RIVN - Behind Tesla's Master Plan

2023-06-21 12:12:00 ET

Summary

• Tesla, Inc. stock has gone up 50% in the past 30 days.
• Cathie Wood enthusiastically predicted that the Tesla Cybertruck will become as popular as the Model Y.
• Elon Musk staunchly links the triumph of autonomous driving to Tesla's market value.
• We believe that more significant events are taking place covertly.

Savoring the journey

We were one of the believers in Tesla, Inc. (TSLA) and initiated coverage of the company with our report , titled "Eyes On Tesla's Unit Cost And Ads ROI," in June 2019. Since then, the stock has surged by an impressive 1740%. Having reaped a satisfactory profit, we opted to close our position in 2021, unaware of the subsequent surge in 2022. Back then, we held the belief that Tesla had transitioned into a mature phase.

Since then, we have intermittently monitored the stock, with recent volatility piquing our interest.

Irrespective of the audacious visions put forth by figures like Elon Musk or Cathie Wood regarding Tesla, encompassing concepts such as autonomous driving or the Cybertruck, we firmly maintain that investment decisions ought to be rooted in the foundation of robust products.

The Cybertruck is still only a concept at this time, with no real product or customer feedback for investors to consider. Therefore, it can be largely disregarded by investors until it becomes a tangible reality.

When it comes to autonomous driving, we don't believe this business holds significant value at this stage, as consumers do not place a high emphasis on it. According to consumer surveys , people primarily buy Tesla vehicles for reasons other than autonomous driving capabilities. We believe that because human drivers are still necessary, Tesla's Level 2 autonomous features cannot be very valuable.

Consequently, we decided to focus on Tesla's more observable commercial operations, such as its energy and auto businesses, both of which have shown to be productive and in great demand.

Bright Spots In Tesla's Automotive Business

The Chinese market can be larger than we think

In Q1 2023, Tesla sold a total of 267k Model Y vehicles, with 94k units sold in China, surpassing the 83k units sold in the United States and the 71k units sold in Europe. Overall, China has emerged as Tesla's largest market.

Compared to the average income of Chinese citizens, the Model Y is substantially more expensive in China. About 8 to 11 times the typical annual salary of 31,370 RMB is spent on it. Let's make a comparison with the U.S. to better comprehend this. The Model Y costs $47,000 in the U.S., which is roughly 0.68 times the $69,717 median yearly income for Americans. This demonstrates that, despite making up a sizable percentage of their income, Chinese consumers are prepared to spend a lot of money on Tesla vehicles. This indicates that, despite what would initially appear impossible, there are many potential customers in China who can afford Tesla vehicles.

Automotive companies that successfully tap into China's consumer base and its cheap labor force can differentiate themselves in the global market. This strategy can help develop a solid, expandable business model. Therefore, Elon Musk's decision to construct a factory in China, which Tesla wholly controls, is crucial since it may have a significant impact on how the company's auto business develops globally.

According to Reuters , the company will sell China-made Model 3 and Model Y vehicles in Canada. The China-made Model Y is priced at CAD 61,990 (USD 47,000) in Canada. Both of these electric vehicle models are eligible for a subsidy of CAD 5,000 (USD 3,700) in Canada. Unlike the United States, Canada does not tie electric vehicle subsidies to the location of vehicle production. As a result, Tesla will enjoy a cost advantage by leveraging its China factory, surpassing other car companies that lack manufacturing facilities in Canada.

Auto business DCF valuation

In our previous article on Amazon.com, Inc. (AMZN), titled "Amazon: How To Evaluate The High P/E Stock," we enlightened readers about the importance of evaluating a company's worth by the sum of the parts method. We intend to look into Tesla's valuation in the same way, starting with its auto business.

According to Tesla's 2022 financial report , the company's average automotive revenue per vehicle sold was $44,000. Assuming that Tesla can achieve a 10% global market share in the next 10 years and maintain a free cash flow margin of 10% (FY2022 margin), applying a discounted cash flow ("DCF") model suggests that Tesla's market value should be $141.2 billion (or $40.7 per share). This valuation would be 85% lower than the current stock price.

No matter what assumptions you utilize, the stock is expensive based on our sensitivity analysis below.

The short sellers may have some valid for now. This is also the reason we decided to exit our position in 2021.

