TSLA - Tesla's Elon Musk Modern-Day Henry Ford With A Twist?

2023-03-30 13:55:52 ET

Summary

• What is it about Tesla, Inc. (Elon Musk) that keeps surprising us all.
• "Disruptive Innovation" would be an improper use of that term. "Altruistic Innovation" might be appropriate but true altruism is likely unachievable for any human being.
• The latest surprise is announcement at the Tesla investor day of elimination of rare earths from next generation motors - it's a big deal with a "Pro-social" objective.
• In this article, I explore a fascinating concept - the primary reason for the existence of Tesla and other Musk businesses is achieving "Pro-social" objectives using new and innovative approaches.

Tesla: Investment Thesis

At the time of my only previous article on Tesla, Inc. ( TSLA ) back on Jun. 9, 2020, the share price was $62.67 and I gave the stock a Buy rating. The article was titled, " Tesla: Fabulous Returns And Growing Balance Sheet Strength ," and my summary points were:

• Tesla has provided fabulous returns for shareholders over the last five years or more.
• Tesla's balance sheet is showing increasing strength.
• This is currently a far more investable company than a few years back.

I have not written on Tesla since, mainly because Tesla gets a lot of coverage. But, I believe possibly not enough has been made of the announcement in Tesla's Investment day presentation of plans to eliminate rare earths in the next generation permanent magnet motor and what it tells us about CEO Elon Musk and Tesla.

Since the time of my article referenced above,

• The Tesla share price has increased by 209.38% to $193.88, compared to a 25.35% increase in the S&P 500 (SP500).
• Actual non-GAAP EPS for FY-2022 was $4.07 compared to SA Premium analysts' consensus EPS estimates at Jun. 9, 2020 of $1.38, a beat of 195%.
• Balance sheet strength has further significantly increased, with Cash and Investments net of Debt of $20.14 billion at end of FY-2022, compared to a Net Debt position of $4.1 billion at end of June 2020. Importantly, the debt component has been reduced from $12.7 billion to $2.0 billion.
• Total shareholders' equity has increased by 305% from $11.4 billion at end of June 2020 to $45.9 billion at end of 2022, while outstanding shares have increased by 13.4%, from 2.79 billion to 3.16 billion over the same time period.

All of the above has been achieved while continuing to reduce the selling price of Tesla vehicles. Anyone who thinks Tesla price cuts are driven by reduced demand, fails to understand the Tesla business model. The Tesla business model is about contributing to world decarbonization by replacing ICE vehicles with BEVs (battery electric vehicles) powered by renewable energy. To achieve that objective requires continuing decreases in Tesla BEV prices to make them more affordable, enabling wide uptake. Excerpts from a reply by Elon Musk in the Q&A session of Tesla's 2023 Investor Day :

...something I should say with respect to demand which I've said a few times over the years but it's sometimes it needs to be said again which is... overwhelmingly there's the desire for people to own a Tesla is extremely high - the limiting factor is their ability to pay for a Tesla not do they want a Tesla... it's easy for people in this room to lose sight of if your income is far in excess of what a car costs - then you look at value for money but you do not consider affordability - but for the vast majority of people it is affordability driven...one of the things we weren't sure about was the price elasticity of demand for Teslas so like as we lower the price how much does the demand increase...and we found that even small changes in the price have a big effect on demand - very big - so that was a good thing to learn...

Over the last two years, Tesla has cut production and other costs sufficiently to reduce Tesla BEV selling prices, while still massively growing EPS and balance sheet strength. I expect Tesla would be cutting selling prices at a faster rate if they could keep up with the increase in demand larger price cuts would generate. In the Q&A session Elon Musk stated the hardest thing is making cars. Tesla is continually working on ways to produce Teslas at lower cost in greater volume. That is the way the real objective of the company to decarbonize the world can be achieved.

Conclusions -

There is clear evidence of strong demand for Tesla products, with affordability a constraint for the majority of potential customers. Tesla has shown an ability to cut Tesla selling prices while achieving strong EPS growth due to cost reduction initiatives. The hardest thing for Tesla is to make enough cars to meet the demand generated by reduction in selling prices. New and innovative approaches are being developed to reduce factory footprints and accelerate production rates while further lowering costs. I can only repeat/update my June 2020 observations,

• Tesla has provided fabulous returns for most shareholders over the last seven years or more.
• Tesla's balance sheet is now very strong and continues to show increasing strength.
• This is currently a very investable company and far more investable than a few years back.

In the balance of this article, I take a more detailed look at profit performance, shareholder returns, and balance sheet strength. I also look at this pattern of what I will term an ethos of "Pro-social" objectives. I might have termed it "Disruptive Innovation" or "Altruistic Innovation," but a closer look at the definitions ruled these terms out.

