Have you come across Tesla’s electric car?

Right now, Tesla is revolutionising the car industry with its Model S battery powered electric car. We often get asked about our views on Tesla shares which are listed on the US NASDAQ exchange.

The following information does not take into account your personal objectives, financial situation or needs. You should consider if the relevant investment is appropriate having regard to your own objectives, financial situation and needs. 

 

We don’t own any Tesla shares ourselves. However, we are actively assessing the company as an investment opportunity for a potentially new “disruptive clean energy” trend fund. Here are our insights.

Is Tesla worth US$28 billion right now?

The short answer is no.

Tesla last traded at US$213 per share which values it at US$28 billion in market capitalisation. They have never had a profitable year and most recently for 2014 the company made an operating loss of US$104m. For 2015 the market expects the company to have similar operating losses while in 2016 there is an expectation that Tesla will turn a US$311m operating profit.

On any traditional measure and comparison, the company’s current and near term financial performance doesn’t justify its extremely expensive valuation. For context, Tesla’s current share price values the entire company at one third the total value of premium car manufacturer Daimler (the maker of Mercedes cars). As a comparison, in 2014 Daimler sold 2.5 million vehicles and generated US$12 billion of operating profit versus Tesla’s delivery of 31,655 cars at an operating loss of US$104 million.

Why is the market valuing Tesla at US$28 billion?

Like many so called “disruptive” businesses, Tesla has a visionary leader in the form of Elon Musk. He is a serial entrepreneur and is an inspiration for the character Tony Stark in the Iron Man movies. How he has managed to convince the market Tesla is worth as much as it is today is testament to his Tony Stark like publicity skills.

Elon Musk is on the record as stating that Tesla will be producing and selling 500,000 electric cars by 2020. This is what the market is using to support Tesla’s current valuation. Our internal analysis is more detailed but in summary Tesla could deliver the following financial performance if it meets the 500,000 car target:

• Sell 500,000 cars at an average selling price of US$50,000 for total revenue of US$25 billion.

• Generate net margins of 10% to 15% (which is still high compared to other car manufacturers) for net profit of US$2.5 billion to US$3.8 billion.

This would mean Tesla is trading at a price to 2020 earnings ratio of 7.5 times to 11.2 times. A more reasonable valuation but 2020 is still 5 years away and delivering 500,000 cars from a mere 31,655 cars last year is a huge step up.

Can Tesla make and sell 500,000 cars in 2020?

The company expects to deliver only 50,000 to 55,000 cars in 2015 and has openly said that getting to 500,000 cars by 2020 requires a new mass market model. This so called Model III will need to be the company’s majority seller since the current Model S and Model X vehicles are pitched at the lower volume premium end of the car market.

If you believe the Model III will be a huge success then perhaps Tesla shares are an investment for you. However, we have the following key concerns:

• On current timing, the Model III is not expected to be launched for sale until 2017 and there is very limited information right now about this car.

• Tesla have encountered a number of delays including the recent launch of its Model X car which was 2 years behind schedule. Any significant delay on Model III will give competitors much needed time to catch up to Tesla on battery technology and perhaps launch similar cars.

• Scaling up to produce 500,000 cars is difficult and expensive. It requires new plants, additional suppliers and a well-oiled logistics chain. Investment bank Morgan Stanley estimates Tesla will spend US$14 billion on capital expenditure, research and development from 2015 to 2020. With low company cash flows, existing and new shareholders will need to keep providing funding for this which may dilute any future earnings per share.

Would we buy Tesla shares now?

Undoubtedly Tesla will continue to revolutionise the car industry with its advanced battery technology. However, at this point Tesla shares are pricing in near perfection.

The market is effectively assuming Tesla’s Model III, a car that won’t be for sale until at least 2017, will be an enormous success and the company will have no material problems producing very large numbers of this car by 2020. At Tesla’s current share price, we would like to see some real evidence of a great Model III car being ready for high volume production before considering an investment. For those with the cash to spend and enjoy, it might be more worthwhile to buy a Tesla car right now, since it is effectively being subsidised by Tesla’s shareholders with the company losing money on every car sold.

 

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