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TSLA a Value Buy? 2019 P/S below 1.5

Mittwoch, 5. September 2018

TSLA a Value Buy? 2019 P/S below 1.5

The Story

Everybody who has been following market news, or actually any news in recent past is probably familiar with the basic story of Tesla. They have been the market leader in electric cars in the US (lately by a huge margin, scoring about 50% of all EV sales in August), have a semi and a pickup truck in the pipeline; claim to already have finished in house developed AI chips that make its computers 10x faster - at the same cost - than with previous hardware bought from suppliers (Nvidia); plans of adding self driving capabilities and being a leader in fully autonomous driving and "MaaS" (mobility as a service) in only a few years; they are also selling solar roofs and battery storage systems for homes and businesses and predict their "energy" division to grow faster than and eventually be as big as their auto business.

For an experienced investor, the Tesla story looks too good to be true, obviously it's one of those "story stocks" - if not the story stock - with a highflying fantasy valuation nowhere near reflecting business reality. In my opinion, this is what TSLA was, but these times have passed.

Contrarian Thoughts

Even among my friends and family there is always somebody immediately responding "it's an overvalued hype stock!", "it's a bubble!", or something similar whenever there is a conversation about Tesla. Often these people are not into investing at all, but "Tesla is an overvalued hype stock" wisdom has spread from the investment community over mainstream media to "common sense". as a consequence, it is no longer true (as I will explain in more detail).

Not many companies (I would even say: no other company) have to deal with more skepticism than Tesla. That every journalist in the world has been informed that there might be something like a cult around this company and its leader was only the beginning of a movement that is, to my knowledge, unprecedented in stock market history.

The #TSLAQ Community 
Tesla has always had its share of short sellers (which by the way is generally not a sufficient reason to buy a stock, as stocks with high short percentage of float do not always go up - on average they even tend to underperform the market. there is no "short squeeze automatism"), but at some point, with this company, something unique set in.

As mainstream media hosts in recent years increasingly realised that Tesla might be a bit overhyped - to be fair: this was to a large extent because its CEO has kept making promises he regularly could not fulfil in time - and (with good intent) more and more often invited bearish analysts and high profile short sellers like Jim Chanos, public sentiment started to turn as well. And besides the broader public becoming more skeptical about tesla and musk's promises, a new dedicated anti-Tesla community developed on social media: the "#TSLAQ" community. (the "q" is added to a stock ticker to signal to investors that the company has filed under chapter 11, bankruptcy, which in almost every case means the future value of the stock is 0.)

These are people who not only think that Tesla is going down (and accordingly sold the stock short or bought puts to profit from it), they are actively trying to help bringing the stock down. Which by itself is still not unusual: exactly like long investors use to promote their picks in every possible way, short sellers have always used to search for and publish negative information about companies, ever since short selling exists.

What is new is that it's not some single investors promoting their short selling idea, but it has become a movement (thanks to social media) and part of mainstream media is supporting it. This is not just some big short sellers with money to buy some negative news. It's a crowd, including many retail investors (i have seen many "this is the first time ever i shorted a stock" on stock message boards) who genuinely think they are doing good when they help exposing Tesla's mistakes. The result is a flood, a tsunami of negative news bits coming from twitter, financial message boards, financial blogs (like zerohedge) - and larger news agencies (sometimes picking up something from a bearish blogger, but sometimes doing extensive research and finding "whistleblowers" to have their own "scoop").

The short selling community has (although lacking a leader) become a "cult" of its own, with plenty of members dedicating their spare time on their "cause" (which is bringing Musk and Tesla down) with great passion.

Mainstream Media
You probably also noticed that recently some (more or less) mainstream media outlets no longer seem to be even trying to produce balanced reporting about Tesla, instead have been writing openly negative - Business Insider most obviously, but also big names like Reuters and the New York Times are repeatedly writing "hit pieces". (Reuters is especially influential outside the USA, as there are many news outlets in Europe who don't do own research about US business, but traditionally use big agencies like Reuters as their sources.)

