Electric-car maker Tesla Motors' (TSLA -1.36%) ambitions are huge. But the problem for many investors interested in the stock is that the market has basically priced in Tesla's success in achieving these wildly large goals. High expectations have driven Tesla's market capitalization to an impressive $33.5 billion -- about half of Ford's market cap of $58.3 billion.
Deutsche Bank analyst Rod Lache, who is bullish on Tesla's business, highlighted this dilemma in a note to investors (via Barron's) today. After reminding the Street that Tesla's valuation could be getting ahead of itself, shares pulled back as much as 7% today as the market seemed to admit shares have become overpriced.
The business is great, but is the stock getting too hot?
Confessing he believes Tesla's business has an impressive runway ahead of it, Lache warned, "Tesla's shares appear to already reflect this opportunity."
Tesla CEO Elon Musk's vision for Tesla is, indeed, somewhat mind-boggling. Not only does Musk believe it's likely that sales of its Model S, which is already the best-selling vehicle in the high-end luxury sedan segment in North America, will continue to grow at about 50% annually for several years, but Musk is also betting its Model X SUV will achieve similar success. And looking out a bit further, Tesla is aiming to deliver 500,000 cars per year by 2020 with the help of its planned lower-cost Model 3. Annual deliveries at this level by 2020 would mark a sharp increase from management expectations for just 55,000 deliveries this year.
And Musk's vision doesn't stop at vehicles. The company wants to help catalyze a shift to clean energy by aiding solar power systems with Tesla energy storage solutions. Lache is particularly bullish about this recent addition to Tesla's business model.
Investors have been relatively optimistic on the market opportunity in Stationary Storage: This market is in its infancy, making it very difficult to forecast how large this will be. Nonetheless, following discussions with industry experts we've concluded that: 1) Growth will be very substantial. (TAM may be >$3.0 bn/year in the U.S. alone by 2020); 2) We believe that the global market will likely be at least 2x this level; 3) Tesla's unrivalled scale, combined with excellent technical capability, positions them to be a dominant force in this market; 4) Assuming 50% share and a 15% operating margin, this would add around $2.20 to Tesla EPS...
With an additional $20 per share expected to come from Tesla's auto business, Lache believes Tesla's total EPS by 2020 could reach about $22.20. Lache believes these assumptions merit a $280 price target. He arrives at this target based on a price-to-earnings ratio of 20 in year 2020, discounting EPS by 12% annually.
Can Musk follow through on this bold vision? It's possible. But there's significant risk, particularly related to execution. Ramping up production this fast will require substantial investment in manufacturing, sales, service, charging infrastructure and international expansion -- all simultaneously.
Lache points to a number of key upside and downside risks, including "ASPs (i.e. mix of higher end vs. lower end vehicles), the company's ability to achieve expectations for cost reduction, achievement of aggressive ramp-up targets for the company's Gigafactory, currency, growth expectations, and competition."
All things considered, Lache said he couldn't call Tesla stock a buy at these levels. Notably, however, after lowering Tesla stock from a buy to a hold and sparking a subsequent sell-off of Tesla shares, the stock now trades at about 6% of his 12-month price target for the stock, trading around $265 at the time of this writing.
No matter how well Musk has executed on expanding Tesla's business in recent years, and no matter how likely it seems the company's Model X, Model 3, and Tesla energy storage solutions will be, investors should take note of the stock's very forward-looking valuation. While recent excellent execution seems to support the case for holding Tesla stock for the long haul, the company's borderline euphoric valuation makes buying the stock at these levels a risky move.