Oct 16 2020 - Tesla: The Story Unfolds

Summary

Tesla's stock has soared, pre- and post-split.

By traditional measures, Tesla stock is overvalued.

Tesla is a powerful story stock and an industry disruptor and paradigm-shifting force.

It should be viewed in that context, which changes the view of its valuation.

Tesla is on its way to becoming an automative/energy space powerhouse and one of the world's most important companies.

Introduction

Tesla (TSLA) is a remarkable company under visionary and controversial leadership. That the company is visionary is seen in the products it creates, the enthusiasm it generates among customers and observers — as well as in the attendant controversy.

Led by Elon Musk, who had already broken ground with several startups, including PayPal, Tesla has aimed to create a new paradigm and standard in the EV market. Elon Musk intended to disrupt the entire vehicle market, undermine the premise of ICE (Internal Combustion Engine) domination, and also impact the energy market.

Tesla’s path has been rocky but spectacular — and that includes the performance of its stock in the public markets.

Premise

The premise of Tesla’s existence is to become a dominant company in the EV and automative space, and to use both its cars and battery technology to help transform the energy space.

History

Tesla’s history is interesting and demonstrates a steady evolution in the direction of an Electric Vehicle (EV) powerhouse. Tesla's current products include electric cars, battery energy storage from home to grid scale, solar products — panels and tiles — and related products and services.

“Founded in July 2003 by engineers Martin Eberhard and Marc Tarpenning as Tesla Motors, the company’s name is a tribute to inventor and electrical engineer Nikola Tesla...After 11 years in the market, Tesla ranked as the world's best-selling plug-in and battery electric passenger car manufacturer in 2019, with a market share of 17% of the plug-in segment and 23% of the battery electric segment. Tesla global vehicle sales increased 50% from 245,240 units in 2018to 367,849 units in 2019. In 2020, the company surpassed the 1 million mark of electric cars produced. The Model 3 ranks as the world's all-time best-selling plug-in electric car, with more than 500,000 delivered. Tesla cars accounted for 81% of the battery electric vehicles sold in the United States in the first half of 2020.”

“Tesla’s product release strategy is to emulate typical technological-product life cycles and initially target affluent buyers, and then move into larger markets at lower price points. The battery and electric drivetrain technology for each model would be developed and partially paid for through the sales of earlier models. The Roadster was low-volume and priced at 9,000. Model S and Model X target the broader luxury market. Model 3 and the Model Y are aimed at a higher-volume segment...with the Model S, Tesla's technology strategy was to start with a 'clean-sheet" design,and build an integrated computer hardware and software architecture at the center of its vehicles.”

The Tesla Business Model

Tesla presents a compelling, multi-faceted business case. It has multiple, overlapping product lines, a leadership position in EV manufacturing that includes the power of software, and 'green' energy applications based on its battery technology.

This Investopedia article presents the unique Tesla business model. The basis of the Tesla business model is the mission of Elon Musk, “To accelerate the advent of sustainable transport by bringing compelling mass market electric cars to market as soon as possible.” Tesla’s CEO has an ideology that motivates him and adds momentum to the company’s strategy and execution.

From the start, Tesla took an Apple-ish approach to marketing and a strategy for building a loyal, continually expanding customer base. Instead building a relatively affordable car that it could mass produce and market, Tesla placed its focus on creating a compelling car. Elon Musk wrote that “…our first product was going to be expensive no matter what it looked like, so we decided to build a sports car, as that seemed like it had the best chance of being competitive with its gasoline alternatives.”

The Tesla business model includes these elements:

• Establish a leading position in EV through innovation, best-of-class design and excellence;
• Build a loyal customer base that recognizes these elements and wants to be part of the Tesla story;
• Use the primary EV effort as a spearhead in Tesla’s plan to become a generic leader in clean energy, including through battery production and applications; and
• Continue to develop new technologies and product lines within the energy space; and
• Finally, leverage each new development to build an effective ecosystem that fulfils the vision of helping the world transition to clean energy (and be rewarded in the process).

Evolution of the ‘Master Plan’

In March of 2019, Tesla unveiled its Model Y SUV. This car is the final step in the company's "Master Plan" to bring an "even-cheaper" EV to the masses. Later in that year, Tesla revealed its Cybertruck concept vehicle with a Futuristic design.

