I’m an investor who collects businesses. And there are two things I must know.
First, is the business fundamentally sound?
Second, am I paying a reasonable price for that piece of business?
For Tesla, I find it hard to answer both questions. Tesla’s cult-like loyalists may not like what they are about to hear: Tesla faces some real problems today.
I’ll explain.
Let’s kick off — Tesla’s background
Two engineers – Martin Eberhard and Marc Tarpenning founded Tesla in 2003. Elon Musk invested in Tesla a year later, took over the company as CEO, and became the electric vehicle (EV) company’s largest shareholder.
Musk saw what many others couldn’t see — the huge potential of electric vehicles.
Tesla first launched the Tesla Roadster in 2009, and failed. In 2012, Tesla pivoted to create a mass market “premium” car — the Model S.
Over the years, Tesla also tested different models, including the Model X SUV and the Model Y. So far, the Model 3 is still the best-selling electric car.
Tesla’s main goal is to create EVs for all different types of cars, including trucks.
There’s no doubt. Tesla grew faster than a speeding train. Today, Tesla commands close to 70% of the entire US EV market share. And it’s now estimated Tesla will sell over a million EVs this year.
To support its colossal growth, Tesla has started production at its gigafactory in Berlin earlier in March, then later on built the first gigafactory in Shanghai.
The car maker also plans to build more factories across the world. Plus, Tesla is now one of the world’s largest supplier of battery storage systems.
Last year, Tesla’s market cap peaked at US$1 trillion, which makes it the sixth US company to achieve that value in history.
The ferocious competition no one wants to talk about
Even though Tesla’s global market share is only 2%, trying to double this share takes more than climbing Mount Everest — even with Tesla’s massive growth.
I mean, Tesla’s cars are made for the mass affluent. And how much Tesla could grow is limited by how much consumers are willing to pay for a car.
You might not agree with me, but car buyers are essentially “bang for your buck” price-takers – they don’t see cars as property assets, but as depreciating liabilities.
And the thing is this. Car makers are a ferocious, throat-cutting bunch, out for blood – do whatever it takes to drive each other’s profit margins down to zero. General Motors now plans to sell EVs by 2025. Ford also expects at least 40% of its sales to be EVs by 2030. That’s soon enough.
What’s more, BYD, a major Chinese EV player, now sells their EVs at just half the price of Tesla cars. Can you see how scary is that? Car makers don’t just get into a dogfight, they want a slugfest.
According to a Bank of America car analyst: “Tesla Inc. is likely to lose its position as the dominant electric-vehicle maker in the US to GM or Ford by 2025 as competitors release a barrage of 135 new electric vehicles, Bank of America analyst John Murphy said in his annual Car Wars forecast…
Elon Musk’s company will still be growing as EV sales continue to soar, but its share of the market will fall to about 11% in 2025 from over 70% today, Murphy wrote. Tesla has loyal fans, but the company won’t be able to keep up with the pace of new models coming from General Motors Co., Ford Motor Co. and several foreign automakers.”
I find the analyst’s prediction too bearish — I don’t believe market share will fall to 11%.
But what I agree with him is this: Tesla doesn’t grow in a vacuum.
Even Mr. Market knows how terrible a car competitions are. That’s why Tesla will eventually follow how General Motor and Ford shares trade – their stocks go up high, then crashes down, then goes back up again, then crumbles down again in a largely sideways manner, but hardly ever chasing the sky. That’s the reality of the car industry. That’s my reality of the car industry.
Competition breeds inventory excesses, which drives lower profit margins, which forces car makers to go bust.
That brings Tesla to its second problem — overvaluation
With problem one, comes problem two.
Because of competition, I don’t understand why Tesla still trades like a helium-pumped party balloon, even after crashing more than 50% since last year.
Source: ShareInvestor Webpro
It doesn’t make much sense. Tesla is now the most valuable car company, yet it produces the smallest revenues – three times smaller than Toyota, the world’s largest car company by revenues.
