Why We Revised Our Price Estimate For Tesla Motors To $205

by Trefis Team
Tesla Motors
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We are increasing out price estimate for Tesla Motors (NYSE:TSLA) to about $205 per share, on account of better than expected margin projections for the company’s mass-market Model 3 sedan as well as a lower discount rate estimate (10% versus ~13% previously) in our DCF model. That said, our price estimate is still significantly below the current market price, as we are still relatively negative on the company’s valuation on account of its high cash burn rate, its mixed track record with scaling up manufacturing, and the possibility that its early-mover advantage in the EV space could diminish. Below we outline some of the key changes to our model and our stance on Tesla stock.

See our full analysis for Tesla Motors

Tesla Is Moving Down The Cost Curve

Tesla launched its new mass-market sedan, the Model 3, late last month, handing over the first few vehicles to its employees. Tesla expects gross margins on the new vehicle to turn positive from Q4 2017, while noting that margins could reach 25% at some point in 2018, putting it almost on par with margins on the luxury Model S and X. Tesla has simplified the design of the Model 3 to make production less complex, learning from its mistakes with the Model S and X. The company intends to initially offer the Model 3 with just 100 permutations, compared to over 1,500 permutations for the Model S. In our valuation model, we expect Model 3 gross margins to reach 25% levels in 2019 (instead of 2018 per Tesla’s projection), on account of potential manufacturing issues – which we explain below.

Tesla’s broader product portfolio (Model X, S) could also see margins improve on account of declining battery costs. The company’s Giga Factory in Nevada could help to double lithium ion battery production in a few years, while cutting down costs via a streamlined supply chain. The lower battery prices should give Tesla more headroom to reduce pricing or improve specifications of the Model S and X. For instance, earlier this month, Tesla dropped the starting price of its Model X SUV from $82,500 to $79,500, on account of improved margins and better manufacturing efficiencies. The relatively high gross margins on the mass market Model 3 and improving margins on other products could help Tesla move towards profitability in 2019.

Production Issues May Persist With Model 3; Near Term Cash Requirements

Tesla intends to scale up Model 3 production from just over 1,500 vehicles in Q3 2017 to a weekly run rate of 5k vehicles by the end of the year and 10k cars per week at some point next year. The company intends to produce around 500k cars next year, more than 4x the 2017 number. We remain somewhat skeptical that this target will be met, as the company has rarely been able to meet past production targets, which have not been particularly high to begin with. For instance, in 2016 Tesla planned as much as 90k units but delivered just about 76k vehicles. It missed its production targets over 2014 and 2015 as well. Tesla is operating with just a single plant (Fremont) and it’s likely that it will have some early manufacturing issues to iron out.

The company’s cash requirements are also likely to remain high (capex of between $3.5 to $4 billion per year over 2017 and 2018), as it moves to increase automotive production capacity and build more battery manufacturing plants. The company is also doubling down on the expansion of its Supercharger network to cope with the needs of its Model 3 customer base.

Tesla’s Early Mover Advantage Could Diminish 

Tesla has been a big beneficiary of the shift to electric drive trains, which offer superior performance as well as lower depreciation, compared to internal combustion engines. The early entry into the space has also allowed Tesla to benefit from the various tax incentives that federal and state governments hand out to EV buyers. That said, the advantages of the all-electric drive train are unlikely to remain exclusive to Tesla over the long term. Mass market manufacturers GM and Nissan have already proven that they can manufacture relatively compelling electric products (Bolt, Leaf). Tesla could also face significantly more competition as German luxury brands such as Mercedes Benz and BMW migrate from ICEs to electric.

Tesla’s incentives in the U.S. could also taper off. For instance, the lucrative $7,500 U.S. federal income tax credit offered on purchases of EVs is phased out after a manufacturer reaches 200k in cumulative sales. It’s possible that phase out process could begin in 2018 for Tesla, potentially putting it at a relative disadvantage to other electric vehicle manufacturers who have sold fewer than 200k units in the U.S.

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