Investment thesis: Not long ago, Tesla, Inc.’s (NASDAQ: TSLA) market capitalization was comparable in size to that of the next largest ten automakers combined. It was a valuation level that made very little sense from a fundamental perspective. It suggested that expectations were that Tesla would eventually capture anywhere from a quarter to half of the global automakers’ revenues and profits.
Tesla was never likely to become this successful, which is why some of the high stock prices we saw about a year ago would never be sustainable. A combination of factors, including some non-fundamental issues such as a negative campaign against the Tesla brand triggered by Elon Musk’s takeover of Twitter and his policy changes, helped drive Tesla shares down to fundamentally reasonable levels. For the first time in arguably many years, TSLA may make sense more conservative investors looking for a mature, established investment opportunity that makes sense as a long-term buy & hold.
An increasingly profitable, mature growth stock
Given the poor performance of Tesla’s stock price in 2022, one would think that Tesla is a company on the verge of a catastrophic adverse event, one that could potentially jeopardize its very existence. In reality, nothing of the sort happened. It was just a relapse into reality, and when we look at the reality, it’s not too bad.
As we can see, total revenue was up 56% yoy, which is pretty impressive and, by most definitions, still makes this a high-growth stock. I have no doubt that this rate of growth will slow down going forward, but I don’t think we’re anywhere near the point where growth will stop. Net profit doubled, meaning profitability improved. The $3.3 billion profit margin on $21.5 billion in revenue is a solid 15.3%. It should be noted that the latest news regarding Tesla’s price cuts suggests that its profit margin will shrink. However, we should not forget to consider factors of continued operational efficiency that can at least partially offset the lower selling price of its cars.
In terms of unit deliveries, I expect a significant slowdown going forward, but as of now, the third quarter has been strong, with growth in most major markets.
With a 42% increase in Tesla unit shipments, it looks like demand is still strong, which, as I’ll explain, could be extended by Tesla winning in new markets that are currently marginal to its sales.
It should be noted that Tesla’s total debt, current and long term, is $2.414 billion. For the same quarter in 2021, it was $6.7 billion as reported in the Q-10 filings. The fact that debt is decreasing even as the company continues to grow and prove profitable suggests that while Tesla will see much slower unit sales and revenue growth going forward, profit margins are likely to follow a path of further improvement, without factoring in the net effect of the selling price declines that we’re seeing, which should continue to help it catch up to that P/E ratio that still has it trading well above its peers by this expense ratio metric.
As we can see, alongside General Motors (GM) and Volkswagen (OTCPK: VWAGY), Tesla is seeing much more robust revenue growth year over year compared to its peers. GM’s alignment of sales growth and Volkswagen’s apparent robust performance in this regard are anomalies, mostly related to ongoing adjustments post-COVID crisis toward normal market trends, rather than a true long-term trend. The most accurate picture in this regard is Tesla versus its other competitors, namely Toyota (TM), Ford (F) and Mercedes (OTCPK:MBGYY).
Of course, there are other factors that play into P/E ratios when comparing peers. The overall financial situation, such as debt levels, is an important factor, as are profit margins, asset values, and so on. In the case of certain legacy automakers, particularly European-based companies, we’re likely looking at stranded assets as well, as EU law currently requires automakers to move to 100% non-ICE car sales in the EU by 2035. In fact, look at companies like Volkswagen dealing with decommissioning costs, a write-off of ICE-related patents, and so on. Dividend is another important factor that can play a role. For example, Ford’s dividend will pay the equivalent of one’s base in dividends in about 3 decades, excluding compound securities. Tesla does not currently offer a dividend.
While many other factors can be considered, one of the most important metrics is whether a company can grow to its market cap and the rate at which it can do so. Looking at revenue growth, Tesla’s P/E ratio is currently about three times higher than Toyota’s and is also growing about four times faster in terms of revenue. I expect sales growth for Tesla to slow significantly over the next several years, but I think the same is true for Toyota. By the way, Tesla’s market cap is now twice that of Toyota, whereas just a year ago it was about twice the market cap of all the companies I included in the comparison table combined.
Tesla’s growth opportunities around the world and future challenges
Just a few years ago, Tesla dominated the electric vehicle (“EV”) market in the Western world. A fundamental flaw in the approach of most established automakers, namely the quest to supply the market with EVs that the average person could afford, led them to focus on producing urban EVs, which lacked attractiveness for consumers looking to more or less match the utility derived from an ICE-powered vehicle. The inevitable result was poor performance from most of them, even as Tesla continued to capture more and more of the luxury car sales segment, where an EV can be priced at a level that allows EV makers to offer the kind of range convenience that consumers want. used to a car.
Other automakers have gradually learned, with the result that the average price of an EV currently sold in Europe is 14% higher than in 2015, while prices in the US rose 43% over the same period.
What the EV pricing data tells us is that Tesla now has a lot more competition in its quest to dominate the Western world’s luxury car segment. It will likely become a barrier to further revenue growth in these markets at some point, perhaps in the not-too-distant future.
In China, a completely different market dynamic is taking shape. Clearly, Chinese consumers don’t care nearly as much about range, nor do they feel the need to splurge on the comforts one would want on a longer-distance road trip. For this reason, there was a rapid decline in average EV prices in that market, even as EV prices rose in the West. This presents Tesla with the challenge of providing a more affordable EV option in China, which can be met in part by manufacturing in China, where the average cost to produce an EV apparently averages as much as $10,000/unit lower. could be, based on some recent estimates. Tesla’s Model 3 starting price was correspondingly about $13,000/unit lower in China than in the US, before the latest price cuts announced by Tesla. I expect Tesla still has significant room to gain market share in the Chinese car market, albeit with very stiff competition from local EV manufacturers.
We shouldn’t forget that while North America, Europe and China are indeed by far the most important auto and EV markets, there are also plenty of other emerging markets where Tesla has plenty of room to penetrate in the future. For example, India has a fast-growing economy that gives rise to a fast-growing stratum of relatively wealthy professional elites and business owners, in other words, the key consumer demographic for Tesla. The number of millionaires will double between 2022 and 2026. For now, Tesla avoided entering the Indian market, but it will probably happen within a few years, and that’s a significant untapped market. The same can be said about South America, the ME region, as well as some Asian markets that have yet to be tapped. Tesla sales in Europe and North America may be reaching a point of stagnation, but there are plenty of opportunities to continue growing in much of the rest of the world.
Implications for investments
The continued volatility of Tesla stock, the lack of a dividend and a number of other factors still make this a less than attractive investment opportunity for more conservative fundamental investors. I have absolutely no doubt that Tesla stock sometimes gets ahead of the fundamentals on repeated occasions, and it can also overshoot the fundamentals on its way down. What I expect more and more is that Tesla’s share price crosses the point where fundamentals can be argued to be more and more reasonable. At the current price/stock, TSLA is now trading in line with reasonable fundamentals when considering most factors, as I see it. That’s why I decided to add Tesla stock to my portfolio. Going forward if it rises and is way ahead of those fundamentals I’ll probably take some profit, if it dips well below fundamentals I would add.
The sell-off of Tesla stock over the past year brought it to its fundamentally reasonable levels, and as the company matures, I expect its valuation to become increasingly tied to those fundamentals. Therefore, Tesla, Inc. stock price performance should be should become less volatile and more predictable from now on.
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