Can Tesla justify it’s valuation?
Updated
Bullish points:
Strong balance sheet
Market dominant position
Usage of EV’s set to soar, a very promising industry
Exciting prospects outside the EV market
Strong ESG credentials
Efficiency set to increase
Very promising technology
Improving margins
Storage capacity set to soar
CEO has plenty of skin in the game
Bearish points:
Competition heating up in the EV market
Hydrogen could become a viable competitor
Profits from the carbon credits could start to decrease
Inflationary threat
Potential resource shortages
Premium valuation
Mass adoption of EV’s still yet to come
Costs of the cars still remain quite high
Never has a company been so divided like Tesla, some argue that it is an extraordinary company with amazing growth opportunities, whilst others believe that it is simply grossly overvalued and set to face some tough competition.
When assessing a company one of the first places to look is at the balance sheet, from that perspective the fundamentals are robust, the group has a strong balance sheet with plenty of cash (over 16 billion cash and cash equivalents compared to just $2.1 billion total debt excluding vehicle and energy product financing) to undertake the expansion of the business. So we can conclude that the company is not in danger financially and has sufficient capital to carry on growing and if at any time this is put under doubt we have seen that the group can perform a rights issue. Both of the groups hugely successful capital raises have meant that the group has had plenty of funds and the shareholders have also been minimally diluted. The group also has plenty of capital to fund the business on a days to day business with a current ratio of over 3.
The group’s core business also is in a very promising line of business EV sales are projected to soar as electric vehicles replace the traditional ICE vehicles. Of course there still remain some tailwinds for the mass adoption of electric vehicles such as the number of charging points and the costs, however, these issues have become less prevalent and with such a crucial environmental crisis the transition to cleaner cars is likely to be quick. Since Tesla is a fully electric car company it is clearly poised to benefit from the transition, in fact the company has been forecasting 50% sales growth of vehicles sold annually.
However, with a roaring EV market competition will come, now nearly every car company company is planning to go electric or has already done so Tesla will have to fight for its market share. The automotive sector has always been a highly competitive one and this is unlikely to change with the use of EVs. Bulls could argue that whilst this may be true Tesla has a market dominant position that will allow it to take up a massive share of the market. For example, they will point to the strong brand name and the technology used in Tesla cars and therefore give the company a competitive edge and a colossal moat.
Having said that, the impacts of the competition are still likely to be very significant to Tesla’s market share, other automotive companies have strong brand names such as Toyota or Volkswagen. Another issue poised is that the cheapest car Tesla sells costs $44,000 which is a price that is too high for many people, meaning that Tesla could either lose market shares to cheaper rivals or be forced to sacrifice margins. So far, Tesla has performed well with margins increasing despite Tesla getting a 6% less average realised price on each sale of a car (as a result of transitioning to lower cost vehicles) as a result of costs decreasing however, this may not be the case coming forwards into the future.
With regards, to the edge surrounding the quality of the cars whilst it may be true that Tesla does have some advantages with regards to the technology surrounding the cars , there are other things when considering the quality of the cars. It is also perhaps worth noting that Tesla spends less on research and development than other automotive companies. For example, Toyota spent over 10 billion on research and development in 2020 compared to under 2 billion for Tesla. True, Tesla has been putting more and more into R and D spend, in the latest quarter (Q3) Tesla spent 611 million, still very far off that of Toyota, around 4 times less if you continue to extrapolate the R and D spend (i.e. multiply the figure by 4.) This is an incredible figure if you keep in mind that Tesla has an Enterprise valuation (EV) of well over twice that of Toyota. So arguably it could be other companies who have the competitive edge and not Tesla. Also, within the technology sector surrounding cars, most notably around self driving cars Tesla can expect to face more competition. For example, even Google’s owner Alphabet has an investment in the self driving car space. It is also worth noting that some of the technology comes in the form of the ability to play video games on a Tesla, whilst this is pleasant, it is unlikely to sway the decision of a customer on which car to buy.
It is also worth noting that battery powered vehicles are not the only alternative to traditional ICE vehicles. Hydrogen fuel cell cars are becoming an increasingly viable option. Whilst hydrogen has a long way to go before being implemented in vehicles on a mass scale (currently there are very few models of hydrogen fuel cells available) it could not be long before hydrogen starts replacing some EVs. Let’s first look at the advantages of the battery powered vehicles. With regards to costs EV’s are a clear winner, the costs of buying and running the car are both significantly lower than that of a hydrogen car. EV’s are more efficient with their energy with around 80% of electricity produced used to power the car compared to 38% for Hydrogen fuel cells (source Lexology.com). There are also far more charging points for electric cars meaning that there are plenty of tailwinds for the mass usage of Hydrogen in cars, whereas electric cars can thrive. On the other hand, hydrogen cars have more range and the refuelling times are a lot quicker. It is also worth noting that the battery pack is a lot heavier than the hydrogen tank, meaning that on larger vehicles batteries are not so viable, although this is unlikely to have a huge affect on Tesla except perhaps in the truck business. Furthermore, the costs of a hydrogen car could come down with more research, closing the gap in price. In all, whilst hydrogen is promising withregards to the vehicle market I expect battery powered cars to continue having the lion’s share of the market until some of the shortcomings of hydrogen power have been ironed out.
