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Elevator Pitch
My rating for Tesla, Inc.’s (NASDAQ:TSLA) stock stays as a Buy.
With my earlier write-up for Tesla published on November 28, 2022, I touched on TSLA’s financial outlook in five years’ time. In the current article, I answer the question of whether Tesla’s shares are undervalued or overvalued.
My analysis of Tesla’s price performance, key metrics, risk factors, valuation multiples and growth prospects leads me to the conclusion that TSLA is an undervalued stock worthy of a Buy.
Why Has Tesla Dropped So Low?
Tesla’s last done share price was $133.42 as of January 20, 2023, and this is -65% below its 52-week high of $384.29 recorded on April 5, 2022. In the last one year, TSLA’s shares have experienced a -60% drop as compared to an -11% pullback for the S&P 500 Index (SP500).
In my view, Tesla’s stock price has dropped so low because of investors’ concerns regarding Elon Musk’s acquisition of Twitter and the company’s growth outlook.
As it stands now, Elon Musk remains as the CEO of both Tesla and Twitter. Notably, Elon Musk had previously sold some of his shares in Tesla and took on debt to fund his takeover of Twitter. It is reasonable to be worried that Elon Musk will spend a significant amount of time trying to optimize Twitter’s business operations. There isn’t any doubt that Tesla’s shareholders would have preferred that Elon Musk devote all his time to TSLA.
Also, Tesla’s most recent quarterly delivery numbers came in below expectations, and it is natural to fear that TSLA’s 2023 financial performance might be disappointing as well.
TSLA’s Q4 2022 deliveries amounting to 405,278 units turned out to be around -4% lower than the market’s consensus forecast of 420,760 units. The demand-supply dynamics for the Electric Vehicle or EV market are becoming more unfavorable, as evidenced by Tesla’s below-expectations delivery numbers for the recent quarter. EV demand is weakening due to poor economic conditions, while supply is increasing as a result of intensifying competition and new EV models launches.
But there has been a positive change in investor sentiment for Tesla since the beginning of this year, and I highlight relevant metrics relating to this in the subsequent section.
TSLA Stock Key Metrics
The key metrics that Tesla’s investors need to watch are the stock’s year-to-date share price performance, the company’s price reductions, and the Wall Street’s consensus financial projections.
In 2023 thus far, Tesla’s stock price rose by +23%, which is far better than the S&P 500’s +4% increase in the same time period. This is likely attributable to the positive read-through from TSLA’s recent pricing changes.
Seeking Alpha News reported on January 13, 2023 that TSLA had initiated “price cuts” which “range from 6% to 20% for Model 3, Model Y” in the U.S. to allow them to qualify for “a $7,500 U.S. government tax credit.”
The sell-side’s consensus financial estimates for Tesla are reflective of trade-offs associated with the company’s pricing strategy. According to consensus financial data sourced from S&P Capital IQ, analysts see TSLA’s gross profit margin and EBIT margin contracting by -2.6 percentage points and -1.5 percentage points to 23.3% and 15.6%, respectively for full-year 2023. On the flip side, the market still expects Tesla to achieve positive bottom line (normalized EPS) expansion of +9.4% on the back of a reasonably strong +30.1% top line growth.
In a nutshell, Tesla is trading off lower gross and operating profit margins (as a result of price cuts) for faster revenue growth and market share gains. Given that automotive manufacturing is a high fixed cost business where operating leverage is critical for profitability, stronger vehicle demand and higher sales volume will help to partially offset the negatives associated with lower selling prices and weaker gross margins. This explains why Tesla is still expected to record positive earnings growth this year notwithstanding price cuts and weak industry demand.
In the subsequent two sections of this article, I discuss the potential risk factors for Tesla.
Is Tesla A High-Risk Stock?
Based on Seeking Alpha’s DATA, Tesla has a 24-month beta of 1.86.
Beta measures a stock’s price volatility, and a beta above one for Tesla suggests that the TSLA has greater price volatility than the broader market. Typically, a high-beta stock has relatively less stable revenue and earnings, which makes it riskier, and this is true of Tesla.
Automobiles, including EVs, are consumer discretionary products, so Tesla’s revenue are naturally lower when economic conditions are unfavorable. TSLA’s Q4 2022 deliveries, which fell short of market expectations, and its recently announced price reductions support the thesis that Tesla’s revenue is more volatile and cyclical in nature.
Also, TSLA’s earnings are more susceptible to wild swings because of operating leverage. Auto or EV manufacturing is a business with a relatively higher proportion of fixed expenses relative to variable expenses, and this implies that a minor decline in revenue will likely drive a substantial drop in earnings for Tesla.
The huge variability in analysts’ top line and bottom line estimates for Tesla also offers evidence that suggest its revenue and earnings are hard to estimate with a high degree of accuracy. TSLA’s current consensus fiscal 2023 top line and normalized EPS forecasts are $80.2-$121.5 billion and $2.38-$6.19, respectively, which is a pretty wide range.
Even though Tesla is a high-risk stock, this doesn’t mean that TSLA isn’t a good investment candidate. Investing is about assessing the risk-reward profile of a stock, rather than just focusing on risks alone. If a company has a favorable reward-to-risk ratio, it can still be a very good investment opportunity.