I do not think any of those journalists are getting bribed by short sellers (or are selling large amounts of stock short themselves) to write negative articles against Tesla and Musk. Some are doing it with best intent, they still think Tesla is an overhyped fantasy stock and company and they have to educate the public, others simply hate Elon Musk (it did not help that he explicitly accused one journalist of bribery this year. That naturally spurred solidarity within the occupational group. Nor did it help that he announced plans for a "Pravduh" project, by which he intends to expose bad journalism) and, not to forget, every Tesla story is making a lot of clicks, which equals money for online news outlets.

The situation has become so wild that there are already websites tracking and trying to quantify negative articles without actual news content. (Maybe a trading strategy can be derived from that, but i am not sure yet.)

I am not here to judge about ethical (or even legal) implications of biased journalism, i'm not even sure about what my own judgement would be. It's not a genuinely bad thing that short selling acts as an incentive to report flaws of business models and business execution. Basically, this is what business journalism should do in first place.

For me the important question is, has this gone unusually far, has it visibly moved tesla's valuation in the stock market, and, therefore, has it created an outstanding investment opportunity?

There are so many Tesla Memes, repeatedly used by even not explicitly bearish commentators on CNBC, usually unquestioned, that are not (no longer) true, but - at least to some degree - all priced into the company's current valuation because people are hearing them on a daily basis - some examples:

  • "It's a cult stock" (Yes, Tesla has a fan base, but since also it has a loud hater community, they neutralise each other in terms of stock valuation),
  • "It's an auto stock, it should be valued like an auto stock" (Yes, Tesla's main business is selling cars. This does not mean it should have a Price to Sales Ratio of 0.5, as some "experts" suggest. Car companies often have these multiples, but not because they are selling cars - they have them because their revenues or margins have not been growing for years and their future prospects look dim because everybody expects EVs and self driving to change the industry),
  • "Competition is coming" (Yes, more car makers are bringing electric vehicles to the market. But it's a fundamental misunderstanding, Tesla would be competing within the EV market. Those tens of thousands lining up to wait months for a Model 3 are not buying it because they desperately wanted an EV and then decided that Tesla might be a good choice among those: they are buying an EV because they want a Tesla. Tesla is competing against all kinds of cars. Competition has been there all the time.),
  • "Demand will come down" (Yes, demand might eventually slow down at some point - from a level so high that they are nowhere near being able to fulfill it: within weeks after announcing Model 3 they had hundreds of thousands customers willing to put down $1000 and wait two years for the car - without even having seen one in real life. It's been one of the most in demand products in history. It looks highly improbably that suddenly, when there is no waiting time, when you can simply go to a Tesla store, make a test drive and buy the car, no one would want it. My estimate is that they could in the USA alone sell all the cars they can produce for the foreseeable future - but they still have to fulfil hundreds of thousands of international orders as well),
  • "They are behind everyone else in autonomous driving" (This opinion stems from 2017 research by Navigant, whose criteria was "vision; go-to market strategy; partners; production strategy; technology; sales, marketing, and distribution; product capability; product quality and reliability; product portfolio; and staying power". This was not about technology. When actual performance is tested, currently Tesla seems to be ahead at least with their lane keeping assistant - but I think it is still to early to judge who will win the self driving race. By the way, my bets are on Tesla and Google: Tesla has the advantage of more real world data by it's semi autonomous fleet on the road and, possibly, their new AI chip, while Google has the advantage of being overall AI technology leader.)
  • "Elon Musk is out of his mind" (Yes, Musk had his outbursts on twitter that did not help his reputation. Notably, his way to communicate the idea of taking Tesla private clearly was a mistake. And he, in many cases, showed he has a hard time with simply saying "Sorry, i was wrong on that", which would, in my opinion, dramatically improve public opinion about him. But, in my view, what the media and the public make of all that  is way overblown - one revealing example was reception of his showing emotions at one point when he talked about not seeing his children because he worked to hard, which the NYT famously described in an article about an interview. He is an emotional human being, he is often overly optimistic about what his company can achieve - btw, analysts already have discounted his optimism in their own TSLA sales estimates, for years - and he still has to learn to be less impulsive on twitter and to immediately apologise when he failed in this respect. But he clearly is not "insane" and he is not a "pathologically lying con-man". By the way, the president of the US, who I explicitly dislike for his political opinions (e.g.) on climate change, is not insane either.)
  • "Tesla is going bankrupt in a few months" (While nobody can look into the future of car sales and nobody from outside can look into Tesla's books, this is one more idea that looks extremely unlikely from a neutral position. Even IF it is another "lie" from CEO and CFO, which many TSLA bears certainly believe, that they are cashflow positive and profitable in the second half of the year and they therefore not only need no new financing, but will be able to repay some debt, this is still far from being the final curtain for Tesla. They could still pledge their "crown jewels", as bloomberg suggests or raise cash from investors. I still think there is a high chance they won't have to do either, because their margins should significantly go up on a more mature production process over the next few months, and this quarter because of selling mainly the most expensive, higher margin versions of the model 3. which leads me directly to...)
  • "They are losing money on every single car they sell" (Tesla already had a couple of breakeven or nearly breakeven quarters. That was shortly before they ramped up Model X production, when Model S started to become profitable and shortly before Model 3 ramp. So, obviously, they are making money on selling Model X and S already and their losses are due to introducing new models. Production was extremely inefficient in the beginning of Model 3 ramp, Tesla is almost famous for the amount of scrap they produced then. But, of course, it is becoming more efficient over time, probably already profitable at the moment i am writing this, almost certainly later this year. Even Tesla critics admit Model 3 has the potential for significantly higher margins than their previous models.)
"Overvalued fantasy stock"?
So, is Tesla still "one of those highfliers", with "fantasy valuation", based on highly vague future projects advertised by "con-man" Musk? At this point, you won't be surprised that my answer is, clearly, No. It isn't, since market has, because everything i wrote above and more, after discounting most of Tesla's future business opportunities, began to discount even what Tesla has already achieved.
At the moment I write, nearly 40k Model 3 have been produced in the ongoing quarter and Tesla seems to be in line with their guidance of 50-55k for total q3, according Tesla Motors Club - Model 3 Production Tracker and Bloomberg.

