There is absolutely no doubt Tesla Motors is the company of the future, but with its growing financial insecurities this company is still not a good investment.
Tesla has an astounding short term and long term plan. In the short term, through the Model S and Model X, Tesla has asserted itself as the dominant player in the automotive industry. Furthermore with the Model 3 set to release later this year, they are now tapping into a completely different consumer market. In the long term, Tesla’s is set to disrupt the entire energy and transportation market. With charging grids established across the United States, once Tesla implements its fully self-driving feature, owners will be able to travel anywhere in the country without having to touch the wheel. When owners are not using their cars, it can be used for ride sharing purposes as the car would be able to drive itself. In the energy sector, Tesla has also introduced the Power Wall, Solar Roof and recently acquired Solar City. The acquisition of Solar City was ideal for Tesla to achieve its long term goal of dominating the energy market as it can create an ecosystem between an owner's’ transportation and home energy.
Though Tesla’s long term future is intact, investors should not be in any rush to buy shares of Tesla. January of 2013, Tesla opened at $35.00 per share and is now priced at $260.00 per share marking a 700% increase in just 4 years. FY 2012 Tesla’s revenue was $413M and income was -$396M. Today Tesla reported, FY 2016 revenue of $7B and income of -$675M or ($4.68). Though Tesla is a great company, its stock is extremely overvalued to its current financial performance.
Tesla loses vast amounts of money every year; it continuously borrows money to keep its operations a float. Of Tesla’s $22.6B in total assets, $16.7B or 76% of the company is debt. In addition, Tesla continues to accrue greater losses each year. This is due to Tesla’s heavy R&D spending coupled with its low gross margin (cost to manufacture a product) of 22.8% (vs. Apple’s at 61.5%). Unfortunately for a company like Tesla, that thrives under innovation, this slim margin forces them to continue and borrow money to expand R&D. For example, Tesla needs to invest an additional $2B - $2.5B later this year into the Model 3 which likely will have to come entirely from debt. Tesla will not be able to continue this process as easily as it has in the past. Under the 0% federal funds rate established over the past few years, Tesla was able to borrow money with very minimal interest payment. Now the interest rates are expected to rise 0.5% - 0.75% a year, making it markedly more difficult for Tesla to continue to borrow money. These conditions, would cause Tesla’s interest expenses to increase in a much heavier rate in the years to come creating extreme uncertainty going into its financial future.
Tesla also provides minimal transparency on its Model 3 business making it very hard to predict. Aside from further cap expenditures and reaffirming its release date, Tesla did not provide much other information in its forward looking 2017 statements. Investors have extraordinarily high expectations for the Model 3’s release and sales. Negative deviances in production, costs, profits or units sold will greatly affect the stock to the downside while positive results will minimally push the stock upwards.
Given normal economic cycling, an economic downturn is expected to take place in the near future. Shares such as Tesla, with little financial backing will take the biggest hit relative to the market. A decreased consumer spending, which results from any economic downturn will heavily impact Tesla’s sales. Tesla’s cars are much more expensive than their competition and thus a negative economic cycle will push customers to purchase cheaper alternatives. This impact will be devastating to Tesla as it cannot afford to see a negative effect on its top line.
Amazon, in 2000, went through a similar situation to Tesla today. Amazon was thought of as the company of the future, in prime position to disrupt ecommerce and retail and so its stock price shot up. In January of 1998 Amazon opened at $4.995 and two years later, January 2000 Amazon hit $91.50 per share in the midst of the stock market bubble. FY 1997 Amazon reported revenue of $147M and income of -$27M or ($1.27) per share. FY 1999 Amazon reported revenue of $1.64B and income of -$720M or ($2.20). As is Tesla currently, Amazon was heavily burdened with debt to compensate for low gross margin (17%) and heavy R&D expenses. Of its $2.46B in assets, $2.2B are entirely from debt. During the stock market crash of 2000, Amazon fell all the way back down to $8.36 reflecting a crash of 90%. Despite the stock price volatility, investors were correct about Amazon’s future. As the company progressed, it began to churn profits and debt represented a smaller portion of the company. January of 2008 (8 years later) Amazon again was in the $90’s but this time it was reporting profits and had a much more favorable debt to equity ratio. During the 2008 crash, its underlying strong finances prevented the crash seen in 2000 and Amazon was able to recover and reach all time highs just 18 months later. Currently Amazon stands at $855.51 and completely dominates the e-commerce field.
Amazon in 1999 shows remarkable similarities to Tesla today. Amazon was valued for the company it could be rather than the company it was. Investors ignored the accumulating debt and underlying financials simply for its prospects. When the market crashed, Amazon fell disproportionately heavily to due its lack of intrinsic value. Tesla is in a similar situation today. Its stock is purely valued for the company it could be and does not reflect the financial uncertainties and the extraordinary debt it carries underneath. Undoubtedly, Tesla can still go up from current price as traders become more excited about the Model 3 and other short term catalysts, but long term investors should stay put as there will be better opportunities to buy. During a market correction or crash, Tesla will fall disproportionately as Amazon did in the past and there will be an opportunity to pick up this company at a significantly cheaper price.
24 mo. price target for Tesla Motors, Inc: $120
Disclosure: I/we are long AMZN, AAPL.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.