TOYOF - Tesla: Back To The Future

2023-07-05 13:08:38 ET

Summary

• Tesla, Inc. is expected to encounter unprecedented competition during 2025/2026.
• However, armed by revamped current models, the Cybertruck, and two new models, Tesla will be tough to unseat.
• Profit margins are bound to rebound as economies of scale materialize on dramatically higher production volumes.
• Based on our 10-year discounted cash flow analysis, we arrive at an updated Price Target of $492/share. Reiterate Buy Rating on Tesla stock.

Investment Thesis

The rate of growth of the Electric Vehicle ((EV)) industry has accelerated significantly over recent quarters. The Environmental Protection Agency ((EPA)) has outlined a mandate that by 2032, EVs are likely to represent between 64% and 67% of the automobile industry. Large automobile manufacturers are shifting majority fractions of their capital expenditures to their EV businesses. EV production figures for the next two to three years have been announced.

Based on the expected contribution of large automobile companies to these numbers, it appears that unprecedented competition is in the cards for Tesla, Inc. (TSLA). Nevertheless, we expect the firm's first mover advantage will continue to deliver, ensuring that demand for its cars exceeds supply. We will lay out the factors driving our conviction below. However, first our opinion on the number of Teslas delivered during 2Q23 and the financial results for the period, scheduled to be reported on July 19, after market close.

Bolstered by substantial discounts on prices of Teslas compared to the prior year, deliveries increased 46% on a year-over-year basis and 11% compared to the previous quarter, to 466,000 vehicles. Given the challenging macroeconomic situation, and that higher interest rates are driving up the ultimate cost of purchasing a Tesla, the considerable growth in the number of vehicles delivered over the prior year is encouraging. Considering TSLA's ability to maneuver demand despite tightening fiscal conditions, it appears that the company is well positioned to sell the 1.8 million Teslas it expects to manufacture this year.

With respect to the 2Q23 financial results ( expected July 19 post-market), based on the dramatic uptrend in deliveries achieved over the period, we expect revenues to exceed consensus projections of $24 billion, reflecting a significant increase in the metric on a year-over-year basis, despite the price cuts that unfolded beginning in January. We expect a similar beat on the bottom line analyst estimate of $0.79/share, driven by operating leverage. Nevertheless, hamstrung by the price cuts, profit margins are likely to contract on a year-over-basis. However, based on some offset due to lower commodity costs, and operating efficiencies related to the ramp in production at the Berlin and Shanghai plants, that are associated with lower cost of manufacturing, on a sequential basis profit margins might advance. Net-net, total income is likely to improve compared to the first quarter, but come in short relative to the same period last year.

Coming to our assessment of TSLA's solid prospects over the next two to three years: we expect the company to produce 6 million cars during 2026, supported by revamped Model Ys and Model 3s, ramp of the Cybertruck, as well as significant roll-out of the two new models anticipated for launch, including the relatively lower priced Model 2. Given that TSLA's current production capacity stands at 2 million, we anticipate the additional 4 million vehicles will be derived from the Mexico facility (expected to produce two million cars/year) and two additional plants, we expect to be introduced shortly, given Elon Musk's recent frenetic activity scouting optimal production sites, including locations in France, Korea, and Indonesia.

In addition, although scarcity of lithium supplies for battery production could limit the roll-out of Teslas, TSLA has debuted a lithium refinery in Texas, which will produce sufficient supplies of the ore to power one million vehicles/year, by 2025. Further, the firm's primary lithium supplier is escalating production, and will provide TSLA enough supplies to produce an incremental two million cars/year.

In the context of demand, considering our projection that 6 million Teslas will be manufactured in 2026, that Toyota Motors (TM) and Ford ( F ) plan to deliver 1.6 million and 2 million EVs during the period, and General Motors ( GM ) has promised 1 million EVs over 2025, it appears that EV supply is positioned to advance substantially during the time horizon. Nevertheless, given that 13.75 million cars were delivered in the U.S. during 2022, with a peak figure of 17.5 million vehicles sold over 2016, and considering that administrations across the world are mandating EV adoption, we do not expect a supply surplus over the period. Instead, we anticipate that demand will exceed supply, with reservations remaining strong, supported by a potentially rebounding global economy.

In regard to competition, it is noteworthy that F's EV activity is largely focused on pickup trucks and commercial vehicles. Indeed, 600,000 of the 2 million EVs F expects to roll out in 2026 will be fleet vehicles. GM is similarly prioritizing EVs in niche categories, including pickup trucks. TSLA's Cybertruck being prepared for debut in late September, with a current wait list of 1.5 million vehicles, is bound to capture some fraction of pickup truck market share from the incumbents. Plans are to roll out 375,000 Cybertrucks/year. Therefore, we do not view F and GM as formidable competitors for TSLA over the next several years.

Toyota Motors is another matter. With the firm's increasing focus on EVs, and announcements regarding optimizing production facilities, and securing battery resources, as well as its ability to reduce costs through lean manufacturing and design innovation, TM could represent the first genuine competition for TSLA. However, TSLA is a dynamic company, cognizant of the developing competition, and will implement strategies to safeguard its interest, supported by the potential launch of its Model 2 economy EV, expected to be priced at <$25,000 (<$20,000 with subsidies), production of which is scheduled to begin next Summer at the Mexico facility. In our opinion, BYD Company Limited ( BYDDY ) is likely to remain a regional player, dominant in China, with reasonable EV market share in less affluent geographies of the world.

With respect to profitability, 1Q23 profit margins declined 22% to 13%. TSLA generated significantly lower profits delivering a substantially larger number of cars. Nevertheless, we believe that discounting is the right strategy, when demand is tightening, particularly due to macroeconomic challenges. As sales volumes increase, at one point the cost savings from economies of scale, will absorb the shortfall associated with lower prices, and profit margins will begin to recover. We expect the scenario to unfold over the next two to three years, as Tesla deliveries advance dramatically.

Net-net, we are encouraged by the strategies TSLA is implementing to maintain its dominance of the industry, expanding production, creating demand, and countering competition. We are shifting to a 10-year Discounted Cash Flow model from our prior 10-year market multiples model, to value shares of TSLA. Based on the switch, we arrive at a Price Target of $492/share for TSLA. Our valuation model incorporates an annualized revenue growth rate of 50%, a profit margin of 10%, operating cash flow margin of 18%, yearly capital expenditures of 2%, average cost of capital of 7%, and a perpetual growth rate of 3%. Reiterate Buy Rating.

Bottom Line

Competition is a predominant reality of every successful industry and Tesla, Inc. will sooner or later be subject to the element in full force. However, the scenario is unlikely to unfold over the next several years, providing the company precious time to further establish its first mover advantage, as the pioneer of the global EV industry. As the EV market matures, TSLA should continue to dominate, followed by a handful of large automobile manufacturers, and some fragmented competition. We believe that, in its leadership role, Tesla, Inc. will capture a majority of the profits associated with the global conversion to EVs, leading to a monumental increase in its market value. Buy, Buy, Buy.

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