Tesla stock continues to trade at lofty valuations despite high risks and continued losses.
The electric vehicle manufacturer Tesla Inc (NASDAQ:TSLA) has weathered another storm, at least temporarily. While Tesla stock is still down 25% from its mid-September peak, the stock has made a remarkable recovery from the recent lows, cheerleaded of course by the CEO Elon Musk. This is not to say that the company is completely out of the woods yet. Far from it. Tesla faces several headwinds as it continues to struggle with Model 3 production. Recent reports indicate that Tesla has once again halted the Model 3 production for four to five days to fix productions issues.
The credibility gap
Tesla again missed on its Model 3 production timeline. The company had earlier set a target of producing 2500 Model 3's a week by the end of March quarter. However, the company was only able to produce 2000 units in the final week of March. In February, Tesla had reiterated that it is on target to produce 2,500 Model 3s per week by the end of the first quarter. The thing is that the 2500 units per week target was an already revised one. Over the past several years, the company and its CEO Elon Musk have regularly made promises which they were unable to keep. The company had initially planned to reach a production rate of 5,000 cars per week for the Model 3 by 2017 end. It later revised target to the end of the first quarter and at the beginning of this year company pushed back the target to the second quarter. Now, many are skeptical about the Q2 targets.
The company had made similar promises about the self-driving and autopilot mode. As this Bloomberg post details, Tesla had started selling its “Full Self Driving” feature for an additional $8,000 on any new Model X or Model S back in 2016. The company was unable to fulfill its promise even a year later, leading to a class action lawsuit. After burning their fingers several times, investors and customers alike have started to take every Tesla announcement with a large grain of salt.
Tesla is hungry for capital.
The resultant credibility gap is not good for the company, especially during a time when it may need to raise additional capital. Tesla has historically been a cash-guzzling company, burning cash almost every quarter. In FY 2017 alone, Tesla burned through $4.1 billion cash. To meet its cash requirements, Tesla had to approach the capital markets quite frequently to raise money through debt or equity offerings. And despite its consistent cash burn and huge debt burden, Tesla has faced little difficulty in charming investors to part with their money. There are several who continue to unequivocally believe in the 'visionary' leadership Elon Musk.
In all likelihood, the company will need to raise capital again in the near future, despite that, Mr. Musk claims to the contrary. During the Q4 FY17 earnings call, the company assured analysts and investors that will raise equity or debt this year. To quote from the call:
"Tesla continues to target a production rate of approximately 5,000 units per week in about three months, laying the groundwork for Q3 to have the long-sought ideal combination of high volume, good gross margin and strong positive operating cash flow. As a result, Tesla does not require an equity or debt raise this year, apart from standard credit lines."
Mr. Musk reiterated the assurance on Twitter a few days ago. However, several analysts and investors are not convinced and for good reason. Tesla is expected to burn around $2 billion cash this year and $1.2 billion in convertible debt maturing through early 2019. Add to this, the company's recently announced plans for Model Y which could further increase the cash demand. Tesla exited Q4 17 with around $3.52 billion in cash. This appears inadequate to meet the company's requirement.
Sooner or later Tesla will approach the market with equity or debt offerings. However, this time will not be easy. Tesla's debt was recently downgraded by Moody's to B3 from B2 and it changed the outlook to negative from stable. This will mean a wider credit spread for Tesla. Its 5% 2025 debt is currently trading at 90 cents to a dollar. Moreover, the overall interest rate in the market is also rising. 3 months libor is up over 100 basis points in the last one year. On the whole, Tesla will have to shell out a lot more this time around. If it takes the equity route, it will not only be dilutive to existing shareholders, the company will need to go the extra length to convince investors.
Tesla 5% 2025 price chart
Competition is coming for Tesla
Last year, Chevvy bolt, first real competition to Tesla Model 3 hit the market. It is first non-Tesla, 100 percent battery electric car capable of 200 miles per charge. Bolt has been well received since its launch. The vehicle has experienced strong demand since launch with 23000 Chevvy's delivered in 2017 (Model 3 total production is yet to hit that mark). In February, Bolt received Consumer Reports' coveted "best compact green car". The arrival of Chevvy Bolt has given another option to customers who have been waiting for their Model 3 for more than a year and has led to the cancellation of several reservations for Model 3. "Mostly people cancel because they needed a car and we didn't have a car for them," Musk recently told CBS.
The competition will only increase from here. From, Toyota, to Audi to Jaguar, all have announced their intention to enter the EV market in a big way. According to some estimates, over 100 models will hit the market by 2021. The rising competition will not only impact Tesla's potential market share, but it will also increase pressure on margins.
Add to this, the price of Cobalt, one of the main ingredients in a battery, is skyrocketing as supply is unable to keep up with demand. In the last one year, Cobal prices have more than doubled. And, the trend is likely to continue given the rising demand and scarcity of the metal. If each of the billion cars on the road were to be replaced today with a Tesla Model X, 14 million tonnes of cobalt would be needed—twice global reserves. All in all, things are not looking too well for Tesla stock which continues to trade at a very rich valuation. Given the risks, Tesla is once again investors' favorite short, ahead of Apple, according to a report from financial analytics firm S3 Partners.
Looking for fundamentally better stocks? Check out Amigobulls' top picks from the auto sector, which have beaten the S&P 500 by a massive 300%. Interested in automotive stock? Then, we also have our top stock picks from the tech sector, which have beaten the NASDAQ by over 116%.