Just How Speculative Is Tesla Motors Inc Stock?

Despite its many accolades, Tesla Motors (NASDAQ: TSLA  ) still faces difficulties. Combined with a soaring stock price, many think it has reached speculative levels. Before we get to that, some context is in order. 

Operational realities bite
California-based Tesla has grown into a $32 billion car manufacturer. According to Bloomberg, the company sold over 22,000 vehicles in 2013. Tesla's most recent annual report shows the company had $2 billion in revenue and lost $74 million for the year.

While many see Tesla as a burgeoning technology start-up, the company is not a baby. Tesla's been around since 2003, it's raised many rounds of capital, and its products have been in the market for some time. After a decade of operations and thousand of cars sold, the reality is that Tesla still operates at a loss. 

Formidable competition
Meanwhile, Tesla competes in a mature industry against large and formidable adversaries. Consider Japanese giant Toyota  (NYSE: TM  ) . Toyota's 2013 fiscal year end doesn't end until March 31st, but according to Yahoo! Finance, it generated $317 billion of revenue and over $23 billion of net income on a trailing twelve-month basis .  

It introduced the first mass-produced electric-hybrid (the Prius) in 1997. Looking ahead, Toyota plans to introduce a hydrogen-powered "fuel cell" vehicle, which according to Toyota's website, will be available by 2015.

Another competitor, closer to home, is Michigan-based General Motors (NYSE: GM  ) . While General Motors had well-known problems, the company has restructured and returned to profitability. GM generated over $155 billion in revenue and $3.77 billion in earnings in 2013. GM showed that it was still in the race for next-generation automotive technology when it introduced the Chevy Volt in 2010.

Figure 1 below compares revenue for Toyota, General Motors, and Tesla.

Note: GM and Tesla revenue is for fiscal year 2013, Toyota's revenue is trailing twelve months as of Feb. 28, 2014.

In Tesla'a favor
Despite the challenges, there are a couple of things that should work in Tesla's favor. First, according to Tesla's CEO Elon Musk, the company's strategy is to sell fewer expensive cars initially and sell a greater number of cheaper cars as production costs decrease.

In other words, Tesla was smart to "start at the top," because it's easier to move down into lower-end markets than to move up. The wheels are already turning as Tesla is preparing to introduce its lower-end Model E. That means Tesla is only getting started in terms of sales. 

That brings up the second point -- scale. Tesla's problem seems to be that operating costs per car are too high. With scale, that could change. For example, think of how the cost for operating a plant is spread across more cars with each additional unit sold.  

In addition, as technology matures, the costs of inputs could decline. For example, one of the most expensive parts of a Tesla is the lithium-ion battery pack. According to Morgan Stanley, Tesla seeks to lower the cost of it's batteries down to $200 per kilowatt-hour. This is significantly lower than the current industry average, which according to business advisory firm AlixPartners LP, is about $400/kwh.    

What this means for Tesla stock
At over $220 per share, Tesla is relying heavily on expectations of what could happen. With that in mind, it's helpful to estimate how realistic those expectations are. To do this, I'll use a simple cost, sales, and earnings scenario using a few assumptions.

  • Assume Tesla's battery costs are no worse than the industry average of $400 / kwh (cost according to AlixPartners LP)
  • Assume the average Model S is sold with about 73,000 kwh of battery (average of the 60 kwh and 85 kwh versions available)
  • Assume Tesla hits its sales goal of 55,000 units in 2014 (and doesn't sell any more)
  • Assume a starting loss of $3,300 per car (based on 22,000 cars sold and $74 million loss in 2013)
  • Finally, to keep things simple, assume everything else stays the same (including the $32 billion market cap)

In Figure 2 below, notice the change in earnings as battery costs fall to $300 / kwh  (all else equal of course). At $200/kwh, Tesla's price-to-earnings ratio could fall to 47, which isn't unreasonable for a high-growth technology leader. Keep in mind this doesn't account for sales beyond 55,000 units, which Tesla could exceed based on its sales trajectory.

Figure 2

Cost / Kwh Kwh Cost / Car Earnings P/E
$400 $31 k ($181) million (176)
$300 $23 k $244 million 130
$200 $15 k $670 million 47

Source: Authors calculations.

Clearly, this cost reduction won't happen overnight.  According to Pike Research, battery costs should fall at about 10% per year for the next three years, then accelerate due to scale. At that rate, $300/kwh would be attainable in three years, and  $200/kwh would not be far behind.

