Tesla is scheduled to report their Q4 2016 and FY2016 operating results Wednesday, February 22nd after the close. (view the earnings Webcast here at 5:30 ET/2:30 PT) Tesla is the most well-known designer, manufacturer, and retailer of electric cars and powertrain components. Unlike the major auto manufacturers, Tesla owns its sales and service network. The company, led by Elon Musk, recently merged with (acquired) one of his other companies, SolarCity. SolarCity designs, finances and installs solar power solutions. SolarCity doesn’t manufacture the solar systems, but designs systems using components from other manufacturers. The systems they design are “turnkey” and they are primarily promoting systems that can be mounted on a roof (or on the ground) to power a house, business or plant. Unlike the utility-scale solar farms whose relationship to the grid is similar to current utility electricity generation, the SolarCity / Tesla model envisions an off-grid solution where solar panels on the roof power one’s home (or business) and also charge one’s electric vehicles using the “PowerWall”. The batteries in the electric vehicles store energy when that generated exceeds demand and meets excess demand when there is insufficient solar power available. These systems can also be tied into the grid whereby the grid can supply additional power if needed, or excess can be sold back. It is a grand vision, particularly when one notes that the cars are also theoretically capable of driving themselves.
For many, this may seem like little more than a dream, but Elon Musk has dreamt big and has already had some astonishing successes in this vision already. Many may fail to grasp how significant some of these accomplishments are. To start with, he created a new car company, whose vehicles are already among the most lusted after. Tesla has completely transformed the image of the electric car. No longer are electric cars exclusively thought of as modest, range-limited, glorified golf carts. The Model S is a sleek luxury car you can buy online, will show up a Mercedes S-class of BMW 7 series in the parking lot (at least in the eyes of some), dust a Porsche 911 at a stoplight (other perhaps than a 911 Turbo S), carry seven passengers (using the rear-facing jump seats), has available all-wheel drive, can be “refueled” in your garage and drives itself. In 2015 a Tesla Model S P85D became the first, and only, car to be awarded a perfect score of 100. It would be hard to overstate the significance of this engineering and operational accomplishment from an existing major manufacturer, but this was Tesla’s first car that was truly their own (an earlier Tesla was a modified and repowered Lotus). More recently the company offered pre-orders for their upcoming lower-cost alternative, the Model 3. They received 400,000 orders in the first month. If that statistic doesn’t impress you it should. That is 10% more orders in 2016 than Toyota received for the Camry, the best-selling sedan in the United States last year. The Camry is readily available on dealer lots everywhere, costs half as much, and is marketed aggressively, yet Tesla managed more orders for a car almost no one had ever seen in person, let alone driven and whose delivery dates are unknown, online in a single month. This company knows how to create something people want. According to Tesla, the car will ultimately be completely self-driving too. The company announced that as of October 2016 all Tesla cars are built with the necessary hardware to permit fully autonomous driving (SAE Level 5 in industry-speak). Of course, Tesla is not the only one designing turnkey solar solutions, or making electric cars, or even making self-driving ones. They are the first tying it all together. Their cars are also peerless among electrics at the moment. A model S is not an iPhone compared to a Pixel or Galaxy. It is the latest and best iPhone compared to a Motorola Startac.
With a vision this transformative, one better understands how some very prominent and thoughtful investors have made substantial investments in the company, and believe the upside potential is enormous. Ron Baron, Chairman, and CEO of Baron Capital has called Tesla “maybe the most interesting” company he has ever invested in (source CNBC) and, although risky and still in the “show me” stage, suggested it could ultimately be worth a trillion dollars. A long-time friend of mine and multi-decade fund manager at Fidelity Investments, Tesla’s second-largest shareholder, once told me that he believed Tesla would completely change the world with respect to energy and transportation. Both Ron Baron and Fidelity saw this opportunity early, both having bought the stock when it was well below $50/share.
As exciting as all this is, there is a problem; valuation. To begin with, neither Tesla (founded 2003) nor SolarCity (founded 2006) is really profitable. Yes, Tesla reported quarterly profits in Q3 2016, but on a GAAP basis, including such things as employee stock compensation, it made just $86 million or .14/share. Incorporate SolarCity into the picture and Q3 2016 falls to a ~($65 million) net loss. This despite billions in government assistance in the form of tax dollars for grants and factory construction, discounted loans, tax credits and rebates for the buyers of both solar panels and electric cars. So while Tesla may have made a car that scores with consumers and Consumer Reports they’re losing money despite government assistance.
