Source: Wikimedia Commons
I have to confess. I had hoped for this article to be a bullish, possibly best-case scenario on how Tesla (TSLA 1.14%) could fundamentally justify its current stock price (and beyond) following an interview with its CEO Elon Musk on CNBC. Even after doing much mental gymnastics, though, I just can't do it. The facts cannot be denied; Tesla is overvalued.
October 2013 interview
Back on Oct. 24, 2013, with the company's stock price hovering around $170, Musk gave an interview that included commentary about Tesla's stock price and valuation. At the time, he stated that Tesla's stock price was "more than we deserve," although to be fair that was completely taken out of context by many talking heads in the media.
The reality is that Musk was referring to the speculation behind the valuation. He also said in the interview: "We're going to do our best to fulfill the expectations of investors, and I think in the long term that stock price is going to seem fair. It's difficult to predict where it goes in the short to medium term, but I do feel good about the company achieving that value and more in the long term."
Source: Wikimedia Commons
June 2014 interview
Fast-forward to the recent past, when Musk offered further clarification, in another interview with CNBC on June 9, that Tesla's value is driven mostly by speculation on its future execution, and any change in that perception has a dramatic effect on the company's stock price. Well, most investors already knew that. I always get a chuckle whenever Tesla's critics attempt to value the company based on historical numbers only.
Probably nobody has more information about the future of Tesla than Musk himself. So, with the company's share price now up more than 20% since October, what does he think? In the recent interview, Musk said, "We need to execute very well over the next few years in order to justify the stock price. I'm feeling like we probably will."
Plugging in some numbers
Tesla has several advantages over other car companies, such as not needing to spend a single penny on advertising and very high profit margins. However, Tesla is only servicing the high-end-vehicle market, and with cars that can be sold for upwards of $100,000, it's automatic to expect profit margins to be robust. But, Tesla's margins don't seem all that special at 25%. For example, Porsche reportedly has garnered 50% gross profit margins in China.
Source: Wikimedia Commons
Tesla expects to expand gross profit margins to 28% by the end of the year. According to Musk during the company's recent shareholder meeting, that will be due to a lower average selling price per vehicle. Musk said during the meeting, "We expect to see a slight decrease from people spending on the order of a $100,000 a car to maybe $95,000 a car which is still quite a lot."
With so many unknowns about costs, administrative expenses, Gigafactory expenses that are allotted to the quarterly income statements, and other expenses, it's like trying to guess the number of jelly beans in a jar to try to accurately pinpoint future earnings per share. With Tesla expecting to enter the mass market with cars priced around $35,000 in the next few years, investors can expect that some degree of advertising will be needed. Overhead will escalate, R&D spending will continue to lift, and Tesla will start to look more like a regular car company in terms of bottom-line profit margins.
More info we do have
We know from previous conference calls that Tesla "ultimately" wants to produce 500,000 cars. We know that it is targeting to produce 1,000 cars per week by the end of this year, a rate of 52,000 annually. Let's assume that the "ultimate" number for production of high-end Tesla vehicles is 150,000 per year, or roughly triple the 2014 end-year target rate. That leaves 350,000 units of the third-generation vehicle, or 70% of production, as a best-case estimate for the mass market release.
Using $100,000 per high-end model and $35,000 per mass-market model, total annual revenue comes out to $27.25 billion. That is pretty close to Tesla's market cap now, which means that it already trades at one time the best-case, long-term sales.
General Motors (GM 0.91%) trades at about one-third of sales. That makes Tesla three times more expensive. True, growth stocks deserve higher multiples, but remember that it is already assumed that the growth will come in as planned and will be executed perfectly, and that Tesla will hit a more mature phase with -- presumably -- a more mature and lower multiple.
Source: Tesla Motors
Will the bottom-line profit margins be higher for Tesla's vehicles forever? Maybe, but Deepak Ahuja, Tesla's CFO, stated in the last conference call, "As revenue is going to pick up significantly, the percentage of revenue of R&D expenses it is going to be I expect in the single-digits – high-single-digits." Backing out 8% from Tesla's 28% gross profit margin estimate leaves around 20% for selling, general, and administrative expenses. That doesn't leave much room to have extraordinary pre-tax net income margins high enough to justify a valuation that is triple the price-to-sales ratio of General Motors.
Foolish takeaway
Either Musk is mistaken that Tesla will be able to realistically justify its current valuation, or he has an ace up his sleeve regarding other revenue sources, a surprise jump in profit margins somewhere, or another game plan that we can't yet imagine. I, for one, will be watching closely... but will be doing so from the sidelines for now.
