Tesla Motors (NYSE:TSLA) beat the market expectations yet again in its recent earnings announcement. The company announced a profit of 20 cents a share (non-GAAP) on revenue of $552 million. What really stood out was the automaker’s guidance of selling 40,000 Model S cars on an annualized basis by the end of 2014. The automaker has only begun to expand internationally, and we estimate selling those many number of cars within the given time frame is pretty impressive.
After the second quarter earnings, we have revised our price estimate for Tesla to $84 per share
Following the guidance given out by Tesla for its Model S sales in 2014, we have upped our long term forecasts for the number of the Model S sales. If Tesla is able sell 40,000 cars annually by 2014, we believe it can sell as many as 100,000 cars annually in the subsequent years when it has a greater international presence. Our revised price estimate is nearly 20% higher and is primarily attributed to greater optimism regarding Model S sales going forward.
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It takes time to understand the local market, tweak your products accordingly and raise the production. For example, in China, the company is focusing on making the rear seat more comfortable since it is a norm there to be driven around by a chauffeur. Then there is the issue of converting the left hand drives to right hand drives for the international markets. All of these act as bottlenecks and prevent the sales from rising at a pace which would impact the real demand.
The Mercedes S-Class, which is more expensive than the Model S, sold about 65,000 units last year. In the long term, that figure could easily rise to 80-90,000 given the pace at which China’s appetite for luxury market is growing. We believe the Model S can match the sales of the S-Class. In fact, the Model S is more likely to compete with the E-Class, whose price starts from $52,000 in the U.S. About 310,000 E-Class vehicles were sold globally. Thus, assuming annual sales of 90-100,000 for the Model S in the long run doesn’t look far fetched.
Why Is Our Price Estimate So Low?
Even though we have raised our valuation by 20%, it is still 40-45% lower than the market price. The market is betting on Tesla to be the next Apple.
Although we think Tesla is a great company making great products, one cannot underestimate the competition. It’s hard to think of a time in the auto industry when a single company dominated the entire market as Apple has done in the smartphone market.
It also makes sense to understand the dynamics of each industry in order to fully appreciate what each incremental sale adds to the company’s valuation. Apple’s products have high gross margins. Thus, a greater proportion of additional smartphone sales will go to the bottom line.
The auto industry does not work this way. It is typically a high revenue, low margin industry. In fact, Tesla has a long term gross margin target of 25%. Thus, less than a fourth of the revenues generated from the incremental sales will go to the bottom line. At the moment, the profits are so small that selling a few more cars can boost net income meaningfully which gives the impression that the company has smashed all estimates. As profits continue to grow, this will not happen.
We do not think our forecasts are conservative. In the long run, we estimate that the automaker will sell about 400,000 cars annually. This includes the sales of Model S, Model X, the Gen III and the Roadster combined. Due to a high degree of uncertainty involved in such forecasts, we have take a discount rate of 14%. If you feel like the company is less risky, you can modify the discount rate. For example, changing it to 12% yields a price of about $115, or about 40% higher than the current valuation.