Analysts Debate: Is Tesla Motors a Top Stock?

The Motley Fool has been making successful stock picks for many years, but we don't always agree on what a great stock looks like. That's what makes us "motley," and it's one of our core values. We can disagree respectfully, as we often do. Investors do better when they share their knowledge.

In that spirit, we three Fools have banded together to find the market's best and worst stocks, which we'll rate on The Motley Fool's CAPS system as outperformers or underperformers. We'll be accountable for every pick based on the sum of our knowledge and the balance of our decisions. Today, we'll be discussing Tesla Motors (TSLA 4.96%), the leading electric vehicle maker.

Tesla Motors by the numbers
Here's a quick snapshot of the company's most important numbers:

Sources: Yahoo! Finance and company earnings release.

Travis' take
Historically, auto companies have been a terrible investment. General Motors went bankrupt a few years ago, so did Chrysler, and even Ford hasn't outperformed the S&P 500 long term.

Source: F Total Return Price data by YCharts.

When you're in a capital-intensive business with union workers it's hard to alter your cost structure when the economy falters or consumer tendencies change. So, I come into any auto debate with a skeptical eye.

What Tesla brings vs. its larger competitors is a whole new look at the auto world. The company is building nothing but electric vehicles, it doesn't have legacy costs to worry about, and it's building its own dealer network. It's also making no qualms about going after the high-end consumer. Instead of trying to build an electric vehicle for the masses, like GM, Honda, and Nissan did, it went after affluent consumers who wanted an electric vehicle with all the perks of a BMW. This year's Motor Trend Car of the Year award validated all of those efforts.

On the financial side, Tesla is seeing some major progress. Revenue for the fourth quarter jumped 500% from the third quarter as production ramped up. Production run rate hit 20,000 annually by the end of the year and the result is an expected profit in the first quarter of this year and will be near breakeven on operational cash flow.  

The future is even brighter given the company's pipeline. Toyota (TM -3.23%) is buying powertrains for the RAV4 EV and the company is progressing on its Mercedes-Benz B-Class EV program. The Model X, a crossover vehicle, will begin production in late 2013, bringing more scale to Tesla's manufacturing. If sales go as well for the Model X as they did for Model S, it could be very profitable next year.

Projecting Tesla's profits involves a lot of guesswork, but if we assume 40,000 units annually at an average price of $60,000 and the 25% gross margin, Tesla could make a $600 million gross profit by 2014. That's not bad for a company so early in its development and it makes me cringe a little less at the $4.5 billion price tag on the stock.

Visionary companies don't come along often but Tesla has the makings of one. I'll take a chance on this stock and give an outperform call.

Sean's take
I'll hand it to Elon Musk for definitely giving consumers something to talk about. The man is without question a visionary who's comparable to few others. But as an investment, buying Tesla Motors is about as appetizing to me as eating dirt. I have quite a few concerns about the longevity of the business that will definitely keep me on the other side of this trade from Travis.

To begin with, Tesla claims to have 20,000 Model S sedans sold for 2013. That's a fine figure, but doesn't it seem a bit disconcerting, then, that it was supposed to deliver 2,500 Model S sedans in its most recent quarter yet it fell 100 short? That's particularly worrying given that it expects to ramp up to 4,500 deliveries in the first quarter. This speaks to the very thing that got Tesla's Model S in trouble with consumers and investors in the first place: delays, delays, delays. Tesla won't speak of any delays now, but the numbers clearly aren't adding up to the expectations as per the norm. As icing on the cake, its Model X was originally scheduled to begin production in late 2013. That's now been moved back to late 2014... surprise! 

Second, have we all just magically forgotten that Tesla has to begin paying back the U.S. Department of Energy for the $465 million it borrowed under the Advanced Technology Vehicle Manufacturing loan program? Tesla has until the end of the decade to pay off this loan, but just keep in mind that it owes $12 million in interest on this loan, each quarter and beginning in the first quarter of 2013.

