- Credit Suisse has issued a positive note on Tesla saying that lower SG&A, R&D spending and sales leverage from strong Model X sales will give a large boost to Tesla earnings.
- The report comes two weeks after Barclays warned that investors could be underestimating Tesla future cash burn rate.
- Is Credit Suisse's optimism well-grounded?
About two weeks ago, Barclays issued a bearish note on Tesla (NASDAQ:TSLA) saying that investors could be underestimating the company’s cash burn rate in coming years as the leading EV manufacturer pursues its quest to become a mass producer of electric vehicles. Barclays said that Tesla would spend ~$11 billion over the next five years, most of it associated with the company’s first mass-produced car, Model 3, which Tesla plans to launch in 2017. Tesla shares sold off quite heavily following the report. I delved a little deeper into Tesla's current cash flow position in this article, and concluded that the company faced no real danger of sinking into a cash crunch over the next two years or so.
But not everybody in Wall Street shares Barclays’ view. Credit Suisse has now issued a positive report on Tesla saying that not only is the company not in danger of facing a cash crunch as Barclays has predicted, but that it will actually realize considerable sales leverage in 2016 mainly due to lower R&D investments as well as subdued SG&A spending, as well as a significant boost from Model X sales:
2016 is a much cleaner year, which enables operating leverage: The biggest future catalyst we see is Tesla generating significantly higher earnings and reducing the cash burn. From $2.30 annualized loss in 3Q15, we estimate 36k incremental Model X units will drive $7 of incremental EPS. This, plus better Model S margin, offset by lower-than-consensus SG&A / R&D growth means that $4 EPS (vs consensus $1.86) and a reduction in full-year FCF burn to ~$500MM is achievable…although we think even hitting consensus numbers in 2016 would be a substantial catalyst.
Additionally, Credit Suisse expressed optimism that Tesla can achieve its fourth quarter target of 17k vehicles:
17k units in Q4 achievable: Investors are skeptical around Tesla’s ability to get to the low-end of delivery guidance which requires a 46% sequential increase. Our estimates are based on 15k orders in Q3, 1k incremental sales in Denmark (due to year-end tax changes), and 1k incremental sales in UK (11-mth backlog of orders prior to right-hand drive “D” launch in Sept)…
Is Credit Suisse Being Overly Optimistic?
One thing that immediately jumps at you about the Credit Suisse report is the banker’s projection that Tesla would be able to sell 36,000 Model X units in 2016, just one year after its launch. In comparison, Tesla launched Model S in July of 2012. About 18 months later, Tesla announced that it had sold only 25,000 units. This in effect means that Credit Suisse expects Model X sales to ramp up at about twice the rate for Model S during its first year.
At first glance, this appears like a really ambitious target since there is only a three-year gap between the launch of the two models. But in a developing technology like EVs, three years can make a whole lot of difference. Early sales of Model S were partly hampered by a lack of adequate support infrastructure such as charging stations. Nobody wants to own an electric vehicle if you have to drive 100 miles to the next charging station. Tesla did not start expanding its dedicated supercharger network until late in 2012. Currently Tesla owns 557 supercharger stations with 3,181 superchargers.
Other than a vastly improved infrastructure, there are a couple of other factors that will help Model X sales to ramp up much faster than Model S. Tesla recently announced that it will sell base Model X at $80k, just $5k higher than base Model S. Federal tax credits and state rebates could shave another $10k or so from that cost. Considering that the new model is a lot flashier than its predecessor without being significantly more expensive, there is a very good chance that it will enjoy very healthy sales.
Tesla could also receive a significant boost from secular tailwinds. The strong economy and cheap gas has been helping discretionary spending. For instance, TrueCar has forecast that auto sales in the U.S. in the month of November will grow 4% to 1.35 million units, a new record for the month of November. Although cheaper gas provides a disincentive for people to purchase electric vehicles, the effect is not nearly as strong as the positive effect of a strong dollar.
Why Tesla Stock Could Be A Long Term Bet
While Credit Suisse’s projections might turn out to be a bit optimistic, I believe the analyst is quite in the ballpark regarding Model X playing a big role in Tesla’s earnings in the coming year. An incremental EPS of $7 by the model as predicted by the analyst would probably be enough to take Tesla very close to breakeven point. But perhaps the most important takeaway from the report is that Tesla is gradually moving closer to becoming profitable, and this makes the shares good for the long haul.