Jump Into Tesla, Wait, Or Get Out?

Tesla (NASDAQ:TSLA) is becoming to the automotive industry what Apple’s iPhone was to the mobile device space. Tesla scores high on desirability – a lot of folks who haven’t been behind the wheels are keen to buy a Tesla – thanks to its industry-leading tech, the high-brand value that’s partly attributed to its visionary CEO, and the availability of more affordable options such as the  Models 3 and Y. So yes, people would love to get into a Tesla, but is this a good time to jump into the stock? Yes – especially if you believe in this one important Tesla metric: Tesla’s time horizon. 

On the flip side, we believe a more balanced, risk-adjusted answer is no, at least at current prices.  Sure Tesla has turned profitable, and earnings could grow nicely over a couple of years, but the stock is up a whopping 130% year-to-date, recently touching the $1,000-mark. Despite the massive rally, Trefis estimates Tesla’s valuation at about $600 per share, roughly 40% below the current market price based on two key risks and one potential opportunity.

The first risk we see is to Tesla’s near-term revenue growth. With the economy barely limping back to normalcy following Covid-19 related shutdowns, and unemployment at multi-decade highs in the U.S., there is less reason for people to buy costly discretionary items such as electric cars at the moment. Sure, the stock markets have recovered sharply, driven by the Fed’s liquidity infusion, but consumer sentiment is still at multi-year lows. Moreover, a second wave of Covid-19 could lead to a significant drop in stock prices, presenting a better entry point for Tesla stock. 

Tesla put its 2020 guidance on hold, while recently cutting prices on its vehicles by as much as $5,000 – a sign that Tesla may be having trouble with demand in the U.S. – its largest market. We project that Tesla’s revenue will stand at about $27 billion for 2020, marking a growth of about 10% year-over-year, despite the production ramp from its Shanghai factory and the launch of the Model Y compact SUV. This marks a decline in growth rate from around 83% in 2018 and 15% in 2019.

The second key risk stems from Tesla’s soaring valuation multiple. The stock now trades at about 260x projected 2020 earnings of about $3.80. In comparison, to earn close to $3.80 per year from a bank, you’d have to deposit about $380 in a savings account today, so we are talking of a P/E multiple of just about 100x desired earnings. Sure, Tesla’s multiple factors in stronger long-term earnings growth prospects, but at these valuations, the company will need to execute to perfection and then some more. We think a multiple closer to 160x is more appropriate, based on our detailed DCF model, which projects that Tesla’s EPS will jump by almost 12x to around $45 by 2025, effectively valuing the company at about 14x projected 2025 earnings. For perspective, automotive stocks traded at about 14.5x projected earnings, prior to the current crisis. ^[1]

That said, there is a long-term opportunity and the Covid-19 crisis might help put Tesla in a better position to capitalize on it. 

Climate change consciousness is growing. There is considerable social and political pressure on fossil fuel producers to reduce emissions, and on consumers to reuse, reduce, recycle! This also means that investors are looking at greener industries much more favorably and Tesla is one such stock investors have thronged to. While mainstream automakers have also been investing heavily to pivot to electric vehicles, the disruption caused by the coronavirus could make this shift harder, as they need to navigate a collapse in sales and significant near-term financial pressures. While Tesla, too, is facing interruptions, the pandemic could help the company widen its lead as the industry transitions to EVs. Separately, Tesla is well ahead in the self-driving race, and this could also help the company drive profitability if it is able to maintain its lead.

While Tesla is distinctive, Ford has weathered many storms in its 100+ year history. We see the economy opening up in 2020 and emerging strongly from the pandemic. Could there be near-term >50% upside for Ford’s stock post the Coronavirus pandemic?

Separately, as we saw large price swings even for trillion-dollar companies, mispricing among peers is more common than you think: here’s one we find remarkable for Google vs. Microsoft.

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1. PE Ratio by Sector, NYU Stern, January 2020 [↩]