Shares of Tesla (NASDAQ:TSLA) took a hit on Tuesday, falling about 3% after an analyst at Jefferies initiated coverage of the electric-car maker with an underperform rating, or a rating indicating that stock is expected to underperform major stock market indices like the S&P 500. But the analyst is making headlines again on Wednesday, saying an error in his calculations means his expectations for the stock are even worse.
Jeffries analyst Philippe Houchois' bearish outlook for Tesla (via CNBC) follows a huge run-up in Tesla's stock price recently. Over the past 12 months, the stock climbed an impressive 83%. Is it time for a pullback?
Expectations are too high
On Tuesday, Houchois initiated coverage of Tesla stock with a 12-month $280 price target. But the analyst said in a note to clients on Wednesday that the price target should have been $240, representing about 36% downside from where Tesla stock is trading at the time of this writing. Houchois' lowered price target reflected the correction of an error in the share count figure used in his discounted cash flow model for valuing Tesla stock.
Houchois asserts that Tesla's current stock price factors in unrealistic growth expectations for the electric-car maker's underlying business. "Achievements to-date and vision are impressive, but we don't think Tesla's vertically integrated business model can be scaled up as profitably and quickly as consensus thinks and valuation multiples imply," Houchois said.
To support his below-consensus forecasts, Houchois said Tesla will likely face headwinds with generating a sufficient gross profit margin to support the capital requirements needed for the electric-car maker's growth plan. Specifically, Houchois said he has "doubts about Tesla's ability to generate 30+% gross [profit] margin required to support its vertically integrated business model in distribution/supercharging."
Tesla has a lot to prove
Banking on the hundreds of thousands of reservations Tesla has generated for its recently launched Model 3, management is planning to increase total vehicle production from an annual run-rate of 100,000 units today to 500,000 units next year. By 2020, Tesla expects to be building around 1 million cars annually.
But Tesla will need to prove it can scale its business. In the trailing 12 months, Tesla had negative free cash flow of about $3.2 billion. Even Tesla's operating cash flow is negative, with net cash used in operating activities during Tesla's most recent quarter at $200 million. Looking ahead, Tesla management believes a 25% gross margin for its higher-volume Model 3 next year will help Tesla begin funding its own growth, no longer needing to repeatedly raise capital.
Today, Tesla has a gross margin of about 24% on a trailing-12-month basis, helped by a meaningful gross profit margin in Tesla's automotive business. Tesla's automotive gross margin in its most recent quarter was about 25% when excluding benefits from zero-emission vehicle credits, up from 23.6% in the year-ago quarter. But Tesla's high operating expenses, namely research and development, administrative costs, and the continued expansion of Tesla's stores and Superchargers, mean Tesla still isn't reporting a profit. Over time, management believes operating costs will come down as a percentage of revenue as sales soar.
Tesla investors may benefit from lending an ear to a cautious voice amid the stock's recent monstrous gain. While it's entirely possible that the electric-car maker's attempt to rapidly scale its business will go smoothly, investors should note that the stock's valuation has already priced in tremendous execution in the coming years. On the other hand, Tesla investors shouldn't be too quick to sell. As of Tesla's last update on its aggressive production plans, the company was on pace to boost production fivefold by next year.
Investors can look for an update from Tesla on the company's progress on ramping up Model 3 production and management's latest expectations for its expansion plans when the automaker reports third-quarter results.