Buy the Tesla Car, but Skip the TSLA Stock
Tesla Motors Inc (NASDAQ:TSLA) CEO Elon Musk just dished out some humble pie to the TSLA stock critics.
Last quarter, the company received more than 325,000 reservations for the new “Model 3.” This marks the biggest consumer product launch in history and confirms electric cars can have mass-market appeal. (Source: “Tesla First Quarter 2016 Update,” Tesla Investor Relations, May 4, 2016.)
Then in a call with analysts, Elon Musk bumped up his production targets. Previously, the company was aiming to deliver 500,000 vehicles by 2020. Now, Musk says Tesla will be able to hit that target by two years earlier than expected. (Source: Ibid.)
The news blew investors out of the water. For perspective, Tesla delivered 50,000 vehicles last year. Musk’s new plan calls for the company to ramp up output tenfold in two years.
The No. 1 Problem with Tesla Stock
You gotta love this story.
Elon Musk has grabbed the world by the cojones and is making things happen. But as much as you have to admire his vision, you don’t want to be the one funding it.
First, consider the valuation. Tesla stock is priced as if it has a car in every driveway. Today, you’re paying $37.0 billion for a company that is only expected to deliver 90,000 vehicles next year. (Source: Ibid.)
By comparison, you have a stock like Fiat Chrysler Automobiles NV (NYSE:FCAU). Right now, this regular old automaker is valued at just $10.0 billion. Yet Fiat produced more than 4.6 million vehicles last year. (Source: “Tesla’s real disruption,” The Globe & Mail, April 9, 2016.)
Something is wrong with this picture.
Chart courtesy of www.StockCharts.com
Investors have priced TSLA stock like a tech company. But what happens if they pull their heads out of the sand and start to price it like an automaker?
An analogy could be LendingClub Corp (NYSE:LC). Here you have a cool new firm using the Internet to match borrowers and lenders. During the recent boom in Silicon Valley, investors slapped a premium tech stock multiple onto this company.
Then last week, investors realized LendingClub is basically a bank—and a bad one at that. All of a sudden, investors started pricing this stock like a boring old financial institution. Since Tuesday, shares have plunged more than 40%.
Is this comparison absurd? Probably. The scenario, though, should keep shareholders up at night.
My crazy analogy aside, Tesla could still run into a lot of problems. Will President Trump cut subsidies? How will Tesla address the lack of fast-changing power stations? Can the company really ramp up production as claimed?
By the auto industry’s standard, Tesla is a glorified mosquito. How do you think competitors will react when Tesla really starts to bite into their businesses? They’re not going to take it lying down.
We’re starting to see them roll out their possible “Tesla Killers.” The “Chevy Bolt” is selling well. Analysts are also impressed with the BMW “i3.” How will Tesla sales fare when shoppers have lots of top-notch electric vehicles to choose from?
None of these concerns are enough to dismiss Tesla outright. You have to question, though, the logic of slapping on such a rich value on a stock with a lot of question marks.
If You’re Bullish on TSLA Stock, Read This
Of course, Tesla has made road pizza out of the skeptics before.
My favorite video is of Elon Musk on CNBC. Jim Cramer bashed the company after its initial public offering, right around the time Tesla was trading at $17.00 per share. Musk flat-out dissed Cramer on live TV, calling him a contrary indicator. (Source: “Elon Musk Disses Jim Cramer live on CNBC,” YouTube, June 29, 2010.)
If you could criticize Elon Musk for anything, you could say he underestimated the size of the market. In a 2011 letter to shareholders, Musk predicted “Model S” shipments would peak at around 20,000 units per year. Today, sales clock in at 50,000 annually and growing. (Source: “Tesla Drastically Underestimated Model S & X Demand (Financials Flashback),” Clean Technica, May 5, 2016.)
Let’s assume the company clears the hurdles. I’m confident they can. But even if Tesla becomes the next great carmaker, we have to acknowledge that making cars is an awful business.
Sergio Marchionne, the CEO of Fiat Chrysler, highlights this point. In his presentation “Confessions of a Capital Junkie,” Marchionne flat out admits automakers are a terrible investment. Original equipment manufacturers (OEMs), he explains, have never earned their cost of capital through any business cycle.
The problem? Every day they turn on the lights, automakers are burning through cash. Building cars—from constructing the plants and factories to meeting new environmental regulations—is an expensive proposition.
One number in Marchionne’s presentation really stuck out. Automakers must recycle all of their enterprise value (debt and equity) in product development costs about every four years. By comparison, oil companies (a low-return business, by the way) recycle their capital only every seven years.
In other words, automakers are on a treadmill. They must constantly plow their profits back into operations just to stand in place. You don’t have a lot of cash left over for shareholders.
By comparison, consumer and retail brands—wonderful businesses like Hershey, Wal-Mart, and Home Depot—take 30 years to recycle their capital. They don’t need to invent the next gee-wiz gizmo every few years. And with all of that extra cash, they’re able to lavish investors with oversized dividends.
Investors have two choices:
On one hand, you can buy an automaker—an automaker, by the way, that will be spending billions over the next few years. In the best-case scenario, it will likely be only sort of profitable.
On the other hand, would you rather own a wonderful business like McDonald’s Corporation (NYSE:MCD)? With its franchise model, McDonald’s puts up almost no capital. In exchange, the company receives steady, ongoing royalty checks year after year.
The Bottom Line on TSLA Stock
I want to be wrong on TSLA stock.
Elon Musk’s big, hairy, audacious goal could change the world. Frankly, he’s well on his way. When Tesla dishes out its next serving of humble pie to skeptics, I’ll be first in line.
That said, I don’t want to fund Elon Musk’s vision. There’s too much money being sunk into the business and I don’t see too much money coming out anytime soon.