The bottom line
Clearly, there are variables that we have not considered and Tesla still faces many challenges. However, based on current sales and cost expectations, profitability is within reach and Tesla may even be reasonably priced. Of course, that's not saying Tesla's stock is cheap.  

In the simple example above, a P/E of 47 is obtained if earnings grow and Tesla's share price remains flat (or grows less). In other words, Tesla's current price already reflects expected growth. At the end of the day, Tesla's stock is cheap if you think $220 per share still underestimates Tesla's growth. And that much, we can say, is certainly speculative.

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Read/Post Comments (11) | Recommend This Article (3)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On March 27, 2014, at 9:01 AM, pondee619 wrote:

    "Assume the average Model S is sold with about 73,000 kwh of battery (average of the 60 kwh and 85 kwh versions available"

    I do not understand how the average of 60 kwh and 85 kwh is 73,000 kwh. Shouldn't the average be 72.5 (73) kwh?

    Sloppy writing + sloppy proof reading = sloppy reporting which does not educate, amuse or enrich.

  • Report this Comment On March 27, 2014, at 9:09 AM, tchams wrote:

    pondee619: key word there is about 73,000. This is an estimate, so it does not have to be an exact average.

    I would even bet that more 85 kwh's are sold compared to 60's. If that assumption were made we could use a weighted average to what we expect customers to buy more of.

    Don't let rounding cloud the bigger picture.

    Even without these factors, the key word is about (indicating that rounding has been done)

  • Report this Comment On March 27, 2014, at 9:57 AM, pondee619 wrote:

    tchams:

    73,000 is nowhere near 60 or 85 much less an average, rounded or otherwise, of the two. It is off by a factor of ONE THOUSAND.

    Sloppy writing, sloppy proof reading leads to sloppy reading and little, or no comprehension. Little, or no , compreshesion as you now defend the position that 73,000 is the (estimated) average of 60 and 85. IWould it not have been more honest to suspect that the author made a sloppy mistake and didn't care enough about his work to check it before publishing? The pressure at the fool to issue bulk over quality must be fantastic.

    Let the reader beware.

  • Report this Comment On March 27, 2014, at 10:36 AM, gjsuhr wrote:

    I read another article yesterday that said Tesla has already capture 13% of the US market for cars in the $70-110k price range....which is great except that means the entire segment of the market is only 150,000 cars. That makes hitting the goal of selling 55,000 cars in 2014 difficult (although Europe and China might make that attainable) but more importantly, going much beyond that becomes virtually impossible without a lower priced car.

    Paying a PE of 47 may be reasonable for a company with a lot of potential growth, but once you get half of a market for example, mathematics says the most you can ever do from that point is double and take all of the market.

    The question always was and remains, can Tesla build a mid-priced car with range equivalent to the Model S. Since they obtained their factory for next to nothing from the Toyota-GM joint venture, I don't see that manufacturing scale will have much of an impact so it all comes down to battery costs.

  • Report this Comment On March 27, 2014, at 10:46 AM, damilkman wrote:

    In the late 90ties. Juniper attempted the same growth model in the router market. They began with high end routers and focused on the high end ISP market with supposedly higher margins. The product that Juniper built was certainly superior to Cisco because of the concentration on a more narrow suite of software services.

    What was interesting is the margin narrowed when Juniper attempted to expand into the enterprise market. As the spectrum of the code base increased to include enterprise services the number of software problems increased and Juniper had difficulty managing all of the new demands on their software. Worse, the high end market was attacked by new players like Brocade and Alcatel who pushed price at a time when even the tier one players were looking to cut costs.

    I see a similar parallel with Tesla. Tesla is selling a 70K car with 25-30K of mark ups. The customers who buy this car are obviously the types who don't care about money. The margins are high and the product is simple. The regular car market is further from this reality.

    Unless you are filthy rich price is often one of the most important variables in selecting a car. Just like the enterprise market the requirements of one individual can be completely different from another. To have the attention of the entire population I need many different options. Since a car is something most of us intend to keep for ten years you also need to figure out how customers will get their vehicles serviced. Unlike the filthy rich we do not have a garage of other cars to use and often require immediate service.

    The automobile field is absolutely saturated, cut throat, requires immense investments and has hidden costs that a napkin calculation does not reveal until too late. The diversification of a product line as required by automobile customers in terms of the impact on complexity and how that product is advertised and supported have not been figured out, just as Juniper had not figured out the cost of supporting a more expansive software suit. And that was just software!

