Shares of Tesla Motors (NASDAQ:TSLA) took a hit this past week after a top Wall Street analyst downgraded the stock -- while insisting that the bullish case for Tesla shares won't hold up.
Bank of America Merrill Lynch auto analyst John Lovallo pulled no punches in his note about Tesla, saying that the "optimistic thesis" for Tesla has been "largely debunked" and cutting his price target for Tesla shares to $65.
Tesla trades at a little over $200 right now. Is a huge collapse coming -- or is Lovallo's argument off-base?
Is Tesla having production trouble -- or demand trouble?
For Lovallo -- and really, for all Tesla investors -- the question is one of supply and demand.
Here's the question in a nutshell. Tesla didn't deliver as many cars as expected in 2014. Tesla CEO Elon Musk has said that the problem is one of supply: Tesla hasn't been able to build enough cars to keep up with demand, which he consistently characterizes as very strong.
That's a really important assertion, because the investment case for Tesla shares relies heavily on the idea that demand for Tesla's cars will continue to be very strong.
As the bulls see it, Tesla's sales will rise as the company continues to ramp up its production ability, which it is doing gradually (because it takes a great deal of money). Musk said recently that the company's 2015 production should rise to 55,000 cars, up from 35,000 or so last year. And he has repeatedly said that the company is targeting sales of 500,000 cars a year by 2020.
Lovallo isn't buying it.
How Tesla might be making weak demand look strong
In his note, Lovallo says that ""[W]e now know Tesla is producing at levels that are both well below past run-rates and the company's current installed capacity. In other words, Tesla appears to be pulling back on production, which we believe could create the appearance of rising demand." (Emphasis added.)
How does Tesla "create the appearance of rising demand"? By creating longer wait times for its cars.
Tesla has never given investors much information about its sales or demand. It used to give an update on "reservations" -- orders -- every three months, but it has discontinued that practice.
But it does give investors (and everyone else) one possibly useful metric: wait times.
Tesla sells its cars through a network of factory stores, but customers can also order their cars online if they wish. The "Design Studio" page on Tesla's website allows those customers to select the model and options they want -- and it gives estimated delivery times for each of the three Model S variants.
Right now, Tesla's website says that a mainstream 60 kWh or 85 kWh model ordered today will be delivered in May. (The high-performance P85D model, which starts at just under $106,000, comes with priority delivery: Order one today and it'll arrive in late March.)
A three-month wait certainly sounds like Tesla has plenty of orders. But Lovallo thinks Tesla is gaming that metric by producing fewer cars than it could be.
Tesla could settle this dispute by opening up
Absent hard evidence that Tesla is misleading investors, we should give the company the benefit of the doubt. But it's worth noting that there are some soft spots in Tesla's case.
Lovallo asked an interesting question during Tesla's fourth-quarter earnings conference call earlier this month. Given that Tesla's cash burn is "pretty aggressive," he asked, if demand is as strong as Tesla claims, why not raise prices?
Musk answered by saying that he thought the Model S was expensive enough:
It's really not a cheap car. For a huge number of our customers, it's the most expensive car that they have ever bought, and they didn't think they would ever buy a car that costs $100,000. So I'm reluctant to raise that price as we start running into fundamental affordability limits.
Musk went on to say that he expected Tesla's cash flow to improve by the end of the year, and CFO Deepak Ahuja noted that Tesla's spending is high right now because it's ramping up to launch the new Model X SUV in the third quarter.
But it's not unreasonable for Lovallo to have taken that answer as one more bit of evidence that Tesla's demand isn't as robust as the company would like us to believe.
Tesla could address this concern quickly by giving investors more specifics about its flow of orders. The company thinks it has good reasons for keeping that information to itself, of course. But as long as it does, Tesla's skeptics will continue to have grist for allegations like these.