For comparison, we can examine a comparably valued US automaker, Ford Motor Company. While Tesla lost ~$900 million in 2015 building and selling ~50,658 very desirable cars. Ford was busy making something investors desire, $7.8 billion in profits. Despite the substantial difference in size and profitability, the market assigns these companies relatively close market capitalizations. ~ $45 billion for Tesla, and ~ $50 billion for Ford. Remarkably Ford’s enterprise value of $38 billion is lower than Tesla’s $44 billion. Naysayers will push back and tell me I cannot drive by looking in the rearview mirror, this is a story about the future. Fair enough. (BTW I can drive looking in the rearview mirror with the autopilot on, but it isn’t recommended)
The auto industry is an exceptionally capital-intensive business. In round numbers, Ford averages ~$7 billion a year in CapEx/Research and Development, more than Tesla’s total FY2016 revenue estimates. The R&D budgets of other big 10 automakers like GM, Volkswagen, Toyota, and Daimler are substantially larger than Ford’s. With product cycles of 6 to 8 years, Tesla not only needs to build the capacity to supply the 400,000 Model 3s they have on order, they need to continue to develop and build new cars. This will require capital, a lot of it, and the company will almost certainly need to raise considerable amounts, which will dilute shareholders. Meanwhile, the major global auto manufacturers are making billions of profits and collectively have well over $100 billion in cash on their balance sheets and huge R&D budgets. They may not have created the “buzz” that Tesla did, but now that consumers are showing interest, they are far better armed financially than Tesla is for the next product cycle, and government assistance isn’t going to last forever.
Of course, Tesla’s cars and image bear little resemblance to the company that brought cars to the masses with the Model T. It might make more sense to compare Tesla’s auto business with an upmarket brand like BMW. BMW sells ~2.2 million vehicles worldwide each year with an average selling price of ~$46,500. With higher margins, BMW is actually more profitable than Ford selling just 1/3rd as many cars, and if any company has electrics that are almost as cool as Tesla it is BMW with the i3 and i8. Still, 2 million cars is a long way considering they delivered fewer than 80,000 in FY2016. Even the most ambitious estimates from respected Tesla bulls like Gene Munster aren’t forecasting 2+ million cars per year from Tesla anytime soon.
How about Porsche? although it has been acquired by Volkswagen, this has historically been the most profitable auto manufacturer in terms of profit margins, reportedly around 20%! Assuming Tesla could achieve margins comparable to those of Porsche and comparable average selling prices, we might be able to work our way back to the number of cars they would ultimately need to produce to justify the current valuation as an automaker. Assuming the market would afford the company a PE of 17 once mature – double the current average multiple of US automakers – the $45 billion market cap would be justified by net income of $2.65 billion per year. Assuming 20% margins that would work out to $13.25 billion in sales. Further assuming an average selling price of $75,000 (based on a mixture of high priced Model S P100Ds which top out around $150k, Model Xs which run in the high $80s and lower priced Model 3s in the $40s) that would translate to 175,000 cars per year. To justify Tesla’s current valuation as a car company, it must be in the top manufacturers, selling millions of cars per year, OR must achieve sales, margins and average selling prices comparable to a legendary brand such as Porsche. Tesla does enjoy a “halo effect” so are these things achievable? Sure its possible, and if any company can do it Tesla is off to a tremendous start, but they still need to ramp production, achieve profitability and then sustain both without diluting the company too much first all while developing new products and fending off the wave of competition that must be coming. That’s a tall order, even for Elon Musk.
One final point before moving on? Accounting. For awhile Tesla was guaranteeing the resale value of their cars. A liability on their balance sheet and questions have arisen in the past about how (and when) they book revenues. It appears the company has satisfied the inquiries from the SEC and agreed to revise how they present non-GAAP measures, but creative accounting is not the type of revenue and earnings numbers investors are looking for.
What of SolarCity? This is a business that appears even further from material profitability than Tesla, although it is likely that one will feed the other. The merger makes sense, because not only are the two products complementary but as more and more Teslas end up in folks garages, the more tempted they will be to install Powerwalls and solar panels. Tesla will already know the most eager customers. If the cars are any guide, the Tesla solar offerings will likely be the most desirable anyway. However again Tesla does face potential well-heeled competition. How about the current electric utilities? Utilities in several places have aggressively and pro-actively begun to install charging stations for electric vehicles, and are unlikely to simply cede the power markets to SolarCity. In round numbers, the total generation in the United States from all sources averages about 350,000,000 megawatt hours per month. The largest percentage of that is from coal. The wind represents the largest renewable source at about 5% while utility-scale solar represents about 1%. Again these are approximations because power demand is quite volatile and weather dependent, as generated from renewables. So while renewables have enormous room for growth, it isn’t clear that Tesla and SolarCity will be the winners. In many places, utility-scale solar is a better solution (such as cities). Even if SolarCity creates a business that competes with conventional generation, it’s worth noting that the largest generation company in the country by Megawatts is Duke Energy which currently has a market capitalization of $51 billion and profits of ~ $3 billion. In other words, Tesla’s valuation has already priced in either the generation business of Duke Energy or the Auto business of a Ford, BMW or Porsche or some split between these.