Average selling price of these cars is well above 50k per car, i estimate 60k for this quarter because of a mix strongly leaning to AWD performance version.

Last year's q3 revenue was about $3b, without a significant number of Model 3 produced. If other revenue approximately is the same as last year (which i think it will be), this makes revenue probably come in at 6b this quarter.

I further estimate they will moderately grow production again next quarter, to about 5.5k-6k Model 3 per week and then to 7k in q1 and 8k in q2 and start delivering to international customers. Expect selling price to come down significantly in 2019, because they will finally introduce the long promised base version at 35k (few will actually sell at this price, because almost everyone who wants to have a Tesla will want to have the autopilot package as well). I expect 55k in q1 and then 50k.

Assuming Tesla won't sell a significant amount of solar roof or battery storage, which is rather pessimistic in my view, they will still increase q4 revenue by about $3.5b from 2017, $4b year over year in q1 2019 followed another 4b in q2.

This would make revenue growth rates come in at about 100% for each of the next three quarters (until year over year growth numbers slow because Model 3 already sold in significant numbers in the previous year quarter; I expect 2020 to be a year of slower gains, with growth picking up again in 2021 with china factory, Model Y, Roadster, Semi; I expect the pickup truck a year later; I'm not sure if solar roof or batteries will make significant revenue, but they might).

Let's not talk about the distant future but stick with what we can predict with pretty high probability: 2019 revenue will be significantly above 30 billion $ and this will be obvious already in a few months; moreover, 2019 should be a highly profitable year because i don't expect significant production of Y and Semi until 2020. Market currently (9/6/2018) values TSLA at 48 billion. This is slightly more than 2 times 2018 and I estimate lower than 1.5x 2019 sales. Its valuation is very down to earth.

