Tesla: The Higher It Goes, The Riskier It Becomes

(Seeking Alpha) Tesla’s battery day did not live up to the hype priced into the stock, but the announcements were quite significant for the future of EVs and a sustainable energy paradigm.

Tesla’s three-year plan to reduce battery costs by ~56% is an ambitious move from the EV maker, and it further illustrates the degree to which Tesla’s moat is formidable.

The affordability of a $25,000 fully autonomous electric car will help Tesla reach millions of households, driving Tesla’s revenues higher.

Finally, Tesla is not just an auto-manufacturer. It is a sustainable energy company with a diverse product portfolio that includes electric vehicles, solar roof & panels, batteries, and software.
In light of the latest announcements, I am updating my valuation to $285. Since the stock continues to trade above $400, I rate it hold at this moment in time.
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Investment Thesis
Tesla’s (TSLA) recent battery further highlighted, or perhaps strengthened, a few facets of the company’s ongoing bullish narrative:

The company’s moat continues to widen from a purely physical hardware perspective.

The company’s vision to mass distribute Teslas then leverage network effects to create higher-margin services atop this aforementioned network of vehicles (similar to the iPhone, though to a less scaled extent due to prohibitive costs) continues to roll right along.

To this end, for competing auto-manufacturers, it’s not simply a game of catch up to Tesla’s battery technology and autonomous vehicle technology. Instead, it’s a game of catch up to the next step after those technologies plateau in terms of their advancement. Through this lens, the argument for competition may not truly come into the picture until the late 2020s… if ever.

So far, Tesla has delivered more than 1 million electric vehicles, generated 17 TWh of Solar power and installed 5 GWh of stationary batteries. However, Tesla is only just getting started.

During the battery event, Tesla presented a plan that would cut battery costs (per KWh) into half, while improving range by 50%. In addition to that, Tesla promised faster manufacturing with lower investment (per unit basis). All these innovations will lead to a $25,000 electric car. If Tesla delivers on this plan, I could see Tesla selling millions of electric vehicles by 2030 with better margins (profitability), as I detailed in a recent note entitled, “World Domination Lies In The Palm Of Its Hands”. Hence, I am bullish on Tesla’s business as a future path to success becomes more apparent.

After reevaluating Tesla in the light of battery day announcements, I am upgrading my intrinsic value estimate to $260 per share. However, while the company is experiencing rapid revenue growth, this is revenue growth with very poor free cash flow margins. Hence, Tesla remains a hold for me.

The Battery Day Announcements Were Revolutionary
In the battery day event, Tesla outlined two major goals for a sustainable future. Here’s what they are:

1. Terawatt-hour scale battery production:

If the world is to move to 100% renewable energy, we require 1,000x growth in battery production. To that end, Tesla has set a goal of Terawatt-hour scale battery production. To put it into context, 1 Tesla gigafactory = 0.15 TWh (or 150 GWh). This means today’s manufacturing processes are inadequate. Therefore, Tesla will be introducing Terafactories in the future.

Now, Tesla is not going to be the only game in town. However, its technological leadership is only getting stronger and traditional auto-makers may never catch up to Tesla’s pace of innovation, as battery technology and range will only be one component of Tesla’s overarching vision for its alternative energy ecosystem.

2. More Affordable Cells:

In addition to having more batteries, we also need the batteries to be cheaper because affordability is critical to the widespread adoption of sustainable energy. The trajectory of reduction in dollar cost per kilowatt-hour for batteries was somewhat flattening in recent years. It seemed like battery costs cannot be reduced significantly going forward; however, Tesla has now come up with a plan that alters the future.

With innovation in cell design, cell factory, anode material, cathode material, and cell vehicle integration, Tesla’s battery day plan could result in increased range (+54%) and reduced battery costs $/KWH (-56%) at lower investment per GWH (-69%). Thus, in my opinion, the battery day demonstrated the perennial innovative and aggressive thinking of Elon Musk and the team at Tesla.

With these advancements in battery tech, Tesla will strive to bring a $25,000 electric car to the market within the next three years. Of course, Tesla’s timelines are always a bit wonky… very, very wonky in fact.

So, while I certainly believe at $25,000 Tesla is on the horizon, I am not sure that 3 years is a realistic timeline. With that being said, the world where Tesla makes up a significant portion of cars on the road in developed nations will be a world in which Tesla can create higher-margin software products atop its enormous network of vehicles.

To that end, Tesla’s lead in the electric vehicle market really cannot be overstated. With about 3-5 year lead and massive momentum behind it in terms of the physical hardware of Tesla’s vehicle, it’s not a matter of legacy manufacturers catching it to their hardware alone.

It’s a matter of legacy manufacturers catching up, then building out the computational prowess that will inevitably become a facet of Tesla’s moat over the coming decade. That is, the end game in the EV market is not who has the best hardware. It’s who has the best network of vehicles and most robust “delighting” factors atop their best of breed hardware.

The affordability of such a $25,000 vehicle would enable millions of households to buy a Tesla. Moreover, Tesla’s battery division could rake in hundreds of billions of dollars in energy storage revenue. Hence, I am revising my growth projections for Tesla, and subsequently, my intrinsic value estimate for the stock.

Raising My Intrinsic Value Estimate To $260 Per Share
In this section, I will revalue Tesla. To do so, I will be utilizing the L.A. Stevens Valuation Model. Here’s what it entails:

Traditional discounted cash flow model using free cash flow to equity discounted by our (as shareholders) cost of capital.

Discounted cash flow model including the effects of buybacks.
Normalizing valuation for future growth prospects at the end of 10 years. (3a.) Then, using today’s share price and the projected share price at the end of 10 years, we arrive at a CAGR. If this beats the market by enough of a margin, we invest. If not, we wait for a better entry point.
Before we dive into the valuation, let’s check out some notable assumptions:

Assumption

Value

Revenue (TTM)

$25.71B

Shares outstanding

1.1 B

Free cash flow margin (long term)

10%

As can be seen above, even with an extraordinarily aggressive (I mean… really aggressive) growth rate of 35% annualized from a revenue base of about $26B, the stock doesn’t make sense.

Next, let’s turn our attention to the projected returns one might receive if one were to buy the stock today.

Again, even with 35% annualized growth, the stock makes little sense at $420 or thereabouts.

Concluding Thoughts
While I don’t love the stock today, I do believe in Tesla’s vision. If Tesla were to get a few hundred million of its vehicles on the road, both new and used, the network effects it could generate with software-based businesses atop its network of physical vehicles would further build out the company’s moat.

With that being said, for a company to grow at an average annualized rate of 35% for 10 straight years from a base of $25.7B in revenue with only 30% more in dilution is not just a lot to ask… it’s outright mind-boggling to ask.

To that end, I rate Tesla a hold, and I would buy aggressively on any market corrections.

Key Takeaway: I rate Tesla a hold at $420.

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