Ask any market analyst and they will tell you the auto business is a tough business for investors. They'll say energy is a tough business, too. While both are tough, they also happen to be businesses Tesla (TSLA -1.11%) competes in. Given Tesla stock's wild success, the company must have been doing something right these past few years.
Still, the market is largely about what a company is going to do in the future, and Tesla's operations are starting to show strain as it manages a dramatic increase in capacity and takes on improved competition globally. Making 100,000 electric vehicles (EVs) at a high margin is one thing in the auto sector, but making millions of vehicles at high margins is something completely different, as Tesla is finding out.
Margins aren't what investors hoped for
Enthusiasm for Tesla stock comes, in part, from its reputation as a high-margin automaker, but that narrative has fallen apart in the last two years. Structural undersupply during the height of the pandemic gave Tesla an excuse to raise prices for vehicles in high demand. Now in late 2023, the company has seen demand ease and competition increase and it's cutting prices to move what is now a growing supply of vehicles. These adjustments led to a sharp decrease in margins that continues today.
TSLA Gross Profit Margin (Quarterly) data by YCharts
Operating margins have become downright pedestrian and if the trajectory continues we may eventually see margins fall below both Ford Motor Company (F -1.92%) and General Motors (GM 0.48%).
TSLA Operating Margin (Quarterly) data by YCharts
Despite falling margins, Tesla continues to increase supply and will introduce the Cybertruck soon, adding more capacity to the market. I don't see how this will help margins, especially as competition gets stronger.
Tesla's Chinese competitors are serious
U.S. EV competition is behind the curve, but Chinese competition is something Tesla investors might want to start worrying about. BYD (BYDDY 4.08%) may end up being the best-selling EV maker globally in 2023 while Nio, Xpeng, and others are growing capacity and lowering prices around the world.
Tesla made a big bet by building a factory in Shanghai but that's now becoming a challenging place to operate because Chinese buyers are moving to domestic brands and Tesla is losing market share in Europe, South America, and Asia to Chinese competitors flooding the market. Innovators don't stay ahead for long in the auto business and Tesla is finding that out now.
Tesla's FSD isn't full self-driving
Tesla CEO Elon Musk talks a lot about autonomous driving, also called full self-driving (FSD), but the reality is that all of Tesla's autonomous driving features are Level 2 autonomy, which means the driver is responsible and ultimately in control. Tesla isn't even testing Level 3 or higher, as far as the public knows.
Meanwhile, GM's Cruise and Alphabet's Waymo have logged millions of miles with no driver in the car, which is Level 4 autonomy. Mercedes-Benz has even introduced Level 3 autonomy in some of its vehicles.
Until Tesla begins testing Level 3 or higher autonomous driving we can assume it will always be 1 year away, just like he's been promising since 2016.
Valuation is a problem for Tesla
None of this would be a problem if Tesla were valued like most auto companies are today. But it's not. Depending on the metric you look at, Tesla stock trades for between a 5x to 30x premium to its competitors. That's a lot of high-margin growth priced into shares at today's price.
TSLA PE Ratio data by YCharts
Tesla has already hinted that it's slowing growth expectations, recently pulling back on investment in Mexico and saying the 50% long-term growth rate is unattainable. So, what are Tesla investors paying a premium for right now?
Manufacturing is a tough business
There's a reason automakers have not historically been very profitable. It's also becoming clear that Tesla hasn't fundamentally changed the supply/demand dynamics that led to weakening profits.
Some investors may point to autonomous software as the differentiator going forward, but I simply don't see that being a reality if Level 3 autonomy isn't even being tested seven years after Musk first promised that full autonomy was just around the corner.
Tesla's foray into the energy business is a nice addition, but again we are talking about a commodity business where Tesla doesn't have any real differentiation. Its efforts there are not deserving of multiples 10x or more higher than peers.
Tesla is a great company that has disrupted how a lot of the world makes and thinks about cars. But it's not all that great of a stock going forward and that's why I don't think it's a good buy at its current valuation.
