensus estimates for 2020 are for $6, implying a forward P/E ratio of about 30).
With an expected revenue growth rate of 23.5% next year, and with the factory in China well on its way to being built, Tesla looks like a compelling buy at 30 or at even 38 times forward earnings.
Additionally, it is difficult to value a company in its transitionary phase of becoming a profitable enterprise. Traditionally, such growth companies are valued on a price to sales basis. Tesla trades at just 1.5 times sales, relative to growth companies like Amazon (AMZN) which trades at 3.72 times sales.

The Chinese Wild Card

China remains an important wild card for Tesla, but I think most concerns are overblown. Everything appears to be going well with Tesla’s Gigafactory in China, and I expect things to progress per schedule.

Image Source
It is in both parties’ (Tesla/Chinese government) best interests that Tesla has a strong foothold in China. Furthermore, even if Chinese consumers have to pay higher prices for Tesla vehicles due to tariffs (worst case scenario), demand should remain strong as Tesla is becoming increasingly popular in China. This is especially advantageous as China remains by far the biggest EV market in the world.

Technical View

We can see that Tesla is deeply oversold here with the RSI at just 23. Other technical indicators like the CCI and full stochastic are also extremely oversold technical conditions, and a possible shift towards a more positive momentum flow.
 It appears that Tesla is attempting to find a bottom at this crucial multi-year level of support ($180-200).

The Bottom Line

While the first half of this year will likely be painful for Tesla, strong international demand should enable the company to recover sales and profitability in the second half.
The U.S. market may be highly saturated with Tesla vehicles, but this should prove to be a temporary phenomenon. Moreover, Tesla is increasingly expanding overseas, is gaining popularity, and is increasing market share outside the U.S.
Some competition has arrived and is encroaching primarily on some of Tesla’s Model S/X market share. This will also likely prove transient as Tesla remains the leading company in 100% performance EVs, and competition should bring more overall interest to the 100% EV space.
Unless a complete debacle occurs, Tesla should deliver at least $5 billion in gross profit and $300-500 million in net income over the next 12 months.
Under more favorable conditions, Tesla’s income could roughly double, in which case the stock could be trading at around 30-40 times forward earnings and at just 1.5 times sales.
Tesla’s project in China shows no signs of slowing down, and a foothold in Asia would give Tesla a tremendous advantage. It would also enable the company to significantly increase revenues and possibly profits in 2020 and beyond.
I’m bullish on the stock at these levels, given that a significant market downturn does not occur. If a recession, coupled with a bear market materialized, Tesla and, stocks in general, could go a lot lower.
My best-case scenario 1-year price target is $400-450, mid-case $300-350, and my lower-end, worst-case scenario, bear market price target on Tesla is $80-100.

Disclosure:  

I am/we are long TSLA. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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