Being a growth stock Tesla can be very vulnerable to inflation, as most of its earnings are promised in the future, which now look less impressive as the money would have devalued. Additionally, the rise in costs could hamper margins as given the high costs of the vehicles, true this could be offset by decrease in the costs of the battery pack, but none the less remains an issue. Another threat are shortages of materials such as chips or metals such as Nickel used in the batteries which has only been accentuated with the supply chain issues, meaning that production of the vehicles could be limited, and this could hurt the revenue and the profits.
Bulls could also point out that the group has numerous assets other than cars. Tesla is a major player in the energy storage and generation market. However, in the latest quarter (Q3) 12,057 million dollars out of 13,757 revenue came of the automatise sector, so Tesla is really a share that you should buy if you are optimistic on the cars. True, the Megapack factory in building should cause the energy storage capabilities to surge however, the effect of the 40GW storage alone is unlikely to be able to change the gargantuan market cap of over 1 trillion by a significant amount.
Tesla’s enterprise valuation of around 1.1 trillion dollars compares with $2 billion operating profit in the latest quarter. Multiply this figure by 4 and the total profit for FY 2021 is likely to be around $8 billion, meaning that the EV to operating profit is just 137.5. In Q3 the revenue was 13.757 billion, multiply this by 4 and the revenue for the full year is just over 55 billion meaning that the EV to sales is around 20 comparing to and EV/Sales of around 1 for a competitor such as Ford, a huge premium.
Overall, we can see that Tesla is a company of great quality and in an industry with great prospects, however the valuation does not seem to reflect the appearance of competition from many other automakers. In fact we are beginning to see already that other car makers have had great success in transitioning to the EV market and I would expect the trend to continue, in fact very recently General Motor’s CEO said that the group could absolutely catch Tesla in EV sales by 2025. The looming threat of inflation along with more competition from the hydrogen market seems like the shares look rather richly valued.
Strong balance sheet
Market dominant position
Usage of EV’s set to soar, a very promising industry
Exciting prospects outside the EV market
Strong ESG credentials
Efficiency set to increase
Very promising technology
Improving margins
Storage capacity set to soar
CEO has plenty of skin in the game
Bearish points:
Competition heating up in the EV market
Hydrogen could become a viable competitor
Profits from the carbon credits could start to decrease
Inflationary threat
Potential resource shortages
Premium valuation
Mass adoption of EV’s still yet to come
Costs of the cars still remain quite high
Never has a company been so divided like Tesla, some argue that it is an extraordinary company with amazing growth opportunities, whilst others believe that it is simply grossly overvalued and set to face some tough competition.
When assessing a company one of the first places to look is at the balance sheet, from that perspective the fundamentals are robust, the group has a strong balance sheet with plenty of cash (over 16 billion cash and cash equivalents compared to just $2.1 billion total debt excluding vehicle and energy product financing) to undertake the expansion of the business. So we can conclude that the company is not in danger financially and has sufficient capital to carry on growing and if at any time this is put under doubt we have seen that the group can perform a rights issue. Both of the groups hugely successful capital raises have meant that the group has had plenty of funds and the shareholders have also been minimally diluted. The group also has plenty of capital to fund the business on a days to day business with a current ratio of over 3.
The group’s core business also is in a very promising line of business EV sales are projected to soar as electric vehicles replace the traditional ICE vehicles. Of course there still remain some tailwinds for the mass adoption of electric vehicles such as the number of charging points and the costs, however, these issues have become less prevalent and with such a crucial environmental crisis the transition to cleaner cars is likely to be quick. Since Tesla is a fully electric car company it is clearly poised to benefit from the transition, in fact the company has been forecasting 50% sales growth of vehicles sold annually.
However, with a roaring EV market competition will come, now nearly every car company company is planning to go electric or has already done so Tesla will have to fight for its market share. The automotive sector has always been a highly competitive one and this is unlikely to change with the use of EVs. Bulls could argue that whilst this may be true Tesla has a market dominant position that will allow it to take up a massive share of the market. For example, they will point to the strong brand name and the technology used in Tesla cars and therefore give the company a competitive edge and a colossal moat.