What the market is missing
News are currently too much focused on Musk's tweets and weekly or even daily production numbers (any other product in the world where bloomberg would try to track weekly production?), accidents, fires, issues with more or less potential impact but virtually all of them short term or singular events (which naturally make the daily news), overshadowing the big picture:
Tens of thousands of Model 3 are just beginning to flood the market. This is real, not "Musk cult" fantasy. And it's not going to stop anytime soon. The more cars on the road, the more people will become interested in the car AND the stock, instantly raising demand for both; news could turn to sales numbers, new upgrades (v9 software, new hardware coming in a few weeks) and new products (y) very fast - in case Musk manages to not insult somebody or tweet anything else that shows he still does not fully understand his responsibility as CEO of a multibillion $ company (that is as closely watched as no other, because retail is overinvested on both side of the trade - people with little stock market experience have invested all their live savings in this one company, while newbie shorts bet more than they can afford to lose on the other side as well).

I don't think the software update or new production records or the new in house developed AI chip or y or semi, self driving Tesla fleets or utility scale energy projects... i do not think any of those future products are unappreciated by observers. Everybody knows these hopes are part of the Tesla story.

What broad market is still missing is that Tesla's valuation is no longer based on these hopes. they are already selling more than 20000 cars a month (almost all of them with a price tag well above $50k). In my opinion you can easily justify the current market cap of 50 billion simply implying the products they are already selling will continue to sell Ok. As customer satisfaction is still outstanding (customers, on average, really love those cars - and reviewers do as well) and they also still have some hundreds of thousands of international orders to fill, there is not much doubt they could do that. (Of course they will add new products, of course they will build a factory in China, of course they are not going to settle with what they already have achieved. I just want to show that the investment story is changing. This stock has value based on real, fast selling products, already on the road. An exciting product pipeline on top of that - is no longer their only asset to win investors.)

Stock Price Potential

As explained above, I expect Tesla's 2018 revenue to top $20b this year and 2019 revenues to grow by more than 50% once again; I expect sustainable (at least until Model Y production ramp) profit from q4 2018. I would not dare to predict a PE, because i think not even Tesla's CEO Deepak Ahuja could precisely the margins for 2019. It's still too early to be looking for stable predictable profits in this company as long as they continue to introduce new products. I would wait for 2025 when they have built all their planned factories to value this by PE. Until then, it should be enough that they stop burning cash and apart from that i look at price to sales. i think a p/s of 2.5 or higher should be in the cards as long as the company is growing fast (my prediction: at least for 5 more years). So with revenues of 35b in 2019 it would be valued at near 90b by the end of next year.

So about $550 per share looks possible.

Warning

Until Tesla actually is as sustainably profitable as it predicts to be, there will always be a chance for the company to fail financially. This it is not a pure short seller's fantasy. Tesla has almost 10b in debt. Although this scenario looks highly unlikely to me, given a big community (including some big pockets) supporting Elon Musk's masterplan and ready to lend or invest a couple of billions if necessary, you should not completely rule it out.

I think there is a high probability for the stock to double in a year, which - for me - justifies taking the risk and buy it now. But I definitely would not buy it on margin and I would not bet more than I can afford to lose completely.

Summary

There are two highly biased communities invested in this stock. Probably more inexperienced investors are short TSLA than have ever been short any other stock in history. It also still has many inexperienced investors betting all their money and more that Musk will succeed. But it's no longer the typical hype stock with fantasy valuation, no longer "priced to perfection". The "TSLAQ" camp has been dominating public sentiment for weeks. CEO Musk has added with some ill-considered tweets about an ill-considered privatization that did not happen. This made valuation come down to reasonable - in my opinion even bargain - levels.

At a market cap of 50b, with 20b in revenue this year, still growing fast, probably on the brink of profitability, I am buying TSLA.

Stock TSLA
Rating Buy
Price Target 550
Current Price 280


Disclosure 

I am long TSLA.

Disclaimer

Of course, everything I write is only my opinion and should not replace your own research. (It's not even a recommendation, it's only an explanation for my own trading.)
I do not know the future either.

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