One analyst thinks there is 39% upside to Tesla (TSLA 0.86%) stock within the next 12 months. Jefferies analyst Dan Dolev said in a note to clients this week that he is maintaining his buy rating, as well as raising his 12-month price target for Tesla stock from $360 to $365. His increased confidence in the electric-car maker is based on an in-depth analysis of expected battery pack costs. Is there merit to his bullish outlook for the company?
Model 3: More profitable than investors are expecting?
Anyone following Tesla closely knows that the stock's current valuation ultimately hinges on successful execution and market demand for the company's planned lower-cost Model 3. Aiming for a starting price of $35,000, the smaller sedan will cost half the price of Tesla's Model S. With the battery pack alone currently accounting for roughly 20% of the average selling price of the company's pricey sedan, these costs will need to come down for the company to profitably sell Model 3.
Dolev thinks Tesla is on a path to a 50%-plus reduction to battery pack costs by 2020, a savings he says will drive a 1,000-basis-point vehicle gross margin tailwind for the company. This would place Tesla "at the upper-end of peer [original equipment manufacturer] profitability levels," he notes.
Three catalysts, in particular, will drive Tesla's total battery pack costs down, Dolev argues:
1. Key advantages in Tesla batteries
We believe that Tesla's use of an efficient nickel cobalt aluminum (NCA) cathode (i.e. the positive electrode), use of a silicon synthetic graphene anode (i.e. the negative electrode) that has 2-6x the lithium-ion storage capacity of today's standard graphite anode, and a possible use of water-based anode solvent, are key advantages.
2. Changes in cell chemistry
There is a "potential path to a 30% cell-level cost reduction" by 2020, according to Dolev. How could Tesla get to this point?
[B]y using a more efficient lithium-rich nickel cobalt manganese cathode (vs. NCA), doubling the percentage of silicon in the synthetic graphene anode, replacing the liquid electrolyte with an ionic gel electrolyte which eliminates the need for a separator, and using a water-based electrode solvent for the cathode.
3. Declining costs for Tesla battery packs
The biggest savings in Tesla's total battery cost, Dolev believes, will come from a reduction in pack-level costs. Pack-level costs can be reduced by 70% by 2020 "via economies of scale, supply chain optimization, increased automation, and production domestication," he predicts.
Between these estimated cell- and pack-level savings, total battery cost reduction would be about 50% by 2020, Dolev believes. He predicts this would give Tesla's Model 3 a gross margin of about 23% while achieving a 33% gross profit margin for the Model S and Model X.
Is an estimated 50% cost reduction to battery costs too aggressive? Probably not to CEO Elon Musk.
Tesla's often-cited target of 30% cost reductions to Tesla's total battery pack cost per kWh is usually misused. This is not the ultimate end goal for the cost reductions Tesla is seeking from transitioning cell- and pack-level manufacturing to its Gigafactory. It's the bare minimum. Indeed, from the very first time Tesla shared its plans for the Gigafactory, the company clearly noted it believed total pack costs would be reduced by more than 30%.
But could Tesla management internally truly be aiming for a 50% cost reduction to battery costs by 2020? After all, this is a significant improvement from 30% savings.
Dolev's projections seem about in line with the path to further savings that Tesla management has laid out. For instance, a 50% cost reduction to Tesla's cost per kilowatt-hour would put Tesla around $125 per kWh, which is still $25 above the company's target of $100 per kilowatt-hour within the next nine years.
Recall this conversation between Musk and Deutsche Bank analyst Rod Lache during an earnings call about a year ago:
Musk: I'd be disappointed if it took us 10 years to get to $100 a kilowatt-hour pack.
Lache: So, basically you're saying that, you know, within the next -- within that time frame you would expect electric vehicles to reach cost parity and maybe even improve upon the cost of an internal combustion vehicle?
Lache: Uh-huh. That's interesting.
Musk: Seems pretty obvious to me.
Tesla's battery guru and Chief Technical Officer JB Straubel added:
Well, we're tracking things that have a whole range of different horizons for implementation. But to get to -- to realize the Gigafactory and those cost targets, we don't need some fundamental breakthrough in chemistry and material science. That -- those things are pretty well understood in front of us.
So, Tesla management does, indeed, seem to be thinking along the same lines as Dolev as far as the potential to reduce total battery costs in the long term. Sure, the means by which Tesla could be aiming to reach these sorts of savings could be totally different -- especially in regard to cell chemistry. But Dolev's prediction seems mostly aligned with Tesla's vision for declining battery costs.
As far as Dolev's 12-month stock price, investors should keep in mind the risk in Tesla's very forward-looking valuation. With meaningful returns from Tesla's roughly $260 stock price today highly dependent on excellent execution on a range of future expansion targets, investors should consider risks carefully before buying shares.