Tesla Motors: Three Risks That Could Affect Our Price Estimate

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Tesla Motors (NYSE:TSLA) recently launched the Model S and has begun delivering the vehicles to customers. The classy sedan has received very positive reviews, and has racked up over 12,200 reservations to date. The company has high hopes for the car, but has a lot of work to do before it can achieve its goal of establishing itself as a large scale electric vehicle manufacturer.  We currently have a Trefis price estimate of $41 for Tesla and below we highlight three broad risks to our views on Tesla:

1.  Production Ramp Up Process May Not Be a Smooth Ride

The company has set a target of producing 5,000 units of the Model S this year and at least 20,000 units annually from 2013 onwards. This seems like a formidable task, considering that they were producing only around 10 units a week in the previous quarter. Management recently outlined its plan to ramp up production in the Q2 earnings conference call. The ramp up would trace an S-shaped curve, with a gradual increase initially (around 40 cars a week in Q3), followed by a steep increase to around 375 cars a week in Q4.

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There are a number of potential impediments to the execution of the ramp up plan, such as supplier delays and quality control issues. However, the company seems very confident that it can pull it off successfully and achieve the year’s target of 5,000 units. Demand this year is not a concern, considering the number of reservations for the vehicle, even after allowance for cancellations.

2.  Long Term Threat from Incumbent Auto Manufacturers

Even if Tesla does manage to achieve its stated targets, demand could pose a long term threat. Management believes that vehicle sales would be limited by production constraints, and not by demand. CEO Elon Musk stated during the Model S unveiling that he expects half of all cars to be manufactured in 20 years would be electric. These assumptions are highly optimistic to say the least. [1]

Demand for Tesla cars is dependent on two factors, namely the demand for battery electric vehicles (BEVs) as a whole, and whether customers would choose Tesla cars over other competing BEVs in the future.  An overview of the issues facing the BEV industry can be found here.

Regarding the second factor, Tesla believes that customers would choose its vehicles because of its cutting edge technology and brand name. It is currently a pioneer in the electric vehicle industry, and the technology in the Model S is on par with any other premium sedan. However, other auto companies are catching up, with luxury manufacturers BMW and Audi having launched electric cars recently.  Ford, GM, Nissan, Honda and Toyota have all either launched an electric vehicle already, or are in the process of doing so.

While Tesla can boast of its cutting edge technology, many of its competitors have been around for generations, and have manufacturing facilities capable of achieving production rates which Tesla can only dream of at this point. Furthermore, they have well established service networks and have developed strong customer loyalty over the years. Why would a customer interested in purchasing an electric car pick a Tesla over any of the others?

3.  Financial Position and Future Plans Heavily Linked to Model S Success

Tesla’s financial position seems relatively stable as of now, but its future health is heavily dependent upon the success of the Model S. As of now, they have a loan facility of up to $465 million and have raised funds of around $480 million from equity offerings. The loan repayments begin in December this year, and this may have an immediate impact on liquidity. Management believes that working capital requirements will be fulfilled by cash inflows generated from sales of the Model S. In case of a shortfall, there is always the possibility of another equity offering, although this is not a preferred option.

The gross margin target for next year is around 25%. It is worth noting that the company has reported gradually increasing gross margins over the last 3 years, primarily due to decreasing manufacturing costs relative to automotive sales revenues. Management also believes that 2013 will be the year that the company turns profitable, on the basis of 25% gross margins and lower R&D and SG&A expenses as a percentage of revenues. This is absolutely critical for the company if it is to successfully execute its plan of launching the Model X in 2014 and the Gen III mass market hatchback in 2015.

We currently have a Trefis price estimate of $41 for Tesla. We are in the process of modifying the price estimate based on recent updates.

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Notes:
  1. Dear Mr. Musk: I’ll Take That Bet, Forbes, August 2012 []