Should You Invest In Tesla Stock?


Should You Invest In Tesla Stock?

Tesla stock has gained over 1,700% since its market debut in 2010. Will the electric automaker’s share price continue to soar or will it come crashing down?

Published on 24 November 2017

Elon Musk, the founder and CEO of Tesla, is a larger than life figure. In addition to launching the world’s most high-profile electric car company, he is the founder of a number of other projects including a proposed colony on Mars, underground tunnels to decongest city roads, and SpaceX, an aerospace manufacturer.

But Tesla’s Model 3 – its first mass-market electric vehicle – is what has really caught the public’s attention. About 400,000 people booked the car without even taking a test-drive.

Tesla’s stock, which is listed on NASDAQ, currently trades at US$312. The company’s initial public offering (IPO) was in June 2010, when 13.3 million shares were issued at a price of US$17 each. If you had invested at that time, you would have seen your money multiply by a factor of 18.6 in a little over seven years.

But is Tesla’s high valuation justified? Consider two other top US car companies, General Motors and Ford. A comparison of key data illustrates that Tesla’s share price is overwhelmingly based on expectations rather than on current performance:

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Tesla has a negative cash flow and has been making losses year after year. It manufactures cars from a single factory in Fremont, California. Production volumes stood at only 76,230 in 2016. This is minuscule compared to its competitors. But Tesla has a market cap that rivals General Motors and Ford.

What has driven the price of Tesla’s shares to its current level? Musk’s personal charisma and his grand vision have certainly played a part, as has a broader surge in interest among investors in the potential of the electric car industry – which is set to expand as more and more countries move to halt the sale of fossil-fuel powered cars.

But – ­given Tesla’s soaring share price – can the company live up to the expectations of investors?

A niche player with big plans

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If you want to buy a Tesla car, you have three options. You can purchase a Model S, which the company promotes as a car that can give you a week’s commute on a single charge. Launched in 2012, it is available at US$69,000, placing it out of the reach of buyers looking for a reasonably priced vehicle. In 2015, Tesla introduced the Model X, which was even more expensive. For US$81,000, buyers get a sports utility vehicle that seats seven and accelerates from 0 to 60 miles per hour in 2.9 seconds. But this, too, is a niche product.

Tesla’s most highly anticipated vehicle is the Model 3, which costs only US$36,000, but comes with many of the features available in the more expensive Tesla cars. This is the car that got 400,000 bookings, sight unseen, at US$1,000 each. Of course, it helped that you could cancel at any time and get your money back.

Although sales have increased in 2017, volumes are still very small. In the third quarter of this year, sales volumes were:

These figures are nowhere near what the company plans to achieve. Production volumes are expected to rise to 5,000 cars per week by year-end and 10,000 cars per week sometime in 2018. The total production planned for next year is 400,000 and Tesla expects to make one million vehicles a year by 2020.

Last week, Tesla unveiled its first electric semi truck, which it will begin producing in 2019 and will cost around US$150,000, as well as a new version of its Roadster sportscar, which it will begin producing in 2020 and will be priced at US$200,000.

Production constraints could limit Tesla’s growth

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Bob Lutz, former vice chairman of General Motors, recently said that Tesla is a “losing enterprise” and is “going out of business.” Although his views may be biased, as his former employer would be negatively impacted by Tesla’s success, there are others who share the same opinion. The pessimism about Tesla boils down to doubts about the company’s ability to ramp up production volumes to meet consumer demand.

Some experts say that the company’s factory in Fremont will find it difficult to produce 400,000 cars in a year, much less the promised one million in 2020. One solution is to set up additional manufacturing facilities, but it takes at least two years to set up a new car plant. The company intends to set up three more factories in the near future, but these are still at the planning stage.

Currently, the company is going through “production hell” (those are Musk’s words) to meet its delivery commitments.

Bleeding cash

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Toni Sacconaghi, a senior technology research analyst with investment management and research firm AB Bernstein says that Tesla could burn more than US$1 billion per quarter as it expands capacity at its manufacturing facility. If production and sales do not pick up, the company may run out of cash.

In September this year, a report from Jefferies, an investment banking firm, said that Tesla’s stock was overvalued and its price should be about US$240. In a more recent report in October, UBS analyst Colin Langan reaffirmed its sell rating for Tesla stock. The financial services firm thinks that Tesla will continue to face problems in producing its Model 3 cars.

The low number of cars manufactured in the third quarter have reinforced the view that Tesla may not be in a position to step up production. The UBS report says, “Not only does the [Model 3] miss undermine the credibility of future Model 3 targets, but it increased the near-term risks.”

The 12-month price target set for Tesla shares by UBS is US$185, a significant discount from the current level.

However, it is important to also note that there are a number of Wall Street analysts who are bullish on Tesla and think the automaker’s shares still have room to run. Nomura Instinet, for example, predicts that Tesla will surge around 40% over the next 12 months to reach US$500 per share, arguing that the company has an “insurmountable lead” among “inferior competitive field” in the electric automotive industry.

The bottom line

At the beginning of the year, the Tesla stock was trading at US$217. In the last 11 months, it has gained almost 150%. Even CEO Musk thinks that the share price is “higher than we have the right to deserve.” That’s what he told Nevada governor Brian Sandoval in mid-July this year. Immediately after he made this statement, Tesla’s share price dipped by 3%. But prices rose again when Musk clarified that valuations were “low if you believe in Tesla’s future.”

Investors will have to make up their own minds about the prospects of the company. If it can overcome its production constraints and capitalise on the growing global demand for electric vehicles, its stock valuations may see another upsurge.