Getting the terminology right

Disruptive Innovation -

Excerpted from an article in Harvard Business Review :

In this article, the architect of disruption theory, Clayton M. Christensen, and his co-authors correct some of the misinformation, describe how the thinking on the subject has evolved, and discuss the utility of the theory. They start by clarifying what classic disruption entails—a small enterprise targeting overlooked customers with a novel but modest offering and gradually moving upmarket to challenge the industry leaders.

The article goes on to describe the Disruptive Innovation Model -

This diagram contrasts product performance trajectories (the red lines showing how products or services improve over time) with customer demand trajectories (the blue lines showing customers' willingness to pay for performance). As incumbent companies introduce higher-quality products or services (upper red line) to satisfy the high end of the market (where profitability is highest), they overshoot the needs of low-end customers and many mainstream customers. This leaves an opening for entrants to find footholds in the less-profitable segments that incumbents are neglecting. Entrants on a disruptive trajectory (lower red line) improve the performance of their offerings and move upmarket (where profitability is highest for them, too) and challenge the dominance of the incumbents.

To anyone at all familiar with Tesla, it should be clear that Tesla does not fit the model described above for Disruptive Innovation. Tesla is not going after the high, the mainstream, or the low end of an established vehicle market. Tesla vehicles have an attraction for the whole of the market. A main objective of Tesla is to reduce production costs so the price of a Tesla becomes affordable for the widest possible market - the objective has never been cheap cars to get a foothold in the industry at the low end of the market.

The term Disruptive Innovation could, however, likely be applied to Tesla competitors such as BYD Company Limited ( BYDDF ), a long-established electric bus manufacturer which is now pushing into the EV car market, competing against Tesla vehicles at a lower price point. For more information on BYD and where it fits in the marketplace, please read SA Contributor, and BYD Atto owner, Keith Williams' article, " BYD Atto 3 Challenges 'Too Hard' Viewpoint For BEVS ."

Altruistic Innovation -

Excerpted from article, " Innovation and Altruism: A New Paradigm Defining the Survival of Corporations? ":

In 1920, Henry Ford claimed that “ the company must make a profit, or it will die. However, if you try to run a business solely on profit, then it will also die because it will no longer have a purpose”... A century later, his statement remains strikingly relevant.... Only by exhibiting truly altruistic behavior, shaping its organizational purpose, will a firm be able to offer an organizational setting in which employees feel comfortable innovating and thus provide offerings that meet society’s actual needs and interests.

The above describes how a corporation should encourage altruistic innovation, not as an end objective, but as a necessary activity to better achieve the primary business objectives of the company.

A Business Based on 'Innovative Altruism' - A Unique Class of Corporation

Microsoft and the Bill & Melinda Gates Foundation

A great example of innovative efforts to achieve altruistic objectives is the Bill & Melinda Gates Foundation. Certainly, starting and growing the Microsoft Corporation ( MSFT ) business required a great deal of innovation, but I doubt the business objectives of Microsoft would ever be considered primarily altruistic. Wealth created through Microsoft has allowed the Bill & Melinda Gates Foundation to achieve amazing reductions in disease in third world and developing countries using innovative approaches employing the types of skills employed at Microsoft.

But the foundation is not a business, it is purely a charity. I am only discussing here the phenomenon of business corporations run as truly commercial businesses but founded with purely altruistic end objectives as their purpose for being. I believe Tesla and other Musk commercial enterprises have been formed, not for business purposes, per se, but with a purpose of applying innovation for achieving altruistic and other social objectives - "Innovative Altruism." But, true altruism requires a complete selflessness of the giver, with no benefit - not even a reward of feeling good - possibly unachievable by Elon Musk or most any human being. The most appropriate term I can find for Musk's objectives for Tesla is "Pro-social." Henry Ford, per the article above, certainly considered Pro-social important, but the primary business objective of Ford was to produce ICE motor vehicles. I believe the reverse is true for Musk's Tesla business - the primary business objective is Pro-social, with production of BEVs a means to that end.

Tesla's Primary Business Objective is Pro-social - Contribute to world decarbonization

If anyone doubts Tesla's primary business objective is to contribute to world decarbonization, a look at the Investor Day 2023 slide presentation should dispel those doubts. The initial slide in Master Plan 3 simply states:

Sustainable Energy For All of Earth

And the penultimate slide sums up how the master plan will be achieved.

Image 1

The 160 odd slides in between provide a detailed description of how each of the steps in Image 2 will be achieved.

Tesla Financial Analysis

Mostly Fabulous Returns

Table 1

Table 1 shows returns for investors who bought Tesla stock at end of years 2014 through 2022. Seven of the nine hypothetical investors achieved fabulous returns ranging from 36.6% for Investor A to 513.7% for Investor I. Despite the lower percentage return, Investor A, due to duration held, has an absolute increase in value of investment of $36,220 compared to $1,722 for Investor I. Investors G and H show negative returns due to buying at inflated share prices in 2020 and 2021, when the market generally was at highs. No matter how good a stock is, it is possible to pay too high a share price.

