The popularity and stock price of Tesla have amazed many investors. With the stock up 13-fold since it IPO in just over four years, critics start wondering whether Tesla may be hyped or if it can really live up to expectations. Is the CEO of Tesla Motors, Elon Musk, capable of maintaining these growth levels or has he bitten off more than he can chew? Musk certainly believes he can, by building a $5 billion dollar mega factory in Nevada of producing 35 GWh batteries, capacity enough for 500,000 Teslas by 2020. Utilizing the additional available supply of this factory, Tesla is aiming for a big part of the Chinese automotive pie. In order to delimit its vehicle’s range, Tesla is unfolding a revolutionizing network of super chargers, which will be carefully analyzed. Then, various visions on the valuation of Tesla will be provided, before I conclude with a technical and sentiment analysis.
In 2003, Tesla was founded as one the first producers of pure Electric Vehicles (EVs). As mineral fuels are finite, geopolitical concerns threaten a steady supply of oil and the combustion engine poses serious threats to the environment, Musk believes that Tesla can spark the globally needed energy transition. Tesla aims at achieving this transition by producing top-notch, long range, electronic sports cars. In 2008, Tesla revealed the Roadster, a very quick EV capable of doing 0-100km in 3.9 seconds. The Roadster was the first EV making use of a lithium-ion-battery resulting in a range of 319 km. This same battery concept has been implemented in the Tesla S, which was introduced in 2012. The Tesla S is in high demand due to its classy appearance, high performance and its range (426km). So far, Tesla is straight on schedule for reaching its 35,000 unit production target in 2014, which is substantially more than the total quantity of Roadsters sold (2400). Tesla’s ability to produce highly efficient power trains has also been recognized by Toyota and Mercedes, for which Tesla now produces electric power train components. Tesla chooses deliberately to share this technological knowledge in order to support the worldwide acceptance and availability of EVs, Tesla’s long-lived ideal.
Model S, what next?
The model S has been the most successful story for Tesla so far with almost 40,000 units sold. This fact, combined with the high prices in the luxurious sedan segment, surged revenues for Tesla (387.2% over 2013). These additional cash flows enable Tesla to invest approximately $750-950 million dollar in 2014 (2Q2014 shareholder letter), which they will invest in future research. As this indicates, Musk’s strategy to use the higher margins received on exclusive cars for developing an affordable EV for the public seems to work. In essence, Tesla is using the Roadster and Model S as a fundament for further development of EVs. However, one side mark has to be made. Although Tesla spends a lot on R&D relative to its size, basically any competitor in the automotive market spends a multiple of Tesla’s budget on R&D. For example, Volkswagen spent most on R&D with €11.74 billion in 2013. So, how does Tesla keep up with the giants?
Expected for Q2 2015 is the Tesla Model X, a unique mixture between a SUV and a minivan. Encompassing Falcon Wings, Dual Motor AWD, space for seven adults and plenty of boot space, the Model X again has once again surprised us all. A great feature of the Model S is its sportiness and speed, although the model X appears less quick, it actually is faster than a Porsche 911 Carrera (0-100km in 4.4sec and 4.6sec respectively). Due to these great features, expectations are high. Rod Lache (Deutsche Bank) would have agreed on this point, stating that the mid-sized luxury SUV market is almost as large as the luxury sedan market. Given an estimated price of $75,000 (based on similar platform and battery pack), the model X looks promising for Tesla’s revenue flow, again replenishing funds for its R&D budget.
By skimming revenues, Tesla is paving the way towards an affordable electric vehicle for everyday use (see figure 1), namely the model III. However, developments on this new model are still in an early stage of development, some features are clear already.
Figure 1 - Source: Morgan Stanley Research North America
The model III will aim to be 20% smaller and 50% cheaper than the model S (±$35,000), encompassing a smaller 200 mile battery pack. This down-scaled Tesla (planned to hit production in 2017) is to compete with cars like the BMW i3. Although creating an EV for the mass seems a noble pursuit, it does pose threats. Not only will selling cheaper cars decrease profit margins, the EV market will start to mature as well and much more companies are active in the mainstream car market. Tesla’s competitors will not just watch Tesla retain its monopoly, they want their share of this promising industry too. Pike Research estimated the total ‘Plug-in Electric Vehicles’ (PEV) market to total 1.75 million cars in 2019 (from 137,000 in 2013). That is more than enough incentive for other major EV brands, such as Chevrolet, Renault and Ford, to enter this market. This will highlight Tesla’s relatively small budget and further dampen Tesla’s monopoly.