At around the same time, Tesla announced that it would be building its Gigafactory 4 near Berlin, Germany. Construction began in 2020 and the factory is expected to produce almost half a million vehicles a year when at full production.

January of 2020 started out with some excellent news for Tesla, as the company announced it had delivered 367,500 vehicles in 2019.

With Tesla building its most affordable car yet, Tesla continues to make products accessible and affordable to more and more people, ultimately accelerating the advent of clean transport and clean energy production.

After a rocky first few years, Tesla has secured a significant share of the EV market, reaching around 12% of global EV sales but closer to 75% of US EV sales in 2019.

A Tech Company?

The idea that Tesla is a technology company gained credibility in 2013, when its stock price shot up by more than 300% within a single year.15 Slate ran a piece that compared Tesla to Apple Inc. (AAPL) and Alphabet Inc.

There are several points of similarity between Tesla and the tech sector. For starters, Tesla's valuation in the markets has increased despite its history of reporting losses. Tesla has also adopted the disruptive theme of the tech sector.

Much like other tech companies, Tesla is intent on changing existing business models by selling directly to consumers. Its product pipeline and charismatic leadership resemble those of iconic tech companies such as Apple.

The Bull Thesis

This is the case for Tesla - practical innovation and penetration of the EV market, the likelihood that it will compete with ICE manufacturers directly in the future, and the tantalising prospect of new businesses rising up from the current structure.

The company’s groundbreaking products and leadership role in EV - combined with its ability to ‘see the future’ and spin out new business units and products — make it a permanent disruptor.

Elon Musk and his team have a track record of creating new businesses or business lines — new stories with enormous potential. A large piece of Tesla’s bull case lies in the vision, energy and execution of its leader.

Supporting News and Events

These recent headlines and developments support the actuality of Tesla dynamism:

• Battery Day: This oft delayed and anticipated event showcased Tesla’s evolving battery technology. While many observers chose to be disappointed at the absence of a revolutionary announcement, Tesla did in fact describe an ongoing implementation of an improved battery production process based on larger, more powerful cells and an enhanced production process. The surprising thing about Battery Day was the number of critics and observers that judged it a flop, apparently on the expectation that a revolutionary breakthrough would be announced. In the process, these observers missed the fact that Tesla has made significant practical advances in battery design and production that 1) make vehicle production more efficient, and 2) should increase the range of Tesla cars.
• Quarterly Vehicle Sales Numbers: Tesla slightly exceeded expected quarterly numbers. Again, critics pointed out that the estimates were slightly lower than before, casting doubt on the results. The ‘beat’ was small. In my opinion, this misses the systematic ramping of production through the firing up of the Shanghai plant and the construction of two new factories — one in Berlin and one in Austin, Texas;
• Factory Build-Out: The construction of these new plants points to the steady implementation of a strategic plan based on a consistent demand increase and a likely future move into economy vehicles; that may in turn lead to a potential vast step forward in Tesla’s market share. Tesla may be positioned to become one of the world’s largest vehicle manufacturers, and within 10 years or so.

It is very hard, in the day-to-day ebb and flow and swirl of Tesla news, to see visible process of the revolution that it is leading. Take a step back and you see a confluence of events towards the emerging EV/clean energy future with Tesla playing a major role and reaping rewards.

Tesla ‘Endorser’ Input: Baron, Maurer & Lee

A strong cohort of intelligent, reasoned investors and analysts are very favourable towards Tesla as a company and optimistic about its long-term stock prospects. One example is billionaire investor Ron Baron, as seen in a 14 October interview with CNBC’s Becky Quick.

Mr. Baron mentions that Tesla is a huge part of two of his managed funds, and that he has made a 10x return on the stock so far. Baron’s additional comments on Tesla in this very recent interview are instructive:

“So far, in the first four or five years that we’ve owned it, the stock went up and down like a yo-yo. And that would be expected, because what they were doing was building facilities, hiring people, coming up with design.”

Then an interesting take on Tesla skeptics: “It would be a reasonable thing to bet against them. All these companies, fifty of them, have failed, and this guy had made it somehow through sheer willpower and raised capital…”

People announce big plans often enough, but following through is another story. It requires elements like planning, vision, execution and persistence. These are essential to building a disruptive company that creates a new paradigm.

