VWAPY - Tesla Needs To Do More Than Just Be The Best To Justify Current Valuation

2023-10-06 11:56:45 ET

Summary

• Tesla, Inc.'s current share price not only implies that it is not on track to become the largest manufacturer, but become around twice as large and thrice as profitable as Toyota.
• Even in an unrealistically bullish scenario, the company would not be cheap today based on 2030 earnings.
• Growing competition, potential political headwinds, and Tesla's history of overpromising are factors that cause me to doubt that it will be able to meet the aspirational targets.

Tesla, Inc. ( TSLA ) may no longer be valued at a trillion dollars, but its share price still implies that it is worth close to the entire rest of the global car manufacturers combined. To justify this valuation, the company would need to not only become the global number one manufacturer of vehicles (electric or otherwise), but have to grow to almost twice the size of what so far represents the world record in this sector.

Below, I will discuss, why I believe that even in an unrealistically bullish scenario Tesla does not look cheap today and why I think that, realistically, the share price overvalues the company by at least 55 percent.

Best Case Scenario Barely Justifies The Current Valuation

The company's CEO, Elon Musk, voiced the aspiration (explicitly not a promise ) of 20 million unit sales by 2030. That would require roughly a 40 percent CAGR from 2024 onwards, based on Tesla's forecast of around 1.8 million units in 2023. To add some more perspective: Toyota Motor Corporation ( TM ) is the current market leader with a little over 10 million units - which includes commercial vehicles and low-cost models tailored to developing markets, two segments that Tesla does not have any presence in currently. So, in order to become twice as big, Tesla will need to be present in about every category of motorized vehicle.

I do not dispute that Tesla has a strong balance sheet . With only $15 billion net debt and ample liquidity of around $23 billion as of June 30th , the company has the means to build new factories and develop new models. Nonetheless, growing from below 2 million sales to 20 million in less than a decade would be a Herculean task for any company.

For the sake of the argument, let us assume that the aspiration becomes a reality. Revenue - on a non-inflation adjusted basis - would realistically be around $600 billion (assuming a little higher unit prices than Toyota currently has). 20 million annual unit sales would inevitably mean volume focus. That, in turn, would almost certainly lead to lower margins overall (operating margin as of Q2 : 9.6 percent).

But even with a profit margin of 10 percent - which is very generous for a volume manufacturer - that would amount to somewhere in the range of $60 billion. While this is a staggering figure, based on today's market capitalization it still represents a PE multiple well above 13 on (pretty unrealistic) 2030 earnings. The likes of Volkswagen AG ( VWAGY , VLKPF , VWAPY ) or Stellantis N.V. ( STLA ) currently are trading closer to a multiple of 3 to 5 (on next year's earnings, not FY2030's).

If Tesla were to reach 20 million annual unit sales and a 10 percent profit margin, it would thus have proven superb execution and probably build the most valuable automotive brand in the process. Therefore, this kind of premium might be justified in such a scenario. Yet, that also means that at the current valuation, Tesla has little to win and everything to lose.

Growing Competition

For years, Tesla, being the first company to offer a mass produced, daily-drivable BEV with acceptable range at a competitive price, did not really have direct competitors. That, however, is changing. Not only are Chinese EV manufacturers like BYD Co. Ltd. ( BYDDF , BYDDY ), Geely Automobile Holdings Ltd. ( GELYF , GELYY ) and others expanding rapidly. Legacy companies are shifting towards electric mobility, too. In the long run, all relevant volume manufacturers will most likely produce predominantly or exclusively electric vehicles. Eventually, I assume that electric carmakers will no longer be their own (sub-)category. They will just be carmakers. Thus, Tesla is not unlikely to lose one of its biggest USPs.

Political Headwinds Not Unlikely

Going forward, Tesla faces the potential of major headwinds on the political front, both domestically and internationally. Absent a major surprise in the Republican primaries, it is overwhelmingly likely that the next President of the United States will either be the incumbent, Joe Biden, who is decidedly pro-union, or former president Donald J. Trump, an outspoken opponent of EVs. Either way, there are downsides for a BEV-manufacturer that is eager to prevent UAW representation in its factories.

Meanwhile, growing nationalist (and by extension anti-American) sentiments in China, the largest car market in the world, could negatively affect Tesla. Despite producing domestically for the Chinese market, the company's American heritage might be a disadvantage in that regard. Too much cozying up to the Chinese government, on the other hand, could get the company in trouble at home and in Europe, with public opinion in the countries of the free world increasingly critical of the PRC.

Elon Musk's personal image and political views could become problematic, too. Few companies are as closely associated with their respective CEOs as Tesla is. The purchase of an EV rather than a conventionally powered ICE vehicle is often motivated by the desire to buy a product that aligns with environmentalist values - and to communicate these values.

