One of the most scrutinized companies on Wall Street is electric vehicle (EV) maker Tesla (TSLA +1.16%). Its eccentric CEO, Elon Musk, is a media darling who seems to either capture the fandom of many or polarize the investment community at large.
Tesla has done a tremendous job in bringing much-needed innovation to the automobile industry. However, after it recently fell short of delivery estimates, investors just got a full-blown picture of how the business looks -- and it's not good. As Tesla's stock price continues to crater after third-quarter earnings, some investors may be wondering if the party is over or if this is a unique buying opportunity.
While Q3 left investors with more concerns than positive affirmations, I still think there is plenty to like. From new product launches to a strong capital structure, Tesla is well-positioned to succeed in the long term.
NASDAQ: TSLA
Key Data Points
Anything that can go wrong will go wrong
In early October, Tesla released delivery and production figures for its vehicles during the third quarter. Management had hinted that Q3 production would be muted due to upgrades in some of the company's factories that caused some brief shutdowns. However, while Tesla managed to post respectable growth on an annual basis, the sequential growth profile from the second quarter decelerated by a noticeable margin-- and the company missed Wall Street expectations.
In other words, the bar was already set pretty low, and Tesla still missed the mark. The big question was how these misses were going to affect the broader financial picture.
The EV space has become increasingly crowded, with new entrants such as Rivian, Polestar, and Lucid. In China, which is one of Tesla's biggest markets, the company faces fierce competition from the likes of Nio and BYD. As a result, Tesla has resorted to aggressive price cutting strategies, a move that has no doubt weighed on the company's margin and cash flow. The table below illustrates several important financial metrics for Tesla per its most recent earnings report.
| ($ in millions) | Q3 2023 | Q3 2022 | Change |
|---|---|---|---|
| Total revenue | $23,350 | $21,454 | 9% |
| Automotive revenue | $19,625 | $18,692 | 5% |
| Operating expenses | $2,414 | $1,694 | 43% |
| Capital expenditures | ($2,460) | ($1,803) | 36% |
| Free cash flow | $848 | $3,297 | (74%) |
| Cash, cash equivalents, and investments | $26,077 | $21,107 | 24% |
| Gross profit margin | 17.9% | 25.1% | (7.2%) |
| Operating margin | 7.6% | 17.2% | (9.6%) |
| Adjusted EBITDA margin | 16.1% | 23.2% | (7.1%) |
Source: Q3 investor presentation. EBITDA = earnings before interest, taxes, depreciation, and amortization.
To put it bluntly, this financial profile is not good. Operating expenses and capital expenditures are rising at a much faster pace than revenue, resulting in significant margin deterioration and less free cash flow. While positive free cash flow is a good sign, the primary reason Tesla's cash balance increased so much during the quarter is due to the company drawing on debt facilities.
On the revenue side of the equation, investors should take into account the macroeconomic environment and how it can affect a business like Tesla. The Federal Reserve has been raising interest rates for over a year in an effort to curb inflation. As a result, mortgage rates are rising, as are loan rates for cars and even solar energy products. Since Tesla's primary end markets are cars and solar panels, the company is facing an uphill battle regarding consumer sentiment.
Concerning expenses, Musk spoke at length during Tesla's Q3 earnings call as to what drove the rise in capital expenditures and operating costs. The increases were primarily attributed to the company's ongoing artificial intelligence (AI) pursuits, including self-driving capabilities. Management made it very clear that research and development costs and capital expenditures will continue to rise in the near term as a result of the company's AI roadmap.
Given this outlook, investors might be wondering what good news (if any) Tesla had to report.
Image source: Getty Images.
Are there any bright spots for Tesla?
One of the more interesting highlights from the earnings call was getting an update about the long-awaited Tesla Cybertruck. Management said that Cybertruck deliveries should begin next month.
While this new vehicle presents a meaningful opportunity to acquire market share in the pickup truck market, which is currently dominated by legacy automakers such as Ford, Musk tempered expectations when he stated it could take "a year to 18 months before it is a significant positive cash flow contributor." In other words, investors should continue expecting costs to rise as production ramps up.
Allowing costs to rise while revenue growth stalls may appear convoluted, if not alarming. But remember, Musk and his team didn't build Tesla overnight. The company spent several years investing billions of dollars building factories all over the globe and working relentlessly to find ways to lower production costs and reach consistent profitability.
While any payoffs from AI are years away, a contrarian may point out that Tesla is still investing in growth and innovation during an otherwise cloudy economic period. In other words, Tesla can actually afford its price reductions and still have cash left over to fund its roadmap. Meanwhile, the company is making massive leaps forward in disrupting a new market -- namely pickup trucks.
Should you buy the dip in Tesla?
Since reporting Q3 earnings on Oct. 18, Tesla stock is down over 16%. The delivery miss had a significant effect on Tesla's financial profile, and the prospects of rising costs in the near term likely didn't sit well with some investors.
TSLA Price to Free Cash Flow data by YCharts
As of this writing, Tesla stock is up over 70% in 2023. And that's after the recent sell-off. Moreover, since the stock started to crater, it now trades almost 30% below its highs earlier this year from a price-to-free cash flow standpoint.
Overall, I view Tesla's Q3 as a mixed bag. On one hand, it looks like the financial profile is getting worse. However, further analysis may suggest otherwise. While I believe the company will continue to face its share of challenges, it's important to keep in mind that every vehicle manufacturer is virtually in the same boat.
What sets Tesla apart is its steadfast product vision, ranging from new vehicles to AI, and its strong liquidity profile. For these reasons, I think now is a fantastic time to buy the dip. At current trading levels, investors have a rare opportunity to lower their cost basis in this growth stock.
