- Tesla CEO Elon Musk recently spoke at the Baron Investment Conference where he said that Tesla could possibly grow bigger than General Motors.
- Mr. Musk also spoke about a 500-mile range Tesla car in about 10 years saying that advances in battery technology would make that possible.
- The more important question for investors is how soon Tesla can realistically expect to become profitable.
Tesla (NASDAQ:TSLA) chief executive Elon Musk recently spoke at the Baron Investment Conference in New York City. Musk spoke at length about Tesla’s long-term ambitions, saying, among other things, that he sees the company producing a 500-mile range vehicle within a decade, and also reiterated the company’s ambition to churn out millions of cars in the future. Among Musk’s most interesting comments was the assertion that Tesla can grow bigger than General Motors (NYSE:GM), noting that Tesla would have to build a lot more gigafactories to achieve that scale. After all, GM sold 9.7 million vehicles in 2014, becoming the world’s third-largest automaker while Tesla expects to sell just 50,000-52,000 vehicles in 2015.
Of course Mr. Musk may have made that comment about Tesla growing bigger than GM in light banter, though one suspects that deep down he truly believes that it could become a reality one day. But how realistic is that goal?
Bringing battery costs down
Tesla’s biggest problem right now is the lack of profits, which in turn is as a result of limited production. Although its possible for even a small automaker to be solidly profitable, that is usually the preserve of ultra-high-end brands that sell for a prince’s ransom. A good case in point is Ferrari NV (NYSE:RACE) whose IPO was held recently.
Ferrari enjoys an EBIT margin of around 14%, way higher than what your average auto manufacturer can lay claim to. The Italian manufacturer is ultra-high-end and severely caps the number of vehicles available for sale to preserve the exclusivity of its brand. Ferrari sold just 7,225 vehicles in 2014. Despite the unusually low volume, Ferrari is solidly profitable and its FY 14 earnings of $275 million euros clocks in at a good 12.1% of parent Fiat Chrysler (NYSE:FCAU) earnings despite contributing just 2.9% to Fiat’s top line. Ferrari of course has the high ASP of its models to thank for its fat bottom line--the company’s entry-level F12 Berlinetta starts at around $320,000 while its high-end "LaFerrari" costs a prince’s ransom--$1.2 million.
In sharp contrast, Tesla’s EBIT margin is a lowly 1.61%.
Despite being a 10-bagger over the last five years, Tesla stock has lately been sluggish due to Tesla’s continued lack of profits. Tesla stock is down 6.8% YTD and 17% over the past 12 months.
Tesla has mainly languished in the red as high development costs continue to outweigh growing sales. Since Tesla is not a luxury brand, the only viable option to profitability is by growing production volumes. For Tesla to start turning a profit consistently, it has to grow its sales volumes to a certain level. According to Musk, Tesla won’t achieve profitability until it hits sales of 500,000 units per year, which the company projects will happen by the turn of the decade. Tesla expects to sell 55,000 units during the current fiscal year. During the company’s last earnings call, sales grew 40%. If Tesla maintains a CAGR of 40% through 2020, it will manage to sell just shy of 300,000 vehicles by 2020. It therefore appears as if Tesla is betting big on Model X to become a hit and sell as many as 200,000 units by 2020.
For Tesla to hit those kind of numbers, it will have to lower its production costs considerably then pass on the benefits to the consumer in the form of affordable prices for its models. And, going by industry trends, Tesla might very well be able to do just that.
The biggest cost component for any EV manufacturer is battery cost. But luckily for Tesla and other EV makers, battery prices appear to be on a free fall and are declining 14% every year. When Tesla first launched Model S, the 90 kWh battery that powers the vehicle would have cost the company a hefty $90,000. Analysts estimate that the battery now costs Tesla ‘‘just’’$36,000.
Industry analysts further project that for EVs to truly compete with conventional vehicles on an even keel, battery costs will have to fall from the current average of $410/kWh to $100/kWh. Going by the current double-digit rate of decline, this should happen in the next 6-7 years. Tesla of course has its massive Gigafactory in Reno, Nevada, that might help it achieve that milestone a bit earlier than its rivals. The company’s estimate of 500,000 sales units by 2020 does not appear to be far-fetched.
Growing bigger than GM
As for Tesla’s ambition to grow bigger than GM, that would not only have to involve the average cost of EVs becoming competitive enough with their gasoline-powered counterparts, but also a radical shift in consumer tastes. Studies have shown that it takes an average of 15 years from a new invention to go from a niche product to becoming mainstream.
We are just at the beginning of an exponential growth stage for EVs, which implies it might take another 15 years or so before EVs become fully mainstream. Tesla might then be able to sell in the millions to overtake GM. It will, however, be interesting to see the company exceed 13 million vehicles, which will be GM’s production 15 years from now assuming it maintains its current growth rate of 2% per annum.
Meanwhile, Goldman Sachs predicts that Tesla will be the 8th largest automaker in the world 10 years from now:
Source: Goldman Sachs, IHS
Tesla investors, hopefully, won’t have to wait that long. As long as Tesla can demonstrate a clear path towards profitability, Tesla stock is likely to make decent gains over the next 2-5 years.