The willpower that Ron Baron refers to is also a form of energy to overcome the troughs that would provoke resignation and failure in most. No one is infallible, but Baron's track record speaks volumes.

Rob Maurer has a YouTube channel he calls Tesla Daily. Several times a week, Maurer uploads videos in which he either narrates recent relevant developments in Tesla’s world or interviews Tesla analysts or experts on aspects of its technology or business.

For instance, Maurer recently released a video on Tesla’s much-anticipated Battery Day. In this presentation, Rob discusses all aspects of the presentation by Tesla and debunks some of the myths and critiques of this important day Tesla event.

Rob Maurer’s Battery Day review is as instructive as Ron Baron’s remarks:

“Tesla just gave us so much information to digest….Tesla announced great detail their plan to become the most valuable company in the world. That plan is all about battery production…so Tesla introduced…their own battery cell, their own battery production line allowing for better performance, cheaper cost per kilowatt hour, more production over time scaling… to three tera-watt hours (TWh) of battery production in-house…by 2030.”

This is just a sample of Maurer’s enthusiastic, fact-based and well-communicated YouTube communications.

A third excellent source of information about Tesla comes fro David Lee, an investor with a history of involvement and understanding of the company that may rival that of Ron Baron. Dave Lee is a self-taught investor who exited first software development and then real estate transactions to devote himself to investing. Along the way, he met Tesla and became fascinated by its story.

Dave Lee offers his own perceptive commentary, as in this video in which Lee discusses the implications of Tesla achieving or surpassing production estimates for 2020. He describes how Tesla would need to produce 182,000 vehicles in the fourth quarter to achieve a goal of 500K produced for the entire year. Lee calls this “a stretch,” an indication of the honesty he mixes with his passion for the company.

Dave Lee believes that Elon Musk is rallying the troops with such numbers, but believes — as I do — that this is an effective strategy.

Dave Lee has more to say about Tesla and its overall vision. He is comprehensive, as is Rob Maurer, and provides insights based on both an understanding of Tesla and a belief in its future.

These are three intelligent, very knowledgeable individuals that present their opinions openly and honestly. I recommend watching several of the Maurer Tesla Daily and Dave Lee Tesla videos.

Tesla Metrics

Tesla’s metrics are a study in contradiction. They reflect a company in hyper-growth, in which many investors have placed their faith, and that indicates a surprising level of stability in key valuation parameters.

I use Morningstar, Guru Focus and additional sources for this section. Links to sources are ‘in-text.’

Tesla Financials

Valuation

Price/Book: 41.15

Price/Cash Flow: 153.85

Price/Sales: 16.13

Price/Earnings: 1000

Financial Health

Quick Ratio: 0.82

Current Ratio: 1.25

Interest Coverage: 1.82

Debt/Equity: 1.57

Growth

Revenue %: 51.99

Note: Morningstar does not have figures for Operating Income, Net Income or Diluted EPS.

Profitability (%)

Return on Assets: 1.05

Return on Equity: 4.73

Return on Invested Capital: 4.05

Net Margin: 1.43

Again, all are measured in percentage points.

Valuation

Current Five-Year

Price/Sales 16.12 5.22

Price/Earnings 1048.31 NA

Price/Cash flow 153.22 NA

Price/Book 41.11 15.96

Price/Forward Earnings 112.36 168.03

PEG Ratio 0.99 NA

Earnings Yield % 0.10 -2.36

Enterprise Value (BIL) 412.02 77.65

Operating Performance

Current Five-Year

Return on Assets % 1.05 -6.18

Return on Equity % 4.73 -37.86

Return on Invested Capital 4.05 -9.16

Gross Margin % 19.77 19.94

Operating Margin % 4.74 -8.23

Net Margin % 1.43 -11.25

Free Cash Flow/Net Income 2.17 NA

Additional Key Valuation Parameters

These metrics tell, in combination, a good deal about the health and viability of a particular equity. In Tesla’s case, a several parameters show more positively than some might estimate.

• Debt/equity 1.57

• Debt/EBITDA 4.43

• Interest coverage 1.76

• BBB- credit rating B2 (stable)

• Dividend growth streak: NA (no dividend).

• Piotroski F-Score: 7 or high (very good)

• Z-score 2.0 9.53 high or safe

• Beneish M-score: -2.61., or low accounting fraud risk

Risks

Tesla has its own set of risks to consider. No company is perfect and no publicly traded company exists without the risk of a downturn in its stock’s fortunes. Tesla is no exception.