And because Tesla recently turned profitable, there’s little earnings to show. The ridiculous thing is, combined revenues of the top five car players actually dwarfed Tesla’s revenues. And dwarfed profits too.
Source: Yahoo! Finance, ShareInvestor Webpro, Dividend Titan
Some people might argue that Tesla isn’t just a car company — it’s a tech company.
Well, even if we compare Tesla’s market cap to tech peers, we see the market cap of Tesla more inflated than Meta Platforms, Alphabet, Microsoft, Apple and Netflix.
Yet these very same tech companies go on to produce much more sustainable revenues, profits and cash flow than Tesla. What’s more, as investors, your profit margins from these tech blue-chips companies are much thicker.
And none of them has to even spend heavy capex building gigafactories.
Source: Yahoo! Finance, ShareInvestor Webpro, Dividend Titan
What’s more, there’s really nothing spectacular about Tesla’s profit margins. I suspect it will continue to go lower.
A car is a car is a car.
Tesla is not immune to the economy. In its latest third financial quarter results, Tesla has lowered their backlogs in China, cut their prices and reduced forecast of car buyer demands.
When the industry slows, all car makers get affected.
Final Thoughts
Munger recently said Tesla is a small miracle in the car industry. I agree. Since its founding, Tesla had to raise massive equity, borrowed a lot of debt, and at one point, almost faced bankruptcy.
Yet, it went on to disrupt car distribution channels (selling directly to consumers), became a major battery storage supplier, and has recently fortified its balance sheet.
Even though Tesla recently turned free cash flow positive, the car maker still has a long way to prove its business is truly worth current valuations. And I don’t think Tesla commands such egregious valuation today.
At some point, Tesla’s EVs will compete with other car makers going into the EV market — it’s not a matter of if, but a matter of when.
And Tesla’s EVs are its only, one trick pony, then this EV maker is in trouble. Most of Tesla’s revenues and profits are still coming from selling EVs. While the other segments are still losing money.
I mean, don’t get me wrong. I love Tesla cars. But falling in love with a product doesn’t mean the business is good, even the stock.
Sometimes, investing can be simple.
Willie Keng, CFA
Founder, Dividend Titan
That was exactly what i am trying to explained to musk supporters. Everyone is talking about how Tesla can achieve the market cap of equivalent to Apple by just simply 10X their current production numbers. Avid fans will keep harping on this possibility rather than look at the probability at this stage.
Hello!
I mean, Tesla is a great company, but I think there’s a lot of exuberance baked into the share price today, despite their correction. A good point — possibility and what’s really probable.
Willie
Analysts have been talking about Tesla killers and competition for years. None have come even close (except for BYD). Tesla has ‘little earnings to show’? Its net profit seems to be on par with the other manufacturers on your table (in fact it is more profitable than Ford & GM which has been selling cars for eons). Tesla sells <20% of the number of cars as Toyota, but has a net profit of abt 50% that of Toyota. Not only that, Tesla is selling EVs! Which have a lower profit margin (I believe most of the other car makers are losing money on their EVs).
Product wise, none of the ‘old boys’ are making decent EVs that compete well with Tesla. If you look at price, range, charging network, tech, and the overall package, Model 3 & Model Y are very competitive. As a business, I think it’s great.
Valuation wise, it’s another story. I do agree it’s expensive. Unless it can really solve Full Self Driving, then that’s another story.
Hello NotFanBoy!
I’m sorry for the late reply. Actually, I find Tesla a great business, just that the problem is valuation. I agree with you, Tesla’s profit margins are much higher than traditional car makers. That’s what is true now. But it’s hard to tell whether they can sustain this margins because the auto industry is a ruthless one, and competition will simply drive these margins lower. I think car makers are already playing very fast catch up, with Ford and Gm making their own EVs. Plus, BYD is also slashing their EV prices in China, which I think Tesla might find a hard time trying to compete.
Their FSD is a huge competitive advantage, if they can pull it off (which I hope they could). I think Tesla will make a great investment if their valuations are cheaper 🙂
Cheers,
Willie