Electric vehicle (EV) pioneer Tesla (TSLA -0.50%) had a rough 2022. After it grew into one of the world’s largest companies in 2021 with a market cap of over $1 trillion, its value fell by more than 50% last year. But the downtrend in the stock has started to reverse rapidly in the first month of 2023. After Tesla reported solid fourth-quarter earnings on Jan. 25 and offered an optimistic outlook, its stock popped more than 20% over the next two trading days.
Shares are now up by about 40% year to date, and the automaker is back to a market cap of more than $500 billion.
Tesla is projecting its EV production will grow yet again in 2023. But that doesn’t mean the stock is a buy. Here’s what Tesla bulls are missing that could tank the stock in 2023.
Q4: No big surprises
Tesla reported solid if unsurprising Q4 results. Revenue came in at $24.3 billion, up 37% year over year. Net income grew at an even larger 59% to $3.7 billion. The company has rapidly scaled its manufacturing over the past few years and started putting up impressive profit margins for an automaker.
For all of 2022, Tesla’s net income was $12.6 billion on $81.5 billion in revenue, giving it a net income margin of 15.4%. This is much higher than its automotive peers, a key reason why investors have bid up the stock. Tesla has achieved these strong margins by spending less on research and development than its competitors do, and by charging premium prices for most of its vehicles.
Tesla is forecasting that it will manufacture 1.8 million vehicles in 2023, up from 1.37 million in 2022, but CEO Elon Musk said on the Q4 conference call with analysts that production could reach 2 million if there aren’t any major hiccups. Many investors cheered this news. But this doesn’t solve Tesla’s major issue at the moment: maintaining demand for its vehicles while pricing them profitably.
TSLA Net Income (TTM) data by YCharts.
All signs point to margin compression
Restricted supply across the automotive market in 2021 and early 2022 enabled Tesla to raise its prices significantly, which led to margin expansion. The company also benefited from older contracts on commodity inputs like lithium, nickel, and cobalt, which allowed it to buy them at lower prices.
Now, all these factors that powered rapid margin expansion are starting to unravel. Since the August peak, the price of a used Tesla has started to plummet and currently sits at around $51,000. This, in turn, has hurt demand for new Tesla vehicles at higher prices, and the company lowered the cost of cars across its fleet by 5% to 20% in early January to spur demand. The company is also dealing with soaring input prices, with commodities like lithium up significantly in the last few years. Tesla just signed a new lithium contract, which includes market-based pricing, that should start showing up on its income statement within the next few quarters, and not in a good way.
On top of decreasing selling prices and rising commodity costs, Tesla is likely getting squeezed by growth in average hourly wages across the U.S. Add up all these factors and Tesla’s profit margins are likely headed much lower. You can already see it in the company’s gross margin, which fell to 25.9% in Q4 compared to its peak of 32.9% in Q1 2022. This will only continue after its latest price cuts. If gross margins decline closer to 20%, it will be almost impossible for the company to maintain a 15% net income margin.
Profit margins are much more important than production growth. If Tesla continues on this margin compression path, its earnings will be much lower in 2023 than they were in 2022.
The stock is wildly overvalued
Tesla is guiding for production of 1.8 million vehicles in 2023, up about 30% from 2022. It is unlikely that the company will be able to raise prices on new vehicles because of declining used car prices — lower used car prices almost always force a manufacturer to lower new car prices — and new price cuts from competitors. With selling prices 10% to 20% lower, this production growth could still lead to Tesla’s revenue going from $80 billion last year to $100 billion this year. Good news, right? Well, not exactly.
If Tesla’s net margin declines to around 10% in 2023 — and all signs point to that being likely, given lower car prices and higher input costs — that would give it $10 billion in earnings on $100 billion in annual revenue, which would be lower than the $12.6 billion in earnings it generated in 2022.
At a market cap of $550 billion (roughly where the stock is now), $10 billion in net income would give Tesla’s stock a price-to-earnings ratio of 55 — almost triple the current market average. Declining earnings and a price-to-earnings ratio of 55 look like a recipe for disastrous stock returns, especially for more mature businesses like Tesla. The average automotive company trades at a P/E ratio below 10. If Tesla fails to grow its earnings at a high rate as it has in the past, there is major downside for shareholders as the stock will likely start trading in line with competitors.
Unless Musk can pull another rabbit out of his hat, Tesla’s stock looks to be in a precarious spot right now, regardless of how fast its production grows in 2023.