Having said that, the impacts of the competition are still likely to be very significant to Tesla’s market share, other automotive companies have strong brand names such as Toyota or Volkswagen. Another issue poised is that the cheapest car Tesla sells costs $44,000 which is a price that is too high for many people, meaning that Tesla could either lose market shares to cheaper rivals or be forced to sacrifice margins. So far, Tesla has performed well with margins increasing despite Tesla getting a 6% less average realised price on each sale of a car (as a result of transitioning to lower cost vehicles) as a result of costs decreasing however, this may not be the case coming forwards into the future.
With regards, to the edge surrounding the quality of the cars whilst it may be true that Tesla does have some advantages with regards to the technology surrounding the cars , there are other things when considering the quality of the cars. It is also perhaps worth noting that Tesla spends less on research and development than other automotive companies. For example, Toyota spent over 10 billion on research and development in 2020 compared to under 2 billion for Tesla. True, Tesla has been putting more and more into R and D spend, in the latest quarter (Q3) Tesla spent 611 million, still very far off that of Toyota, around 4 times less if you continue to extrapolate the R and D spend (i.e. multiply the figure by 4.) This is an incredible figure if you keep in mind that Tesla has an Enterprise valuation (EV) of well over twice that of Toyota. So arguably it could be other companies who have the competitive edge and not Tesla. Also, within the technology sector surrounding cars, most notably around self driving cars Tesla can expect to face more competition. For example, even Google’s owner Alphabet has an investment in the self driving car space. It is also worth noting that some of the technology comes in the form of the ability to play video games on a Tesla, whilst this is pleasant, it is unlikely to sway the decision of a customer on which car to buy.
It is also worth noting that battery powered vehicles are not the only alternative to traditional ICE vehicles. Hydrogen fuel cell cars are becoming an increasingly viable option. Whilst hydrogen has a long way to go before being implemented in vehicles on a mass scale (currently there are very few models of hydrogen fuel cells available) it could not be long before hydrogen starts replacing some EVs. Let’s first look at the advantages of the battery powered vehicles. With regards to costs EV’s are a clear winner, the costs of buying and running the car are both significantly lower than that of a hydrogen car. EV’s are more efficient with their energy with around 80% of electricity produced used to power the car compared to 38% for Hydrogen fuel cells (source Lexology.com). There are also far more charging points for electric cars meaning that there are plenty of tailwinds for the mass usage of Hydrogen in cars, whereas electric cars can thrive. On the other hand, hydrogen cars have more range and the refuelling times are a lot quicker. It is also worth noting that the battery pack is a lot heavier than the hydrogen tank, meaning that on larger vehicles batteries are not so viable, although this is unlikely to have a huge affect on Tesla except perhaps in the truck business. Furthermore, the costs of a hydrogen car could come down with more research, closing the gap in price. In all, whilst hydrogen is promising withregards to the vehicle market I expect battery powered cars to continue having the lion’s share of the market until some of the shortcomings of hydrogen power have been ironed out.
Being a growth stock Tesla can be very vulnerable to inflation, as most of its earnings are promised in the future, which now look less impressive as the money would have devalued. Additionally, the rise in costs could hamper margins as given the high costs of the vehicles, true this could be offset by decrease in the costs of the battery pack, but none the less remains an issue. Another threat are shortages of materials such as chips or metals such as Nickel used in the batteries which has only been accentuated with the supply chain issues, meaning that production of the vehicles could be limited, and this could hurt the revenue and the profits.
Bulls could also point out that the group has numerous assets other than cars. Tesla is a major player in the energy storage and generation market. However, in the latest quarter (Q3) 12,057 million dollars out of 13,757 revenue came of the automatise sector, so Tesla is really a share that you should buy if you are optimistic on the cars. True, the Megapack factory in building should cause the energy storage capabilities to surge however, the effect of the 40GW storage alone is unlikely to be able to change the gargantuan market cap of over 1 trillion by a significant amount.
Tesla’s enterprise valuation of around 1.1 trillion dollars compares with $2 billion operating profit in the latest quarter. Multiply this figure by 4 and the total profit for FY 2021 is likely to be around $8 billion, meaning that the EV to operating profit is just 137.5. In Q3 the revenue was 13.757 billion, multiply this by 4 and the revenue for the full year is just over 55 billion meaning that the EV to sales is around 20 comparing to and EV/Sales of around 1 for a competitor such as Ford, a huge premium.
Overall, we can see that Tesla is a company of great quality and in an industry with great prospects, however the valuation does not seem to reflect the appearance of competition from many other automakers. In fact we are beginning to see already that other car makers have had great success in transitioning to the EV market and I would expect the trend to continue, in fact very recently General Motor’s CEO said that the group could absolutely catch Tesla in EV sales by 2025. The looming threat of inflation along with more competition from the hydrogen market seems like the shares look rather richly valued.
Trade closed: target reached
Has fallen massively since bearish call. This could be a fairer price (but I haven’t done much analysis on the stock recently). Maybe time to stop being as bearish as previously.
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