Is Tesla out of juice?
The high expectations embedded in elevated valuations leave little room for anything to go less than perfectly.
Mentioned: Tesla Inc (TSLA)
Telsa (NAS: TSLA) is having a rough run. On April 5, Tesla shares fell as much as 6% during the day on a Reuters article stating Tesla will cancel its plans to build an affordable vehicle, instead using the same small vehicle platform to build robotaxis.
On Tesla's prior earnings call, management said it aimed for the affordable vehicle to enter production by the end of 2025 and hailed the vehicle as the driver of the next phase of growth for Tesla. Less than an hour after the article was published, Tesla CEO Elon Musk disputed Reuters' claim in a post on the social media platform X, formerly known as Twitter.
After Musk's post, Tesla shares rallied and were down just over 3% at the time of writing.
This follows an announcement that quarterly year-on-year deliveries fell for the first time since 2020.
The shares are down more than 33% year to date. In November 2021 Tesla shares reached an all-time high topping $400. The shares traded at a forward price to earnings ratio (“P/E”) of 98 which was roughly 80% over the fair value estimated by our analyst.
We also took a sceptical view of the company on an episode of our podcast Investing Compass shortly after the all-time high.
Tesla’s strategy
Tesla is one of the largest battery electric vehicle automakers in the world. In less than a decade, the company went from a startup to a globally recognized luxury automaker with its Model S and Model X vehicles.
The company competes in the entry-level luxury car and midsize crossover sport utility vehicle markets with its Model 3 and Model Y vehicles. Tesla also sells a light truck—the Cybertruck, and a semi truck. The company plans to launch an affordable SUV and luxury sports car in the future.
Tesla aims to retain its market leader status as EVs grow from a niche market to reaching mass consumer adoption. We forecast EVs will reach 40% of global auto sales by 2030. To meet growing demand, Tesla opened two new factories in 2022, which increased its production capacity. Tesla also invests around 4% of its sales in research and development, focusing on improving its market-leading technology and reducing its manufacturing costs.
For EVs to see mass adoption, they need to reach cost and function parity with internal combustion engines. To reduce costs, Tesla focuses on automation and efficiency in its manufacturing process, such as reducing the total number of parts that need to be assembled in a vehicle. The company also began designing its own batteries. Tesla's goal is to reduce costs by over 50%.
To reach functional parity, EVs will need to have adequate range, reduced charging times, and availability of charging infrastructure. Tesla’s extended-range EVs are already at range parity with ICE vehicles. The firm also continues to expand its supercharging network, which consists of fast chargers built along highways and in cities throughout the U.S., EU, and China. The range and supercharger network help eliminate road trip anxiety, or the functional barrier to mass market EV adoption.
Tesla is also attempting to take a larger share of its customers’ auto-related spending, which includes selling insurance and offering paid services such as autonomous driving software.
It also sells solar panels and batteries used for energy storage to consumers and utilities. As the solar generation and battery storage market expands, Tesla is well positioned to grow accordingly.
Business risk
We assign Tesla a Very High Morningstar Uncertainty Rating as we see a wide range of potential outcomes for the company. Read more about how to evaluate business risk in a company.
The automotive market is highly cyclical and subject to sharp demand declines based on economic conditions. As the EV market leader, Tesla is subject to growing competition from traditional automakers and new entrants. As new lower-priced EVs enter the market, Tesla may be forced to continue to cut prices, reducing the firm's industry-leading profits. With more EV choices, consumers may view Tesla less favorably.
The firm is investing heavily in capacity expansions that carry the risk of delays and cost overruns. The company is also investing in R&D in an attempt to maintain its technological advantage and generate software-based revenue with no guarantee these investments will bear fruit. Tesla’s CEO owns a little less than 15% of the company's stock and uses it as collateral for personal loans, which raises the risk of a large sale to repay debt.
Tesla faces environmental, social, and governance risks. As an automaker, Tesla is subject to potential product defects that could result in recalls, including its autonomous driving software. We see a moderate impact should this occur. Another risk involves employee retention. If Tesla is unable to retain key employees, such as CEO Elon Musk, its favorable brand image could decline. Should the company not be able to retain production line employees, it could see delays. We see a low probability but moderate materiality for both risks.