  • Report this Comment On March 27, 2014, at 10:53 AM, nonqual wrote:

    Guidance is for 35k not 55k in 2014, also that Q1 deliveries will be about 5% below Q4 deliveries and about 14% below planned production. Growth???? Based on Jan and Feb reported registrations, hitting 6,400 in Q1 looks difficult. Pump so Bellwether can dump. What a racket!

  • Report this Comment On March 27, 2014, at 10:55 AM, drax7 wrote:

    Tesla's competitive advantages are so many it's tedious to go over them. The author is totally uninformed and uneducated in the matter, , and should go back and study and read and think before writing such an article.

  • Report this Comment On March 27, 2014, at 1:57 PM, SteveTG3 wrote:

    there is very strong indication Tesla's cost per kWh is $200-250 today.

    you might want to start digging into this with the following article. you'll note Tesla's use of the small cell format creates this very large pricing advantage over the large cell format all the other automakers are using.

    http://www.greencarreports.com/news/1084682_what-goes-into-a...

  • Report this Comment On March 27, 2014, at 6:03 PM, fooyoo wrote:

    you people are doing and saying any and everything especially this site to bad mouth it .The only reason it did go down was the stories that the meatball from jorzy tried to ban sales.the fact is it's being shorted big time by the same people and they will not tell you that .These people are hell bent on critisizing it just so it will go down .! crazy tv guy actually says do'nt buy it but will after he already in and sell after he told his audience to buy it. You catch my drift. I unsubscribed to this site after thier first year more or less and reregistered just to comment and soon will unsubscribe ect

    If you follow any stories about it other than this stuff you would know that tesla plans on setting up free charging station all over the country and a full charge will take less than 20 mins. any and all debate and critcimsm of kwh ect horse manure irrevelant

  • Report this Comment On March 28, 2014, at 8:59 AM, DoubleFelix wrote:

    SteveTG3 wrote "Tesla's use of the small cell format creates this very large pricing advantage over the large cell format all the other automakers are using."

    That is Tesla's claim. They MAY have a $/kWH advantage today on the complete battery assembly, but that is not at all certain because there is a lot of cost in soldering together a bunch of toothbrush batteries. Even if it is a cost advantage, it very defeinitely is not a size and weight advantage, as the cylindrival form factor is super inefficienct. The batter pack in the S is 1200 freaking pounds.

    Moreover, Musk tries to have it both ways. On one hand he says he is a genius for using the commodity toothbrush batteries. On the other hand he says his real breakthrough into the mainstream market will come when he gets the greater densities of Lithium-air or other technologies , which will not be in the toothbrush battery. At that point, he will have to go with a more application-specific battery package.

    And that may be one of the reasons why Panasonic is balking at getting in on the (at present) mythical giga-factory.

    So I wouldn't put too much stock in this supposed big advantage.

  • Report this Comment On March 28, 2014, at 10:12 AM, DoubleFelix wrote:

    Damiklman wrote: "Unless you are filthy rich price is often one of the most important variables in selecting a car. "

    I agree with the parallels you drew with Juniper Networks. And I would argue that it is even more extreme in the consumer market for cars -- the 83 million vehicle market. While enterprise network managers are cost conscious, they will spend money for a better solution, and they will spend a lot of money for the convenience and efficiency of a uniform solution across the network.

    In the car market, most people don't even look at life cycle costs. 95% of them just look at their monthly loan or lease payment and don't even factor in monthly operating costs (fuel, maint etc). The Prius/Volt/Leaf buyer is the rare exception to the rule, and even in those cases, they are buying vehicles that have a competitive total cost of ownership to same-size non-hybrid cars.

    Tesla is so far away from that point, it isn't even a real discussion. Much is made of their gross margin, but that can be a fishy number. They are only now starting to accumulate costs for dealerships and warranty repairs. That is going to eat most of that fluffy gross margin.

    To stretch the Juniper analogy just a little more, compatibility / seamless operation is a key factor in selecting any network gear. The equivalent in this case is the charging network. By pushing his own charging network that isn't compatible with any others in the industry, Musk is erecting a barrier that will be extremely significant to the mainstream buyer. This is equivalent to having gas stations that only serve Fords and other stations that serve Chevys and a few stations hundreds of miles apart that serve Porsches. Why does anybody think this is a good idea?

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