The Master Plan Spiced Things Up

What caught our attention is Tesla's master plan. Elon Musk unveiled its master plan in 2006 and wrote an article titled:

"The Secret Tesla Motors Master Plan (just between you and me)"

The master plan outlined by Tesla initially focused on high-performance electric sports cars and gradually expanded into the more affordable consumer vehicle market while driving the transition from a mineral-fuel economy to a solar-powered economy. They dedicated their efforts to the development of electric vehicles, introducing more products through technological optimization and cost reduction. Tesla's vehicle batteries are recyclable, and the carbon emissions from electricity generation can be addressed through the use of renewable energy sources.

For investors who are unaware of Tesla's past, the business was formerly known as Tesla Motors. In 2017, the company rebranded from Tesla Motors to Tesla. This name change signaled the company's expansion beyond automobiles into broader energy domains, akin to Apple's (AAPL) approach. In 2007, Apple dropped the "Computer" portion from its name to reflect its new products, including the iPhone and Apple TV.

Tesla officially entered the energy business in 2015. In April of that year, Tesla announced the launch of its energy division, which aimed to develop and sell energy storage products for both residential and commercial use.

In Q1 2023, despite the energy business accounting for only 6.6% of total revenue and 3.8% of total gross profit, it grew at a remarkable rate of 148%. Moreover, its energy storage capacity of the Tesla Megapack is growing at a rate of 360%.

What is a megapack?

In Tesla's 41-page report on Master Plan Part 3 , the company provides the answers.

According to the International Energy Agency (IEA) 2019 World Energy Balances, the global primary energy supply is 165 PWh/ year, and total fossil fuel supply is 134PWh/year. 37% (61PWh) is consumed before making it to the end consumer. This includes the fossil fuel industries' self-consumption during extraction/refining, and transformation losses during electricity generation. Another 27% (44PWh) is lost by inefficient end-uses such as internal combustion engine vehicles and natural gas furnaces. In total, only 36% (59PWh) of the primary energy supply produces useful work or heat for the economy. Analysis from Lawrence Livermore National Lab shows similar levels of inefficiency for the global and US energy supply2,3.

The Tesla Megapack is a large-scale rechargeable lithium-ion battery stationary energy storage product. It is manufactured by Tesla Energy, the clean energy subsidiary of Tesla, Inc.

Utility companies primarily deploy Megapacks to store energy generated by intermittent renewable power sources like solar and wind. This stored energy can then be utilized by the grid during periods of high electricity demand, providing a more stable and reliable power supply.

In 2021, Tesla purchased a former JC Penney's distribution center in Lathrop, California, to establish a new battery plant known as the Megafactory.

Introduced in 2019, each Megapack has the capacity to store up to 3.9 megawatt-hours (MWh) of electricity. Tesla's Megapack costs $1.8 million for a single unit. The factory has an annual production capacity of 10,000 Megapacks, which can generate over $2 billion in sales for Tesla, equivalent to 5,700 Model 3 vehicles.

Compared to traditional storage systems:

Megapack :

• Impressive efficiency: The Megapack demonstrates exceptional round-trip efficiency, operating at 90% or higher. This high efficiency significantly minimizes energy loss during the processes of storing and discharging electricity.
• Swift and efficient installation: When it comes to deployment, the Megapack offers remarkable advantages. A power plant with a capacity of 250 MW and energy storage of 1 GWh can be fully installed in under three months using Megapack technology. This expedited installation process allows for faster implementation of energy storage solutions, providing a reliable and sustainable power source within a short timeframe.
• Optimized land utilization: The Megapack solution optimizes land usage, requiring only three acres of land for a power plant. This footprint is four times smaller compared to traditional fossil fuel plants.
• Seamless integration with solar systems: The Megapack's seamless interaction with solar systems is one of its standout characteristics. By combining solar power generation with the Megapack's energy storage capabilities, integrated renewable energy plants can be built.

Traditional storage systems: Varying efficiencies.

• Pumped hydro storage: High efficiency (70-85%) but needs specific conditions and large-scale infrastructure.
• Natural gas peaker plants: Relatively low efficiency (40-50%).

In conclusion, Megapack offers high efficiency, rapid installation, minimal land usage, seamless solar integration, and outperforms traditional storage systems in terms of efficiency.

Is this the real deal?

