Tesla China Factory: What It Means for TSLA Stock

TSLA stock
iStock.com/jetcityimage

Is Tesla Moving to China?

Despite rising tensions in the U.S.-China trade war, Tesla Inc (NASDAQ:TSLA) is putting all its hopes on expansion in the Middle Kingdom. The first step, a Tesla China factory, has already been signed, sealed, and…well, not delivered quite yet, but it should be by 2023. What does this mean for TSLA stock?

Nothing good, I’m afraid.

Tesla is a sitting duck between two superpowers. So if the trade war escalates—and it certainly looks like that could happen—we could see its factory become a bargaining chip in geopolitical negotiations.

We’ve seen it happen before.

Advertisement

QUALCOMM, Inc. (NASDAQ:QCOM) was caught in the same trap for more than two years.

Ever since 2016, the chipmaker’s proposed merger with NXP Semiconductors NV (NASDAQ:NXPI) has been delayed by the Chinese government as retribution for something the United States did to a major Chinese smartphone maker called ZTE Corporation (OTCMKTS:ZTCOF, HKG:0763).

Here’s what happened to QCOM stock as a result:

Chart courtesy of StockCharts.com

The link between stock prices and geopolitics is ugly, messy, and worst of all, unpredictable. It’s not something investors want to hear, either.

In an ideal world, those two things would have nothing to do with each other. But reality isn’t neat. It isn’t tidy.

Elon Musk is smart enough to know this, yet he decided to roll the dice anyway. He’s betting that China—the world’s biggest market for automobiles—can become a springboard for Tesla’s leap to mass production.

The only problem is that he’s gambling with shareholders’ money—not his own.

Should You Bail on Tesla Stock?

I want to be fair here. Elon Musk has done the impossible time and again, so it’s hard to bet against the man. But the odds are not in his favor.

Tesla is on thin ice, financially. It burns cash faster than any car company in existence, and (in order to stay in business) it keeps raising equity, thereby diluting the value of existing shares.

This routine—of spending cash faster than it comes through the door—has damaged Tesla’s reputation on Wall Street. It also eviscerated TSLA stock’s performance. Even the biggest bulls have a hard time arguing that TSLA is an outperforming asset when it dropped 7.7% over the last few months.

Chart courtesy of StockCharts.com

Investors are fed up with broken promises and shifting timelines. They stopped glossing over the company’s less flattering aspects and started treating TSLA stock more like any other investment.

Any misstep could upset the firm’s delicately balanced financials. That’s why you see Elon Musk moving heaven and hell to meet quarterly shipment numbers. Reports say employees had to extend their assembly line outside the factory and walk through sewage in order to meet production quotas.

The results were mixed:

  1. TSLA stock jumped when the company met quotas,
  2. Then fell when reports emerged about how Tesla treats its workers.

Musk wasn’t sitting in an ivory tower, though. To his credit, he slept on the Tesla factory floor and worked 80 hours a week to bring the numbers up to scratch.

Other Details to Keep in Mind

Tesla recently hit produced its 200,000th vehicle, meaning that the $7,500 tax credit provided to first-time buyers is going to expire. As a result, we could see lower demand for Tesla vehicles. In turn, this could lead to a reduced outlook for 2019. By extension, this would also mean a lower share price for the next 12 months.

This impact won’t be seen for another two quarters or more, so I’m not bearish on Tesla’s next earnings announcement. But the ones thereafter are a toss-up.

Musk already raised expectations by promising positive earnings in the second half of 2018. When you contrast those expectations with the expiry of a key tax provision, I’d say the outlook for TSLA stock is negative.

Markets appear to be saying the same thing. A new report shows that the default risk on Tesla’s debt obligations is rising. Investors are worried the company will run out of money, in part because Tesla asked a few suppliers to refund their cash. Healthy companies don’t tend to do those things.

But let’s say I’m wrong. Imagine that Tesla meets its production quotas, expands revenue, and opens a factory in China. How much would that elevate its already exorbitant share price? Not much, considering that its price-to-sales ratio is four times the industry average.

Analyst Take

We often forget that Tesla is a manufacturing stock. It has all the trappings of Silicon Valley—a famous CEO, celebrity investors, heavy automation—but that doesn’t mean it can mimic perennial winners like Alphabet Inc (NASDAQ:GOOG) or Facebook, Inc. (NASDAQ:FB). Their share prices are built on high-margin software businesses.

In short, Tesla doesn’t have much room to the upside. Even if it did, I’m not sure the company has the financial stability to get there.