I will touch on Tesla’s valuations and long-term growth prospects in subsequent sections of the article. TSLA is a reasonably good high-risk, high-reward value proposition, as its valuations have priced in Tesla’s risks to a large extent and investors haven’t given the stock sufficient credit for its long term growth potential.
Is Tesla In Financial Trouble?
Tesla isn’t in financial trouble based on an assessment of specific ratios for the company, despite the fact that it is a high-risk stock as mentioned in the prior section.
TSLA’s gross debt-to-equity as of the recent quarter and trailing twelve months gross debt-to-EBITDA ratios were reasonably low at 14.3% and 0.35 times, respectively as per S&P Capital IQ data. Furthermore, Tesla has been free cash flow positive for three years running between fiscal 2019 and FY 2021, and the Wall Street analysts predict that TSLA will continue to generate positive free cash flow in the next couple of years. It is also worthy of note that TSLA has an investment grade or BBB credit rating from S&P Global.
Nevertheless, one key thing to note is that Tesla probably has a meaningful amount of cash held with its Mainland Chinese business operations. A June 23, 2022 CNN news article cited comments from GLJ Research’s analysts highlighted that “a lot of their (Tesla’s) cash is locked up in China” and noted that “China does not allow companies to repatriate” cash. For example, if Tesla’s US business requires financing, it might be hard for the company to utilize its financial resources in China. That said, TSLA’s recent pricing changes, as outlined in an earlier section, should allow the company’s US business to be self-sustaining without financial support from its Chinese business.
Barring a worse-case scenario involving plunging sales and substantial (unexpected) capital expenditures, it is unlikely that Tesla will end up in a situation of reporting negative free cash flow or having issues repaying or refinancing its existing debt.
Is Tesla Stock Undervalued Or Overvalued Now?
TSLA’s stock is undervalued now.
Tesla currently trades at consensus forward fiscal 2024 Enterprise Value-to-Revenue, EV/EBITDA and normalized P/E multiples of 2.8 times, 12.4 times and 22.7 times, respectively as per S&P Capital IQ data. TSLA’s current valuation multiples are undemanding, as compared with the company’s long-term annual deliveries growth guidance of +50% and the market’s consensus fiscal 2023-2025 normalized EPS CAGR of +22.1% (source: S&P Capital IQ). I think that it will be reasonable for Tesla to command a P/E multiple of 30 times or higher in view of its growth profile.
More significantly, there are visible catalysts to support a positive valuation re-rating for the stock.
One catalyst is the appointment of a new CEO for Twitter. Elon Musk has already indicated that he is seeking someone to succeed him as Twitter’s CEO. Once Elon Musk resigns as the CEO of Twitter, he will be able to focus all his attention on the day-to-day running of Tesla, which will boost investors’ confidence.
Another catalyst relates to shareholder capital return and the risk of insider sells. Elon Musk hosted a Twitter Spaces chat on December 22, 2022; he noted that “the Tesla board is open to buybacks” and mentioned that he won’t dispose of “additional Tesla stock until ‘probably’ 2025.” Elon Musk’s comments are taken from a December 23, 2022 Canaccord Genuity research report (not publicly available) titled “Notes from Elon Musk’s Twitter Spaces Chat.” The initiation of share repurchases will help to send a strong message about the undervaluation of TSLA’s shares; while the absence of share sales by Elon Musk will ease selling pressure on Tesla’s stock.
The final catalyst is better-than-expected profit margins for Tesla in 2023 and beyond. As noted earlier in this article, the market anticipates that TSLA will suffer from significant margin contraction this year as a result of price cuts. In my opinion, Tesla’s actual profitability for 2023 might beat the analysts’ expectations thanks to a decline in commodity prices and a higher mix of production contributed by its new Berlin and Austin facilities.
What Is The Long-Term Outlook?
The long-term outlook for Tesla is positive, the company should expand its market gain and extend its lead as the largest company in the EV industry in the years ahead.
Deutsche Bank (DB) issued a research report (not publicly available) on December 19, 2022 titled “Takeaways from DB AutoTech Conference Meeting” which shared insights from Tesla’s Senior Manager of Investor Relations, Travis Axelrod, who participated in a DB investor event in mid-December last year. In this report, Travis Axelrod is quoted as emphasizing that Tesla “is best placed to face any softness in macro conditions, based on its best cost structure, superior margins, and oft demonstrated operational nimbleness.” This sums up Tesla’s competitive edge very well.
As economic growth slows and demand for EVs weaken, Tesla, Inc. is in an excellent position to take market share away from its rivals. Thanks to its cost competitiveness and decent profitability, the company is able to use price reductions as a lever to boost sales in tough times like these. In contrast, a large number of TSLA’s competitors will find it difficult to initiate price cuts, as they are usually unprofitable with untenable financial positions.
Tesla, Inc. is a beneficiary of a virtuous cycle. As Tesla’s revenue base and market share grow, it is able to achieve higher profitability as a result of positive operating leverage and an increased proportion of sales derived from high-margin software and services. This, in turn, allows Tesla to reinvest a meaningful amount of profits into new products to further extend its market leadership.
Is TSLA Stock A Buy, Sell, or Hold?
I continue to rate Tesla, Inc.’s stock as a Buy. I am of the view that TSLA’s shares are undervalued and that there are catalysts in place to correct this mispricing.