My Relationship with Tesla
I have had a love hate relationship with Tesla stock since 2018.
I’ll admit I didn’t understand the vision with Tesla at the time and what seemed like a cult following when it came to the stock. To me it looked like an overpriced car company that was losing a crazy amount of cash and was just making electric cars. I figured that the company would lose it’s premium, once other car companies came out with their own version of electric cars and the stock would lose it’s high valuation multiples.
I’ve never really loved car companies due to the high capital structure and low margin business model. Also, the car business tends be cyclical meaning that they go through boom and bust cycles making them dependent on the economy. But people always argued Tesla was more than a car business. Since their sales were like 98% cars, I never got it and continued to see Tesla as a cash losing car business.
I’ll give them that Tesla has been a company that always pushed to disrupt the status quo and had a cult customer base (that praised the cars), so they probably deserved a slight premium to other car companies. Unfortunately, I never had a Tesla to have that amazing customer experience and maybe turn me into a cult stock investor earlier.
Then at the end of 2019, the stock went bonkers. And then in 2020 it went even more nuts.
Now that the euphoria around buying growth stocks no matter what has stopped and some of Tesla’s financial numbers have caught up with the valuation, I am now re-evaluating whether or not I would own Tesla at these prices regardless of my thoughts in the past.
How I View Telsa Now
So what has changed for me? I’ll be honest, it took that giant move to make me realize the company isn’t just another car company because of the press the company continued to get due to the explosion in stock price. It has more potential than Ford or GM because Tesla is the kind of company that is disruptive not just in car sales, but in software, artificial intelligence, manufacturing, and renewable energy.
This realization is what me actually interested in Tesla over any other electric car company that has popped up through SPACs in 2020, because once again I don’t love just owning a car business.
At the same time, just because they are disruptive and expanding across sectors, doesn’t mean the valuation doesn’t matter and I’m going to buy the company no matter what. It just means I would value it today more like a growing tech company than a legacy car company, that is really the only difference for me.
Although 87% of their revenue in Q1 of 2021 was automotive related:
I have heard comparisons to the likes of Amazon, and I’ll admit that is probably a good comparison in regards to the disruptive nature. Although Tesla doesn’t currently have a high growing, high margin, cash cow called AWS that literally prints money.
But if they win the self driving software race to lease to other companies, that could provide much higher margins in the future (that is a big if though).
The most exciting market that I feel is most relevant to Tesla at this time is the autonomous driving segment. And is the biggest reason I would want to own Tesla stock.
The total addressable market is also expected to grow pretty fast in the upcoming years at a 39.5% CAGR.
Now tesla isn’t the only ones involved in this space, but they are one of the front running companies as they have collecting drivers data for years and already offer some features related to autonomous driving.
Of course the other obvious growing market they are in is the electric vehicle space. That currently has a forecasted growth rate of 22.6% through 2027 as the world may focus more and more on sustainable energy and environmental issues over whatever source of energy is the cheapest or most convenient.
There is also the renewable energy piece, which is expected to grow at a 6.1% growth rate which doesn’t sound that big but we are talking about a $1.5 Trillion space.
So there is definitely a narrative when it comes to investing in Tesla. Disruption, sustainability, and fast growing markets. But the real question is whether or not the stock is grossly overvalued and has already baked in unrealistic expectations or not?
It all comes down to assumptions when you are trying to value a company like Tesla.
According to Cathie Wood of Ark Invest, the worst case scenario is that Tesla is worth $1500/share by 2025 🙂
Now that is based on some insane margin expansion, revenue streams that don’t exist yet like insurance, robotaxi networks, and around 5 million cars sold annually.
The forecasted amount of deliveries for 2021 is around 1 million cars, so they would need to be expand their deliveries at around a 43% CAGR to achieve 5 million deliveries in 2025.
Now I would say Cathie and her predictions may be slightly biased as her funds have a larger position in Tesla. So of course the target price in the next 5 years would be elevated.
At a $1500 price target that is around a 21.6% return each year through 2025 (which is pretty great but also not mind boggling returns for potential downside risks with the stock).
So I did a DCF (which will be available in the premium discord).
With the following assumptions:
I came up with a fair value of around $439.24/share. Now this assumes a a revenue of around $112 billion by 2025 and no where near as bullish as the bear case like Ark Invest.
I assumed a small expansion of operating margin as they align with margins similar to Toyota on the car business side while the expansion of other software related revenue may have better margins and the mix would increase overall margins in 2025 to around 14%.
Overall I think there is still some premium built into Tesla stock after the huge run up in 2020. Of course the stock could also trade sideways until the financials catch up more with the valuation. Tesla is still one of the stocks that you are heavily relying on the growth assumptions on new sectors and massive growth in the EV/autonomous driver space.
When it comes to self driving, as I mentioned above that Tesla is not the only player in town. There is waymo, other robo tax companies, mobileye, or even another country like china. Although Tesla would probably use it’s own autonomous driving software for it’s own vehicles, it would be massive if it could roll the software out to other firms as a larger source of future revenue. If it doesn’t win that battle, then the future revenue stream won’t be as large.
The electric vehicle regulatory credits that tesla is able to sell due to not needing them allows the company to be profitable over the past year. These credits are a little secret sauce that Tesla has right now as other car companies have to buy these regulatory credits when they don’t have enough low emission cars. Eventually Tesla will not be able to lean on what is essentially a nice little profit boost as other legacy car companies shift their production to low emission vehicles and no longer need to buy these zero emission vehicle (ZEV) credits.
I like the company and it’s vision. I am definitely interested in the business but with a 30% downside to what I think is a fair value, Tesla will continue to be on the watchlist as a disruptive company that gets interesting at a lower valuation or if it trades sideways for a couple years then it may become interesting as well.
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