Why Tesla’s Growth Story May Not Go As Per The Script

Although Tesla Motors‘ (NYSE:TSLA) stock has witnessed some deterioration in the last couple of months, shares of the company are still up more than 300% since the start of the year. However, one must take into account that the current valuation models of Tesla incorporate pretty aggressive growth assumptions and any deviation from these forecasts can adversely affect the company’s valuation. Here are some of the factors that can distort Tesla’s growth story.

We have a price estimate of $112 for Tesla, which is about 20% below the current market price

See full analysis for Tesla Motors

a) Dealership Troubles

Unlike mainstream automakers, Tesla does not sell its vehicles through dealers. It sells the Model S car either through its own shops or online. This hasn’t left auto dealers particularly pleased.

Franchise laws in certain states provide protection to car dealers by preventing auto companies from selling their cars directly to customers. One of these states is Texas, where the influential Texas Automobile Dealers Association (TADA) has spent millions of dollars on lobbying to prevent Tesla from selling its cars directly to customers. ^[1] The union also fears that if Tesla gets its way, other automakers might follow suit. This could eventually eliminate the role of the dealerships.

Tesla is also embroiled in legal battles in other states such as New York and North Carolina. In Colorado, the legislature has already banned the company from opening any more shops (it currently has one). Any loss of sales due to Tesla’s inability to open stores in some of its key markets could prevent the company from realizing its full potential on its home turf.

b) Serious Competition

In the U.S., Tesla enjoys a great following because the Model S is seen as a breakthrough product that is far ahead of its competition. Automakers such as GM or Ford are sometimes viewed as bureaucratic companies holding on to their past legacies and incompetent to launch something like a Model S. (GM is even referred to as ‘Government Motors’ jokingly!). But the same may not hold true overseas, especially in Europe, where Tesla started selling its cars recently. The German automakers are never really viewed as bureaucratic. In fact, they are known for building high tech, swanky and chic cars. Hence, Tesla may not be able to create the same buzz as it did in the U.S.

Earlier in the year, BMW introduced its i8 plugin supercar – at a staggering $135,000 before any government incentives. Unlike the Model S, it is not a pure electric car, but has a range of 310 miles in the hybrid mode. BMW also introduced the i3, with an electric range of 90 miles, which hit the German showrooms in November. The price of the cheapest model could be anything between $40,000-50,000 and will be launched in the U.S. in the first half of 2014. ^[2] BMW has a target of selling 10,000 models next year.

Similarly, Volkswagen is in the process of introducing two electric cars. The first is the electric version of Golf or the e-Golf with an electric range of 120 miles. The pricing of the car has not been announced. The second is the e-Up ! with an electric range of 100 miles, that starts at 27,000 euros (~$35,500). Audi also plans to join the fray with the launch of the A3 e-tron hybrid. ((Electric Cars Dominate Frankfurt Auto Show, September 11, 2013, discovery.com))

Till now, there was a paucity of electric cars in the premium car segment, which if at all, only benefited Tesla’s Model S sales. In the entry level end of the segment, GM’s Volt was a good attempt but failed to create the desired impact. The car wasn’t cheap while its performance was mediocre. Its running cost was low but it did not free the owners from range anxiety. In short, the car had a bit of everything but did not score highly on any single parameter. The new set of electric/hybrid cars, however are much improved models.

With the competition now heating up in both, the entry level and the premium car segment, Tesla will find it much tougher to sell those incremental units. The exclusivity factor of owning a Tesla could soon fade.

c) Margins Could Decline

Tesla has a target of achieving 25% gross margins by the fourth quarter of 2013. In the third quarter, the figure stood at 21% (excluding the benefit of ZEV credit sales), which is a huge improvement from ~6% witnessed in the first quarter. ^[3] While achieving 25% gross margins for luxury cars may not be that tough, the real challenge for the automaker would be to sustain the figure when it introduces the Gen III within the next couple of years. Due to its lower price (expected price ~$35,000-40,000), the model should see higher volumes than the Model S.

Luxury cars generally have higher margins than mid-price cars. Therefore, the weighted average result of the company-wide margins could see some decline as sales of Gen III pick up. A single percentage change in the company wide gross margins can affect the stock price as much as 10%, according to our estimates.

Understand How a Company’s Products Impact its Stock Price at Trefis

1. Tesla Versus Texas, eworld.com [↩]
2. Tesla Challenges BMW on Home Turf as Germans Go Green, September 12, 2013, bloomberg.com [↩]
3. TSLA 10-Q [↩]