According to Electrek , in April 2022, Pacific Gas and Electric Company (PG&E) announced the successful activation of their Tesla Megapack project, which has a storage capacity of 730 MWh. This project is expected to improve the overall reliability of California's energy supply.

Due to increasing market demand, Tesla's Megapack has rapidly gained market share and become increasingly popular. Currently, Megapack is sold out, and there is a considerable waiting period. Tesla is expanding its energy storage production capacity at a rapid pace in its Megafactory located in Lathrop. Additionally, Tesla recently announced the establishment of a new Megafactory in Shanghai.

Amidst inflation's squeeze on consumers' purchasing power, this offers a promising growth driver for Tesla. Following agreement on the debt ceiling plan, the Biden administration moved quickly to authorize a natural gas-related open project. Energy is a topic of interest for governments worldwide, particularly in countries that do not produce their own oil. Even the Chinese government appears ready to increase its spending in this area. Just last week, BloombergNEF significantly raised its forecast for China's solar installations in 2023, expecting the country's solar capacity to nearly triple compared to two years ago, surpassing the total capacity of the United States. Electric vehicles are also taking off in the Chinese market, with over one-third of car sales being electric last month, according to Bloomberg. In our opinion, Elon Musk recently completed a visit to China, and Tesla's Megapack seems to align well with China's current energy storage needs.

How much can the stock go?

If we assume that Tesla's energy business can penetrate 5% of total energy market, it would require approximately 2.1 trillion Megapacks, which would translate to approximately $4.2 trillion in revenue, 14 times the revenue of Tesla's electric vehicle business. The company will need to grow at a CAGR of 49% for the next 10 years.

If we assume a free cash flow margin of 12.5% for the energy business, and apply a DCF model, along with the previous valuation of Tesla's automotive business at $141.2 billion, the combined market value of Tesla (automotive + energy) should be $1.01 trillion ($291 per share). This would represent a 30% premium over the current stock price.

Please note that current major utilities players have EBIT margins in the range of high teens. Hence, our assumption of 12.5% margin can be conservative.

If we go by Musk's own assumptions that Tesla's energy business can reach 240 TWh, which is about 15% penetration to the energy market, then Tesla will grow to a 13 trillion revenue company at CAGR of 66%, the stock price should reach $924 per share.

Compared to the upcoming Cybertruck or the exciting autonomous driving technology, we believe that the energy business holds higher feasibility and greater market potential.

Does the energy business have a moat?

1. First mover advantage

Tesla remains at the forefront, consistently enhancing its technology. The newest Megapack configurator boasts a 3.9 MWh capacity, representing a remarkable 50% increase in energy storage compared to its previous version.

2. Integrated solution

Tesla not only offers the Megapack energy storage system but also provides complementary solar panels and charging infrastructure. Their comprehensive solution caters to customers' demand for renewable energy while delivering a sustainable energy supply.

In addition, electric vehicle manufacturer Rivian ( RIVN ) announced on Tuesday that it has reached an agreement to utilize Tesla's charging standard, enabling its customers to access the extensive Tesla Supercharger network. General Motors (GM) and Ford Motor Company (F) also decided to collaborate with Tesla on an electric charging partnership. Further, Blink Charging (BLNK) and ChargePoint Holdings (CHPT) are to launch EV chargers with Tesla's charging connector. We believe that this will help solidify Tesla's competitive advantage in the Megapack business by establishing a certain level of moat.

China's solar and other energy companies have the potential to compete globally in the energy business with the support of subsidies from the Chinese government. Therefore, the alliances and agreements formed by Tesla with other automakers and charging companies will strengthen its position in setting energy standards.

Summary

Considering Tesla's valuation is built on its vast energy business, we maintain an optimistic but cautious attitude. The recent announcement of partnerships with automobile companies and charging stations marks the initial steps towards Tesla's establishment of a competitive advantage in the energy sector.

We believe that the focus of market attention will be on the establishment of its energy business and the construction of a renewable energy ecosystem. The energy density of the Megapack and the growth rate of the energy business are key factors to monitor, as they can influence both the profitability of the energy sector and the market penetration of the business. These can have a great impact on the valuation, per our sensitivity analysis.

While there are geopolitical risks at the moment, we believe Tesla's energy proposition aligns with the interests of the majority of mainstream countries globally. In the short term, there may be a risk of Tesla stock pulling back. We think it is worth buying the pullback. We give Tesla, Inc. stock a "buy" rating.

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