The increasing global demand for Teslas increased the required number of lithium-ion batteries, which puts a lot of pressure on the current production capacity of Tesla. Fortunately, Musk identified this problem early on and has been planning the construction of a Giga Factory. As announced by Tesla on the third of September, this factory will be built in Nevada and cost approximately five billion dollars. Upon completion in 2017, it is capable of producing the 35 gigawatt-hours (per annum in 2020) needed for Tesla’s forecast of 500,000 cars in 2020 (see figure 2). The Giga Factory’s projected battery capacity (35 gigawatt-hours) will double the global supply of lithium-ion batteries by decade’s end.
Figure 2 - Source: Tesla Motors
This display of power mainly aims at exploiting economies at scale, lowering the average cost per battery. Although this may seem wise, doubts exist whether this cost reductions will be sufficient and worth the investment. Lux Research estimated a cost reduction of $2800 for a model X battery pack in 2020, implying a cost decrease from $37,800 to the desired $35,000 mark. In the end, this probably will not be the decisive factor on which to persuade a new customer.
As stated above, the Giga Factory’s production capacity in 2020 is more than double the supply of lithium-ion batteries in 2013. Besides the risk of over capacity, which will be discussed later on, is the risk of a raw materials supply shortage. As Bloomberg indicates, we may face a shortage if we continue using lithium in the same fashion we do now (see figure 3). Lithium is used quite extensively: batteries for tablets/phones, power tools, medication, air-conditioners and even space shuttles. This is not so much the case due to a lack of availability (13 million tons) but rather because mining lithium is a lengthy process, which takes years. Demand will keep rising which drives prices up. This may lower the $2800 cost reduction, further narrowing its competitive advantage.
Figure 3 - Source: Bloomberg
The planning of a factory this size does pose some threats and certainly requires upmost diligence. However, Tesla seems not to underestimate the magnitude of this project, stressing that the ramp up will take place in phases (see figure 4). Each phase will constitute additional cost efficiencies, thus the factory will start early on with earning back the invested capital.
Figure 4 - Source: Tesla Motors
Although phasing the construction dampens the capital demand to some extent, enormous amounts of capital are still needed. Tesla aimed achieving those by negotiating government cuts ($1.3bln, whereas $500mln forecasted), Tesla and Partners will provide the remainder of the CapEx ($4-5bln). At this point, Tesla seems to have negotiated efficiently and planned carefully.
However, questions concerning long term forecasts still remain dubious. So far, Tesla has sold less than 50,000 cars, which implies an ambitious ten-fold increase over the coming six years. An analysis from Lux Research indicates that it is much more likely for Tesla to produce around 240k EVs, instead of the rosy 500k forecast. If this prevails, this implies overcapacity of more than 50%. This overcapacity may spook current partners and is difficult to overcome, since its battery packs are incompatible with the ones of competitors, i.e. the Nissan Leaf or Chevrolet Volt.
Furthermore, the Giga Factory is betting against innovation, assuming that lithium-ion batteries will remain dominant for the next decade. Whether more high-tech will beat traditional batteries within this decade remains to be seen, but if they do, Tesla might be stuck with a five billion Giga Factory, producing old fashioned technology.
In conclusion, severe questions prevail on the outcome of this multi-billion project. The realization of the desired cost reductions, the necessary supply of lithium and the feasibility of forecasted sales figures are all possibly disastrous factors. On the other hand, Tesla is acting with great care, decreasing CapEx needs by phasing the ramp up, realizing that failure of the Giga Factory will be a serious blow to the company.
China is a market with high growth potential for the automotive industry (see figure 6). However, vehicle penetration in China remains very low. Extrapolating these findings, one can easily understand the enormous growth potential present in China. Tesla is already reaping the benefits from this potential, with Chinese demand for the Model S increasing. However, physical distance and cultural difference does pose threats, which is less present in Europe. Managing these issues will be critical of Tesla’s success in China.
Figure 6 - Forecasted growth in Chinese light automotive market Source: IHS AutoInsight April 2013; Accenture Research Analysis
Considering the demand from China, Tesla has to bear in mind its current production capacity. After a production shut-down in 2014Q3, waiting times in China are already 4-6 months. This implies that Tesla has to operate carefully and should not let waiting times spiral out of control even further.
Apart from production capacity, the physical distance and cultural differences pose some problems. Tesla’s logistics and garage & dealer coverage is not (yet) sophisticated enough to cope with demand. Tesla engaged in partnerships with independent service providers in order to manage deliveries, small repair work and after-sales service. However, replacement parts still have to come from the USA, which makes it costly and slow as shipping of a new model S to China alone can take close to a month.