Additional ESG risks include potential patent litigation as the company relies on new technology to improve its EVs and energy storage systems. We see a low probability, but moderate materiality should this occur. Tesla may also face regulatory issues in some U.S. states due to laws that require automakers and dealers to be separate. We see a moderate probability but low materiality.
Are the shares cheap after the drop?
Our fair value estimate is $195 per share. In 2024, we forecast Tesla's deliveries will be roughly flat versus 1.8 million in 2023. We forecast lower average selling prices as Tesla will likely have to cut prices in key markets, such as China, in line with peers. We forecast automotive gross margins will be 18% in 2024, in line with 2023 results.
Longer-term, we assume Tesla delivers a little over 5 million vehicles per year in 2030. This includes fleet sales, an expanding opportunity for Tesla. Our forecast is well below management’s aspirational goal of selling 20 million vehicles by the end of this decade. However, it is nearly 3 times the 1.8 million vehicles delivered in 2023.
Our forecast assumes Tesla slightly grows its Model 3 and Model Y deliveries and ramps up volumes of the light truck, named the Cybertruck, to around 100,000 deliveries per year, far below management's goal of 250,000.
We forecast Tesla will launch its affordable SUV with initial deliveries coming in late 2025, and a ramp up in 2026 at a pace similar to the Model 3 ramp up in 2018, the first full year the vehicle was sold. We think deliveries of the affordable SUV will exceed those of the Model Y and Model 3 as the lower price point of this vehicle should attract a larger consumer base.
We think Tesla will be successful in continuing to reduce its manufacturing costs on a per vehicle basis. We forecast segment gross margins will recover to the mid-20% range by the end of the decade, well above the 19% level generated in 2023, but below the 29% margin achieved in 2022.
Addtionally, we assume revenue growth and margin expansion from autonomous software sold on a subscription basis. We also assume the successful growth of the insurance business and increased profits from the charging business result in long-term profit growth and margin expansion in the services and other segment.
In energy generation and storage, we assume the business averages over a 20% annual growth rate during our 10-year forecast, primarily driven by accelerating demand for energy storage systems.
While we forecast ESS prices to decline, the fall will largely be driven by cheaper battery costs, which should not affect profitability. As volume grows, unit costs should fall. Combined with recurring revenue from long-term power purchase agreements and AI trading software, we expect the business will turn profitable and generate gross margins in line with peers such as Enphase and SolarEdge.
Additionally, we assume Tesla's overhead expenses continue to decline as a percentage of sales as the company benefits from operating leverage as deliveries grow. As a result, we forecast companywide operating margins will return to the midteens levels by the end of the decade in line with the 17% achieved in 2022, and well above the 9% margin in 2023.
To fund this growth, we assume Tesla will need to spend over $100 billion in capital expenditures over the next decade. Our base case also adds the present value of Tesla’s autonomous vehicle ride-hailing (robotaxi) business, which accounts for roughly 7% of our total valuation. This figure assumes Tesla captures a 2.5% market share across the combined markets of the U.S., EU, and China and charges $0.75 per mile. Finally, we add the present value of Dojo's AI training services and the present value of humanoid robot sales, which accounts for less than 1% of our total valuation combined.
Given the wide range of outcomes for Tesla, we also model additional scenarios. Our downside scenario fair value estimate is $90 per share. In a downside scenario, we assume Tesla delivers under 4 million vehicles in 2030. We also assume cost reductions do not materialize as planned and Tesla is forced to cut prices amid increasing competition. This keeps gross profit in the high teens to low-20% range, in line with the 19% generated in 2023. We also assume Tesla gets no benefit from autonomous driving software and sees slower growth in the insurance business. Finally, in this scenario, we assign no value to the company's ancillary business including robotaxi, Dojo's AI training services, and humanoid robots.
Our upside scenario fair value estimate is $400 per share. In an upside scenario, we assume Tesla delivers over 9 million vehicles per year by 2030 and the company further benefits from cost reductions in excess of our base-case forecast. We also assume greater adoption of autonomous driving software and faster growth in the insurance business.