So, how does that relate to Elon Musk's political views and personal statements? There is a significant correlation between environmentalism and generally liberal/left-leaning political views. The growing availability of BEV alternatives makes it easier for these consumers to refrain from buying a Tesla vehicle on the grounds of Mr. Musk voicing or tolerating (for example on X, formerly Twitter, which he personally own, independently of Tesla) views that these people may perceive as politically/ racially/ otherwise insensitive or inappropriate.

History of Overpromising

It should also not be entirely forgotten that Tesla has a history of overpromising and/or underdelivering on its (admittedly rather ambitious) predictions. In the German language there is a word: " Ankündigungsweltmeister " (literally: "world champion of announcements"). It is used to describe a person, group or company that regularly makes bold promises without producing tangible results. It could be said that Tesla fits that description. To give a few examples:

• Since 2016, Tesla claims to be able to (in principle) offer full self-driving ("FSD") features. In reality, its Autopilot is neither the most advanced system on the market, nor really what the name suggests (instead, it appears to be potentially dangerous and made the company the target of multiple investigations by federal authorities).
• In 2015, the company promised batteries with 1,000 km range per charge within two years. To date, no production model achieves this kind of maximum range (to be fair, no other manufacturer does either).
• Tesla has to regularly push back production and launch dates of new models - which, bear in mind, it will need in order to become the number one manufacturer by shipments. The Cybertruck - thousands of which were supposed to be on the road by now, according to the initial timeline, is delayed, with no definitive launch scheduled to date. Commercial availability of the Semi-Truck - originally planned for 2019 - has been delayed to at least late 2024. The same applies to the second-generation Tesla Roadster (initially announced to begin shipping in 2020).

This being an investment website, readers probably are well aware that past performance is not indicative of future results. But this track record surely does not increase my confidence regarding the lofty target of 20 million annual unit sales (or even just the 10 million + x needed to match Toyota).

Conglomerate Factor

Tesla is primarily a carmaker, but it also has non-core segments besides. Through its Tesla Energy division, the company also deals in solar roofs and storage systems. The segment grows considerably faster than the car business (+ 74 YoY as of Q2), so Tesla might indeed become a (somewhat) relevant utility. There is no real technological advantage over competing products, but the case can be made that the Tesla brand helps, as the company has built a dedicated "fan base."

However, margins are lower than in the car business. And, arguably, in order to become the number one vehicle manufacturer in terms of volume, it might be advisable to focus time and resources fully on the core business. There are technical similarities between storage batteries and car batteries, but I fail to see much synergy beyond that. So, all in all, I do not believe that Tesla Energy goes a long way in terms of justifying the company's high valuation as compared to competitors. Notably, conglomerates tend to trade at a discount, so in the long run, it might even be advantageous for shareholder value to spin off the Energy segment once it has reached a certain size (while licensing the Tesla brand name).

Conclusion

All in all, I believe that Tesla's current valuation is materially higher than warranted. I do not doubt that the company will continue to be a successful carmaker. But being successful is not enough to justify the current share price. Becoming the global number one manufacturer is more than priced in. Even if Tesla were to overtake Toyota as the largest and most profitable builder of vehicles globally, the company would be overvalued by 50 percent, give or take. Reaching twice Toyota's current size and thrice its profitability would justify the current price, but not leave additional upside. And to even reach half of the 20 million unit "aspirational" target will be a Herculean task.

Tesla has its merits. It has a very healthy balance sheet and a strong brand. Its products, while maybe not everything that Elon Musk regularly promises them to be, are nonetheless able to go head to head with any other BEVs in their respective price ranges. The Tesla Energy segment is not really a good fit, but it clearly has the potential to generate value, particularly when considering the possibility of an eventual spinoff. Not having a legacy ICE business or union representation could be an advantage in a phase of technological transition in the transportation sector.

All this justifies a certain premium compared to other carmakers. Realistically, a valuation of around $200 billion could be justified, I believe. On an undiluted basis, that would translate to a share price of slightly below $65 per share. If - and that is a capital "If" - the company were to become the volume leader, thus overtaking Toyota in terms of sales, without ruining its balance sheet in the process, I could see it valued at $300, maybe $350 billion. This would represent $97 to $114 per share on an undiluted basis. In other words: the stock is currently overvalued by 55 to 75 percent.

I, therefore, view Tesla stock as a sell. In fact, the only reason not to assign a strong sell rating is that I am rather sure that the entrenched base of "Tesla super-bulls" is overwhelmingly likely to ensure a relative overvaluation for quite some time.

To be perfectly clear, I do not own Tesla stock. Nor do I intend to at anywhere close to the current valuation levels. I would, however, also caution against an outright short sale. It is not only the company's cars that have a loyal fan base, the stock does, too. Tesla has, not without some merit, been called the " original meme stock. " Additionally, Elon Musk has used his considerable reach more than once to circulate statements that have at least the potential to drive the stock up sharply within a short time frame.

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