The Chinese government devotes many resources in contributing to the amount of EVs. China aims for 500k EVs in 2015 and 5mln EVs in 2020. Although Tesla has not yet ‘met’ the specifics needed to be part of this special subsidy program, they are negotiating it heavily. Whether Tesla will be able to fully be part of this program remains dubious, since the Chinese government highly values local sourcing, such as local manufacturers like BYD. Another subsidy plan by the Chinese government is a strict agreement on having 30% New Energy Vehicles (NEV) in its government fleet. This may sound promising but bear in mind the difference in value attached to a car; driving a big luxurious American sedan may not be as accepted in China, with respect to its left wing politics. The above factors limit the upside potential of these kind of subsidies.
In sum, distribution is likely to be the real constraint in the short term. In the medium run, issues like production capacity come into play, which probably will be relieved too by the new Giga Factory. Whether Tesla can manage to get a piece of the large subsidy pies remains highly dubious. Implementing Tesla’s business model in China is already proving more difficult than in other parts of the world. If this challenge is adequately coped with, China may turn out as an important area of distribution, but this is something which remains to be seen.
An important restriction of EVs is the range they are able to travel on one charge. Currently, Tesla is market leader in producing EVs with the longest range (426 km). However, in order to fully overcome this range constraint Tesla has invented Superchargers (see figure 7).
Figure 7 - Supercharger Station - Source: Tesla Motors
These chargers are able of providing half a charge in 20 minutes and 80% in 40 minutes, due to the diminishing rate of charging. Tesla’s Superchargers are strategically located along main traffic veins in order to create maximum coverage. Up till date, 115 Supercharge stations have been placed in the USA, 71 in EU and 23 in Asia. This coverage is continuously being expanded and subject to strict growth criteria (see figure 8), aiming to decrease the barrier to go electric. Besides the fact that these Superchargers are much more efficient than chargers connected to the home grid, another substantial factor decreasing this aforementioned barrier is that Superchargers are completely free, which is pleasant when bearing oil prices in mind.
Figure 8 - Superchargers in Europe: Now vs 2016 - Source: Tesla Motors
Besides that these Superchargers are very useful for current Tesla drivers, they pack a lot more opportunities. As coverage increases, Superchargers may form an important factor in choosing to buy a Tesla, since Tesla is creating an Apple-like ecosystem of Tesla Superchargers. In the long run, this charging network may even be the decisive factor in buying a Tesla. Moreover, Tesla’s system of Superchargers may prove extremely useful, efficient and environmental friendly to the trucking industry. Although alterations to current policies should be implemented, why not combine the compulsory breaks with charging your truck? At this point, Tesla is too young to allocate resources to the development of such systems, but this may definitely prove a long term opportunity, both for EVs and the environment.
As with every fast growing company, the million dollar question always is: what is the actual value, i.e. is it overpriced? On any valuation metric, Tesla is expensive. The company is only 11 years old, has a total quantity produced of less than 50,000 and its 124.63 million shares outstanding sell for around $240 each (10 October 2014), which equals a capitalization of around 30 billion. Many institutions have different opinions on whether this is, or will be, a correct valuation. According to figure 11, the analysts are fairly positive on Tesla, while a large share stays neutral in the short term. In order to take a closer looks, I will compare Morgan Stanley’s and Goldman Sachs’s forecasts for Tesla, since their contrasting visions provide nuance to this highly popular stock.
Figure 9 - Sentiment Analysis - Source: 4traders
Goldman Sachs (GS) forecasts sales to reach 290k in 2020 (TSLA forecasts 500k) in the base case, which they consider most feasible (Pbase=0.5). Furthermore, a best and worst case scenario has been analyzed, resulting in a target price of $190. GS adds another $20 markup to this target in order to account for their “Grid Storage Option”, a scenario in which Tesla sells its superfluous energy supply. In sum, GS’s price target is considerably lower than current share prices and embodies a bearish sentiment.
In contrast with GS, Morgan Stanley (MS) takes a much more bullish approach. For its base case, MS forecasts sales to reach 1.1mln in 2028, based on pursued success of the Model S and strong sales-performance of new models. This, along with a long term operating margin results in a price target of $320 based on 15 year DCF, including $15 for regulatory credits (see figure 12). MS’s “disruption on premium car market” amounts to a forecasted stock price of $500 whereas its worst case scenario estimates “a small but thriving company” resulting in an estimated stock price of $100.
Figure 10 - Morgan Stanley target Tesla
Finding common ground between these two vastly different forecasts is challenging, but both GS and MS agree on certain core factors, which need to be monitored closely: technological advancement, cost reductions in TSLA’s powertrain, development of oil prices and government support. Should there be any deviations from estimated parameters, the definitive outcome will turn out different from any forecast.
Investing in the short term
After having carefully analyzed potential catalysts for the medium and long term, it is time to cast light on the short term. In order to conduct the technical/sentiment analysis, I closely collaborated with Simon Waslander.