Controversial Visionary: Elon Musk

Tesla has a flamboyant, mercurial and visionary leader called Elon Musk. Elon is now one of the most famous people in the world and also one of the wealthiest. The reason? He has led the growth of the most exciting vehicle company in the world and the leader in the EV space. In addition, Musk has made waves with SpaceX - and spiced the entire mix with his outsized personality.

In the past more so than today, it was natural to see Elon’s more outlandish comments and actions as a direct risk to Tesla. This is partly an ‘organic’ result of his centrality to Tesla and its future, but the comments themselves fuelled speculation about his nature and, perhaps, stability.

It is my view that the media and many observers exaggerated or overreacted to his statements and claims. True, his predictions about autonomous driving fleets have not yet materialized, and floating the idea of Saudi funding could be seen as speculation beyond his CEO box.

Elon Musk has never really liked convention. He is both a man of ideas and execution, someone trying to transform the future. His devotion to the idea of a green energy future is almost certainly more than marketing noise for Tesla. And when a person has such accomplishments, drive and ambition, conventional restraints are unlikely to interest him.

Musk is more or less reformed, and Tesla’s progress defies and refutes the negative take on his role.

Potential Obstacles List

Aside from the unlikely failure of its visionary CEO, several potential obstacles might trip up Tesla on its way to "world dominance:"

• It experiences fiscal problems that force it either to scale back production or potentially damage Tesla as a company. I believe that this possibility is unlikely. For starters, Tesla has experienced financial stresses and survived and prospered. It has shown the ability to raise money (see Ron Baron’s comment), is producing large numbers of vehicles, hiring workers and building out plants at a rapid rate. While there is a risk that it may be moving too quickly, what I see is a systematic build-out based on production improvements and proof of essential market demand.
• The Coronavirus pandemic worsens and affects enough customers and potential customers that demand shrinks significantly and rapidly. This in turn stresses Tesla’s financials in a manner suggested in the previous bullet point. Given the general improvement in the virus situation compared to six months ago, and that demand for Tesla’s products seems strong and fine, I think such a scenario is very unlikely.
• Elon Musk melts down, becomes ill or worse, causing a collapse in Tesla.

Evidence suggests that Musk is both healthy and very motivated in his role. Beyond those factors, Tesla is a going and growing concern with a strong leadership group.

• There is a shortage in supply of essential components used to build EV vehicles. Most unlikely.
• Competition arises from additional EV makers or traditional ICE companies. This sets Tesla back and knocks it from its leadership position in the space.This scenario has been floated many times. Only a few of the big ICE companies like Volkswagen might threaten Tesla, and none have succeeded in denting its EV leadership position to this point. There is no reason to suggest that this will change in the near future. Meanwhile, Tesla is improving its efficiency, ramping up vehicle production, and eyeing an EV economy vehicle(S).

Summary

Tesla is neither a typical car manufacturer nor typical company. It has a visionary, iconoclastic and super-achieving leadership. Its products are cleverly designed and fit into a ‘clean’ or ‘green’ energy space.

Electric vehicles have modest maintenance overhead and a manageable cost of operation. As battery technology and vehicle range improves, there is less dependance on recharging and more of a sense of driver control.

Tesla is building the sort of loyal and expanding customer base that most companies would love to have. People like the products and feel good contributing to a piece of societal transformation.

Tesla has gone through some profound growing pains and survived questions about its leader’s personality. Production issues dogged the company, and, for a time, the Coronavirus crisis added to those pressures.

Overall, Tesla is a remarkable story. Yes, it has a ‘crazy’ valuation but that is because investors clearly view it as a major disruptive force and a paradigm-changer along the lines of an Amazon. The doomsday predictions for Tesla have fallen away as it has met production challenges, built dispersed and powerful factories, and created new models to attract customers.

Viewed from the perspective of evaluating a traditional company, Tesla is overvalued, but in the context of its progress and role, I believe that Tesla is a ‘buy’ for long-term investors. If you have a horizon of 5-10 years, Tesla may turn out to be one of the strongest pieces of a portfolio. I own Tesla and plan to slowly build my stake slowly over time.

“Electric cars, batteries, and renewable energy generation and storage already exist independently, but when combined, they become even more powerful." - Tesla.