Tesla has been the talk of the town so far in 2020. The tech-driven company’s stock price has more than doubled since the start of the year thanks to a strong end to 2019 for its business.
With the recent hype around Tesla, here’s a look at some of the reasons why Tesla’s stock may have surged and whether it is still worth investing in.
Free cash flow generation
Previously, one of the concerns investors had with Tesla was its cash burn rate. The company’s high cash burn (see chart below) had resulted in Tesla raising money through secondary offerings that diluted existing shareholders.
However, 2019 could be a turning point for Elon Musk’s brainchild. The electric vehicle company was GAAP-profitable in the second half of 2019 and had generated US$1.4 billion in free cash flow for the same period. Its 2020 outlook was also extremely positive. Tesla said:
“We expect positive quarterly free cash flow going forward, with possible temporary exceptions, particularly around the launch and ramp of new products. We continue to believe our business has grown to the point of being self-funding.”
And although Tesla announced another secondary offering last week, I think this time it was not because of cash flow issues but rather to take advantage of the run-up in its share price.
The chart below illustrates improvements in its trailing twelve months (TTM) of free cash flow over the last 12 quarters.
Ramping up production capacity
Another major plus for the company was the announcement that it was going to ramp up production capacity. In its outlook statement, Tesla said:
“For full-year 2020, vehicle deliveries should comfortably exceed 500,000 units. Due to ramp of Model 3 in Shanghai and Model Y in Fremont, production will likely outpace deliveries this year.”
Tesla’s 2020 projection translates to at least a 36% jump in deliveries from 2019.
Perhaps the most impressive part of its 2019 fourth-quarter earnings announcement was that it was able to start Model 3 production in its Gigafactory in Shanghai in less than 10 months from breaking ground- a sign that the company is becoming more efficient in ramping up production.
The China factory will boost production capacity by around 150,000. Besides the factory in China, Tesla has moved forward with its preparations to build a factory near Berlin, which is expected to be open by 2021.
Irresistible demand for products to meet its production ramp-up
The production ramp-up is only possible due to the strong demand for Tesla’s products. In his earnings call with analysts, Musk gushed:
“Our deliveries reached over 112,000 vehicles in a single quarter. It’s hard to think of a similar product with such strong demand that it can generate more than US$20 billion in revenue with zero advertising spend.”
Musk was even more optimistic about Tesla’s new Cybertruck vehicle. He said:
“I have never seen actually such a level of demand at this — we’ve never seen anything like it basically. I think we will make as about as many as we can sell for many years. So — as many — we’ll sell as many as we can make, it’s going to be pretty nuts.”
As Tesla plans to start production of its Cybertruck only in 2021, investors will need to wait at least a year before the initial sales figures are released but the early signs are certainly encouraging.
Better gross margins
In addition, gross margins for Tesla should improve.
Improved efficiency in product cost and higher gross margins for its newest car (Model Y) will be the driving force behind Tesla’s better gross margins.
The company will deliver its first Model Y in this quarter and expects to ramp up sales of its latest model over the year. As the product-mix shifts towards Model Y, I think investors can expect a slight improvement in gross Tesla’s margin.
On top of improvements in gross margin, Tesla also said that it is likely going to be more efficient in terms of capital expenditure per production capacity. The improvements to capital efficiency should enable the company to scale its capacity faster and produce its vehicles at a cheaper rate on a per unit basis.
Other factors
Besides selling electric vehicles, there are a few other potential drivers of growth:
- Tesla is at the forefront of the fully autonomous vehicles trend. The technology-driven company logged 500 million autonomous miles in 2018. Tesla is, literally, miles ahead of its rivals, Waymo and GM’s Cruise, which logged 1.3 million and 447,000 miles respectively.
Currently, Tesla sells cars that are fitted with the hardware needed for full self-driving (FSD), with an optional upgrade for FSD software features. As FSD technology matures, we can expect Tesla to roll out updates to the software. In addition, Tesla can also retain a fleet of FSD vehicles for rental and driverless transportation- in a way becoming the Uber of driverless vehicles. Ark Invest estimates that autonomous ride-hailing platforms in aggregate could have a value of a whopping US$9 trillion by 2029. - Tesla also sells vehicle software such as its Premium Vehicle Connectivity feature which enables users to stream music on their cars. Owners of Tesla vehicles can also buy other software updates such as acceleration boost, basic Autopilot, and additional premium features. As Tesla grows its suite of software products, this revenue stream is expected to become another important driver of growth for the company.
- The company’s energy storage and solar roof installations businesses have also increased year-on-year. Tesla expects both storage and solar roofing to grow by 50% in 2020.
But is Tesla’s stock too expensive?
2019 is a year which Tesla proved many of its doubters wrong. But has the market gotten ahead of itself?
After the surge in its share price, Tesla’s valuation currently tops US$160 billion. That translates to nearly seven times trailing sales. For a company that has a gross profit margin for its automotive business of 22% (which is high for vehicle sales but low compared to other industries), its current share price certainly seems rich- even for a company growing as fast as Tesla is.
Even if Tesla can quadruple its sales figures to a US$80 billion run rate and earn a 10% net profit margin, today’s share price still represents 20 times that possible earnings. And Tesla will need to keep its foot to the floor of the accelerator to generate that kind of numbers.
In addition, the automotive industry has traditionally been in a tough operating environment. Even though demand for Tesla’s vehicle models seem irresistible at the moment, things could change in the future and a drop in popularity could hurt sales.
The Good Investors’ conclusion
Tesla’s products are in hot demand now and the company has plans to ramp-up its production capacity. And if Tesla can deliver on all fronts (including full-self-driving), I could still stand to make a very decent profit if I buy shares today.
However, its stock does seem a little bit expensive. Any misstep in Tesla’s growth could send the stock price tumbling. As such, despite the tailwinds and huge market opportunity, I prefer to take a wait-and-see approach for now.
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