BYDDY - Tesla: Still Shining On Strong Fundamentals

Summary

• Competition appears hamstrung after Tesla’s aggressive discounting on cars.
• Tesla more than likely to capture additional market share based on this price cut maneuver.
• Margin shortfall due to reduced Tesla prices positioned for an offset.
• We reiterate our Buy Rating and $802/share Price Target on Tesla stock.

Investment Conclusion

Following strong F4Q2022 financial results , we remain bullish on Tesla, Inc. ( TSLA ), as outlined in our initiation report on the company, published last October. Longer-term, Tesla has the largest production capacity, industry leading margins, leading global market share, competitively priced cars, and strong customer demand. Therefore, the company has a wide moat which given current industry dynamics appears difficult to surmount.

In regard to the short-term, Tesla recently dealt a significant blow to the competition (which was just beginning to ramp on their respective production capacities), by substantially lowering prices on its cars. Considering that Tesla with its superior margins can absorb losses associated with reduced prices, whereas other EV manufacturers with their low to negative margins, appear unable to, positions the firm to benefit.

Overall, considering dynamics associated with supply (anticipated expansion in production at the Austin, Berlin, and Shanghai facilities; and that Tesla expects to produce between 1.8 million to 2 million cars in 2023), and demand (increased customer interest due to price cuts on Teslas, and benefits associated with the Federal tax rebate on purchase of EVs; and the impact of the industry grappling with Tesla’s discounting), we expect a surge in the volume of Tesla's being purchased (in-line with management commentary on the recent Earnings Call that demand is outstripping production).

In addition, a significant fraction of the shortfall in margins due to the aggressive discounting is likely to be mitigated due to revenue leverage from potentially higher sales, expected deflation in commodity prices, and lower overheads associated with Tesla’s larger factories, as they expand production towards full capacity. Therefore, driven by advance in sales and flattish margins, earnings and free cash flows are likely to surge, over upcoming quarters, and for the full year.

Given that Tesla’s F4Q2022 financial outperformance has increased our confidence in the company’s long-term prospects, we reiterate our Buy Rating and $802/share Price Target, derived using a 10-year Discounted Cash Flow model, that anticipates that the number of Teslas produced every year will expand by ~40%, compared to an expected growth of between ~31% and ~46% estimated by the company for 2023.

Key Takeaways From The Fourth Quarter

F4Q2022 Results Summary. For the quarter, revenues were ~$21.3 billion (+33% compared to F4Q2021), and earnings per share came in at $1.07 (versus $0.68 during the same quarter last year). On a year-over-year basis, gross margins declined by 360 bps to 23.8%, and operating margins expanded by 129 bps to 16%. Net income for F4Q2022 was ~$3.69 billion, reflecting an uptrend of 59%, over the previous year’s same quarter.

During the period, the firm generated operating cash flows of $14.7 billion and free cash flows of $1.42 billion. At the end of F4Q2022, the company had a cash and cash equivalents balance of ~$22.2 billion and long-term debt of ~$1.6 billion, on its balance sheet.

For FY2022, revenues were ~$71.5 billion (+51 % compared to FY2021), and earnings per share came in at $3.62 (versus $1.63 during the previous year). On a year-over-year basis, gross margins expanded by 32 bps to 25.6%, and operating margins escalated by 464 bps to 16.8%. Net income for the period was ~$12.6 billion, reflecting an uptrend of 128% over the prior year.

Tesla Well-Positioned To Benefit From Price Cuts. The company rolled out price reductions in the U.S., on its most popular cars (Model Y is down to $52,990 and Model 3 is now selling at $53,990), in early January. Given that Tesla additionally lowered prices on its Model S and Model X cars, it appears the maneuver is deeply strategic.

In our opinion, factors that drove the heavy discounting included: expectations that the supply of EV’s is likely to exceed demand in 2023; an attempt to drive MSRPs on Teslas to below the $55,000 required for customers to receive the $7,500 tax rebate on purchase of an EV; and an effort to shoulder some of the customer’s financial burden related to higher interest rates, which substantially increases the purchase price of cars.

Competitively, the price cuts, set Tesla up to benefit, as the company’s margins are considerably higher than that of its peer group. Specifically, during F3Q2022, Tesla’s gross profit/car was $15,653, while that of General Motors ( GM ) was $9,969, BYD Company Limited ( BYDDF ) was $5,456, and Ford’s ( F ) was $3,115. During the same period, Tesla’s net profit/car was $9,574, compared to GM’s $2,150, BYD’s $1,575, and F’s $927. Given their margin profile, it will be challenging for the competition to reduce prices on their EV’s, invariably reflecting in the crowding out of some firms.

In that regard, it is noteworthy that during 2022, Tesla accounted for ~65% of total revenues associated with the EV industry, with F at ~7.6%, and GM at ~3.5%, far behind. In addition, although the Model Y at $52,990 is still priced at a premium to F’s best selling EV Model, the Mach-E, it is priced below the firm’s higher-end EV Models. With respect to GM’s EV’s, Model Y’s base price is ~$10,000 below that of the company’s similarly sized EV SUV, the Cadillac Lyriq.

Cumulatively, combining the aggressive discounting Tesla has introduced on its cars, with its industry leading production capacity, positions the firm to capture market share from the competition, in our assessment.

Growth In Production Capacity On Cards. On track towards the launch of an additional 10 to 12 factories over the next few years, Tesla has indicated plans to debut a new plant over the near-term. Rumors suggest that the company is close to a commitment in Indonesia. Considering that the country at 25% has among the largest deposits of nickel, a key component of battery packs, used in Teslas, the development appears plausible.

Last year, during the Summer, Tesla launched two facilities, one each in Austin, Texas, and Berlin, Germany. Both factories are equipped to manufacture >250,000 cars/year. The firm recently shared plans indicating a ~$750 million expansion of the Austin facility, adding 1.4 million square feet to the factory, resulting in a floor space of 5.6 million square feet. The intention is to utilize the additional capacity for manufacturing battery packs and drive units, testing battery cells, and building a die shop. Initial production of Tesla’s Cybertruck is expected to begin over the Summer at the facility. Additional plans for the plant include the manufacture of Tesla Semis, some time in the future.

Further, the Shanghai factory which had its production capacity of >750,000 cars reduced significantly due to the resurfacing of COVID-19 in China, will likely return to regular manufacturing shortly, as the country rolls back its zero tolerance policy towards the pandemic. In addition, the Berlin facility is expected to attain full production capacity this year. Overall, over the long term, Tesla expects its present and potential manufacturing facilities across the world to produce >1,000,000 cars each/year.

Given our thesis that customer demand for Teslas is likely to escalate over the near-term, the potential expansion in production of cars, appears well-timed.

Bottom Line

General Motors and Ford, previously indicated that their objective is to usurp Tesla’s leadership position in the EV industry. Given, company and industry dynamics, it appears improbable that the scenario will ever unfold. Tesla has production might, industry leading margins, pricing power, and customer demand. In addition, it is leagues ahead on the full self driving feature. The first mover advantage Tesla secured, sustained, and built on, almost ensures its dominance over the EV industry, through the course of its life cycle. The competition is fragmented, and appears poorly positioned to mount a formidable challenge to Tesla.

At current levels, Tesla’s stock represents a significant opportunity to generate massive returns on capital, over the long term.

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