Regardless utilities stand to benefit from a significant increase in off-peak power demand if all the cars in the United States become electric! Could utilities be the way to play Tesla? Is that why they’ve been trading at above market multiples? How big will the incremental demand be?
While the size of the auto industry is likely to grow with the population of car drivers and riders, it is fair to say that electricity generation will need to expand substantially. In the United States, we consume about 9.2 million barrels of gasoline per day. Using the gasoline gallon equivalent (GGE aka GEG) of ~33.7 kWh/gal we get 396,076,100 mWh/month of incremental power demand if gasoline cars went electric. In other words, we need to essentially double generation. This is a very rough back of the napkin type of estimate but is really just to provoke thought about the scale. Utilities could be a hidden way to play the future of electric cars whether or not they’re Teslas. Another way to play if one is taking a very long view is downstream oil. Even if fossil fuels remain the primary source of electricity generation, and even if fossil fuels benefit from significantly higher generation needs to meet a growing fleet of electric vehicles, it seems unlikely that gas stations will be able to adapt. It is easier and more practical to use charging stations at home and in parking lots than stopping at a charging station for a quick top up between errands. Electric vehicles have historically had inconveniences that owners had to overcome, such as limited range and places to charge up. As electric vehicle ranges increase and charging stations pop up everywhere the perception of inconvenience may actually swing against conventional gasoline and diesel-powered vehicles which cannot be fueled at home or in the grocery store parking lot while you’re shopping. How those charging stations are ultimately monetized also provides an enormous business opportunity, but again who and how to pay for it remain the open questions.
In most instances, stocks will respond favorably or unfavorably to their operating performance. Did the company grow revenues, earn profits, generate free cash flow? Did the company have positive trends including growth in the aforementioned financial metrics and others that might apply to their business? Are management comments positive or negative? How are they guiding for the future; assuming they provide guidance. Naturally, this data is also taken within the context of the street’s expectations and estimates for all of these. Deliver solid results while beating The Street expectations and offer some upbeat guidance and the stock will show relative strength. Disappoint on all of those and the stock will show relative weakness.
In Tesla’s case, investors are probably not concerned with the Q4 2016 results as much as they are the forward-looking statements. The narrative is one of a transformative renewable energy, infrastructure and transportation company and investors need color on the prospects for profitability, not details on past financial performance. How might emissions credits phasing out affect the ultimate the Model 3? How many of those who ordered expecting to receive a $7500 tax credit might elect not to actually purchase if they don’t receive one? Is the company on pace to meet their goals and projections regarding Model 3 deliveries? Can the company provide evidence that they can achieve profitability in line with other auto companies (at least!) without the assistance of government incentives? Watch GAAP earnings carefully. Tesla may be competing with industrials, but employees receive significant stock-based compensation which is more common for tech companies, which is also how they view themselves.
The solar industry is going to grow by orders of magnitude. The future of the automobile industry involves autonomous, electric vehicles, and no manufacturer in the world is better known for either of those than Tesla. Ask yourself, can Tesla more easily replicate Uber’s business model and technology? Or could Uber replicate Tesla? Tesla has demonstrated they can design and build excellent autonomous cars, develop cutting-edge software, and create a premier brand. Uber has self-driving cars picking up passengers in Tempe, Arizona. We spoke about competition from the automakers and utilities, let’s not forget some competition may come from a neighbor in Silicon Valley.
One takeaway is that the future of Tesla offers enormous potential, but enormous risks as well, and the ride is likely to be a very bumpy one. For these reasons, on Options Action Friday, my friend and co-contributor Dan Nathan advocated a zero-cost collar ahead of earnings as a means to provide some protection against a sharp downside move while still providing some upside in the event TSLA, currently trading tantalizingly close to the mid-2015 all-time closing high of $280, rallies out of earnings. The street is expecting net losses of ~ ($140 million) on revenues of approximately 2.155 billion, and EBITDA (earnings before interest, taxes, depreciation, and amortization) of just over $200 million. On average, since TSLA first reported earnings as a publicly traded company, it has moved slightly over 10% the day following earnings, although the four most recent quarters have been substantially more subdued with moves no larger than 5%. The options market is implying a one-day move of roughly 6%.
Now they just have to figure out how to do all these things while delivering consistent annual and growing profits to shareholders. We’ll see if that turns out to be harder than building a car that comes when you call it.