Future Return Projections Based On Analysts' EPS Estimates

Table 2.1

Table 2.1 above compares actual EPS results and current SA Premium analysts' EPS estimates to analysts' EPS estimates for FY-2020 to FY-2024 at Jun. 9, 2020. Tesla's actual results and current EPS projections significantly exceed corresponding analysts' EPS projections made back in June 2020. Table 2.2 below shows actual and projected year on year ("YoY") EPS growth from FY-2021 through FY-2030 plus average yearly estimated EPS growth rate for FY-2022 to FY-2030.

Table 2.2

Table 2.2 shows explosive EPS growth rates for FY-2021 and FY-2022. SA Premium analysts' long-term EPS average yearly growth rate estimates through FY-2030 range from a low of 7.1% to a high of 19.1%, with consensus 13.8%. Tesla has significantly beaten both consensus and high EPS estimates in the past. But even the analysts' EPS growth rates for consensus and high are attractive, in the double digits. The Low EPS estimates are still positive at 7.1% average per year through FY-2030.

Checking the Tesla "Equity Bucket"

Table 3.1 Tesla Balance Sheet - Summary Format

Table 3.1 shows an increase in investment in net assets used in operations of $15.94 billion, and an increase in cash net of debt of $24.01 billion over the 6 years, January 1, 2017, through end of December 31, 2022. This $39.95 billion increase in total net assets was funded by an increase in shareholders' equity of $39.95 billion. The analysis of how that increase of $39.95 billion in equity was derived is shown in Table 3.2 below.

Table 3.2 Tesla Balance Sheet - Equity Section

I often find with companies, while they produce earnings that increase shareholders' equity, significant amounts of distributions out of equity do not benefit shareholders. Hence the term "leaky equity bucket." For the most part, I do not see that with Tesla - the company's profits are being reinvested for the benefit of its shareholders. However, issues of shares to staff are being accounted for well below average market prices at time of issue, as discussed below.

Explanatory comments on Table 3.2 for the period January 1, 2017, to December 31, 2022 -

• Headline non-GAAP income over the 6-year period totals to $22.5 billion profit, equivalent to diluted net income per share of $6.39.
• This $22.50 billion profit over the 6 years is after increasing GAAP net income of $14.99 billion by a total of $7.51 billion to arrive at the adjusted non-GAAP result. This non-GAAP adjustment is primarily due to charges for stock compensation to employees being excluded from the non-GAAP result.
• By using shares for a portion of employee compensation, Tesla in effect has conducted capital raisings from this source with deemed proceeds of $10.9 billion, an average deemed issue price of $28.55 per share. That likely reflects share prices at the time of grant of options. At the time of issue of these shares, share price has gone as high as $350 and above. That, of course, is a main objective of including stock as part of employee compensation to incentivize actions that improve performance and consequently share price.
• There has also been a further $13.96 billion addition to equity from public equity raisings and conversion of notes/preferred shares. The average net proceeds per share over the 6 year period was $39.04. That average price would reflect the share price levels at time of issue of convertible notes and preference shares and not the share prices current at time of conversion.
• In summary, increase in shareholders' equity over the 6-year period totals to $39.95 billion, comprised of $15.09 billion from operating activities, $10.90 billion capital raised through compensating staff by means of share issues, and $13.96 billion capital raised through public share and note issues.
• The public equity raisings and use of Tesla stock as part of employee compensation have significantly strengthened Tesla's balance sheet. Net debt as a percentage of net debt + equity has reduced from 61.2% at end of 2017 to zero net debt at December 31, 2022.

Tesla: Summary and Conclusions

Tesla has provided outstanding returns for the great majority of investors over the last seven years. Continued share price growth is reliant on strong EPS growth. Analysts' EPS estimates are for strong EPS growth through end of 2030. If Tesla continues to beat these estimates, then strong share price growth will likely follow. Tesla now has a fortress style balance sheet to cope with the large swings in liquidity requirements arising from its business model. Excerpted from Zachary Kirkhorn's, Master of Coin and Chief Financial Officer of Tesla, address to the 2023 Investor Day:

... this is a working capital intensive business and this has to be managed very carefully and so you know over the course of a quarter there can be multi-billion swings in our cash balance up and down just depending on the timing of when we build and deliver cars...downside protection is another really important area where we have money set aside for that... over the last couple of years throughout the pandemic I think this just highlights why being ready for downside protection is important...preserving daily operations is the engine that then generates cash that allows us to reinvest into the growth of the business...very proud that over the last couple of years despite the ups and downs in the macro environment and interruptions to supply chains we have never once pulled back on our investments in growth so that remains a huge priority for us...

This ability to operate without financial constraints and a proven ability to continually take out costs, enabling price reductions to drive demand growth, should likely enable Tesla, Inc. to continue to outperform.

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