As stated earlier, Tesla Motors has been an absolute market darling for investors. The stock is up roughly 50% Year-to-Date and up more than 700% on a three year timeframe, as of Tuesday, October 14th. However, the stock is also very volatile and prone to violent corrections as seen in Q4 2013 and Q2 2014 when Tesla declined 40% and 30% respectively. This enormous volatility makes it quite difficult to predict future price movements with a reasonable degree of certainty. Nevertheless, technical and sentiment indicators can provide us with powerful clues as to where Tesla might be headed.
As one can deduce from the Tesla’s stock chart (see Figure 11), Tesla has been in a massive uptrend for the past few years. Although the long-term trend definitely points to the upside, the medium-term prospects are a lot murkier. The stock seems to have broken down a bit as of late and is currently retesting the 200 day moving average (dma). In the past such retests (green circles) have translated into powerful buying opportunities for Tesla stock. The RSI and MACD indicators have also reached their respective support levels.
Figure 11- Technical analysis
Yet, I am not comfortable with buying Tesla at the moment, as Reuters data clearly shows analyst sentiment to be universally bullish towards Tesla (see Figure 9), while various market commentators have given CEO Elon Musk a near God-like status, with comparisons to Steve Jobs and Henry Ford.
This universal bullishness, cult-like adoration and the extreme upward trajectory of Tesla has caught the attention of CEO Elon Musk, who, in the past few months, has been trying to remove the frothiness in Tesla stock with various media appearances in which he questions the current valuation the market is giving Tesla. During an interview on September 4th 2014, CEO Elon Musk said investors often "get carried away" with the electric car company's stock price. “I think our stock price is kind of high right now,” “If you care about the long term, Tesla, I think the stock is a good price. If you look at the short term, it is less clear.” It is quite rare to see a company’s founder, CEO and largest shareholder telling the market that he thinks the stock price is too high, which means there is ever the more reason to pay close attention to his warning. Looking back at the technical chart, Tesla decisively broke the light-blue uptrend line and the stock is currently stuck in trading range between the resistance at $265-$290 and support zone at $200-$175. With the trend break this month, I feel that Tesla has a clear downward bias in the short-term, and I think it is likely that we will see a retest of the support zone around $200-$175 in the coming weeks. A powerful catalyst which investors have to pay attention to is that Tesla will announce earnings between November 3rd and November 7th. This can cause large swings in the stock price and I would advise investors not to speculate to aggressively with Tesla before the earnings release, as the risks of being caught on the wrong side of the trade are quite high. After the earnings release we will have much more information to work with and therefore we will be able to form a better picture of the trend going forward.
In summary, I feel that Tesla Motors stock is overpriced on the short-term and that sentiment is far too bullish. This makes Tesla vulnerable on the short-term and I expect a retest of the support-zone around $200-$175 to occur in due order. The long-term trend is clearly up, but I would advise investors to wait for this expected correction to unfold before increasing their long exposure to Tesla stock. Lastly, investor can expect some large price swings in the first week of November due to the quarterly earnings release. Although my bias is towards the downside, it is very risky to trade stocks around earnings releases. Therefore, I would advise investors not to take large positions in Tesla until we see the quarterly results.
Over recent years, Tesla has achieved a somewhat utopian status. In this article, I have conducted a thorough review in order to test whether this status is deserved. The Roadster and the model S are great cars and the public cannot wait to drive upcoming models. However, as Tesla is more and more approaching the mass public via cheaper EVs, margins will shrink and competition will intensify. In order to overcome these challenges, Tesla announced the construction of its Giga Factory, intended at exploiting economies of scale; increasing profit margins by lowering average cost. However, Tesla is all-in on batteries, while questions like the steady supply of lithium and innovation to replace lithium-ion batteries remain unanswered. In pursuance of greater sales volume, the biggest car market in the world, China cannot be neglected. Tesla is devoting a lot of resources to developing its Chinese supply chain. Unfortunately, long waiting times and cultural differences may drag Tesla’s Chinese sales down. Concerning the global transition to EVs, Tesla is investing heavily to decrease the main detriment of Evs range. Tesla is implementing a global Supercharger network, which is free to use and allows for longer road trips. As a result of all these developments valuation remains extremely strenuous, with valuations fluctuating more than hundred dollars. However, as Musk addressed too, sentiment on Tesla is too bullish. This will probably lead to a correction in the short term towards $200. So, is Tesla aiming too high? Q3 earnings will give us many new insights on that question. Whether Tesla will end as a big player in the automotive market or as a small scale innovative car brand depends on the upcoming five years for Tesla, which requires close monitoring. However, one thing is sure; Elon Musk is determined to revolutionize the car industry and so far, it is working.
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Karsten is currently studying finance and is a member of Risk. He organised the Risk Finance Symposium and invests on his own account. He specializes in equities, technology and emerging markets.