Third, do we really expect Tesla's competition to just roll over and die in "you got us" fashion? Travis is spot on that Tesla is hitting an affluent niche of the market that Ford and General Motors ignored when they developed the electric Focus and hybrid Volt. But who's to say that these automakers won't attempt to infiltrate this space? In addition, how does Musk plan to conceptually get beyond its roughly 20,000 unit sales? This is a production figure I'm skeptical it can hit, and its price points leave little room for error with taxes rising on middle- and upper-income earners.

Fourth, there's still little comparison to the massive infrastructure and timelessness associated with gas-powered vehicles. I believe getting Americans to give into the finite driving range and expensive setup needed to power electric vehicles will prove more difficult than Musk thinks.

Finally, there's no substance to its figures. Sure, sales were up 500%, but so was every dot-com in the late 1990s that burned through all of its remaining cash. Tesla's quarterly report delivered a wider-than-expected loss. Period! Until Tesla is cash-flow positive and can get its production line in order, as well as show me what other buyers are going to step up to its premium price range in order to make it profitable, I'm going to suggest we slap a CAPScall of underperform on Tesla.

Alex's take
Tesla is a different sort of automaker, as Travis has pointed out. But how different? One thing to focus on is how much of Tesla's revenue comes from providing technology and development services to larger automakers. Is this going to be a significant part of Tesla's business model going forward? Let's see what percentage of the company's revenue has been derived from services to other automakers so far:

• 2010: 17% ($20 million)
• 2011: 27% ($56 million)
• 2012: 7% ($28 million)

It's likely that this will be a smaller percentage of Tesla's revenue going forward as it builds out production capacity. It also counts some sales to larger automakers as part of its core automotive sales revenue. As Travis mentioned, Toyota is buying powertrains for its electric RAV4 -- this will generate $100 million between 2012 and 2014. Annualized out to about $33 million per year, that's not likely to be a huge driver of revenue either, as it's less than a tenth of total automotive sales revenue in 2012. Ultimately, this company will live or die by its auto sales.

So, about that 25% gross margin...

Source: Morningstar. TTM = trailing 12 months.

Tesla's gross margin certainly could expand -- it was 30% in 2011, so the earnings history supports that projection. However, sales expenses are higher as a percentage of revenue than its large peers, in part due to the scale of those automakers but also undoubtedly because of Tesla's decision to operate its own sales program internally rather than adopt the standard dealer model. Internalizing the cost of sales might help Tesla better control its overall cost structure, but the ultimate benefit of that decision may be found much further in the future than many people expect.

Even if we assume that $600 million in gross profit is attainable in 2014, as Travis projects, there's still the matter of operating expenses, of which sales is a smaller component than research and development. If we assume that both R&D spending (which grew at an annualized rate of 43% from 2010-2012) and sales expenses (which grew at an annualized rate of 21% over the same period) will increase at the same pace through 2014 as they have since 2010, that still results in $780 million in operating expenses in 2014, and thus a net loss for the year in spite of $600 million in gross profit. If these expenses increase half as much per year to 2014 as they have since 2010, then Tesla winds up with about $7 million in operating profit in two years' time, before it has to pay any taxes.

Gross margins do matter. However, they matter less than the money that winds up in the company's bank account after all is said and done. Tesla makes nice cars, and I don't doubt that it will sell everything in its limited production runs. However, that does not seem to be enough, based on Travis' very generous calculation, to do more than merely break even on an operating basis.

I'm going to side with Sean and give Tesla an underperform call, but it's going to be a very cautious one. Since its IPO, Tesla has tracked the S&P 500 very closely, and as of this writing the difference between the automaker and the index is only two percentage points in the S&P's favor. There seems to be more of a risk of decline due to production bottlenecks and consumer backlash than a big pop due to an already-expected rise in sales. However, if Tesla pulls out a big surprise, such as unexpected profitability or some light-years-ahead new battery technology, I would like to quickly revisit this with the intent of avoiding a big short squeeze on our call.

The final call
Alex played the swing vote this time and we'll add an underperform call but will keep it on a short leash. So far, the other 26 picks we've made have beaten the market by 429 points so we hope the streak will continue.