Tesla: Bears Have No Moat Here

(Seeking Alpha) – Tesla (TSLA) recently reported one of its strongest earnings reports in history and the company is on track to deliver 500k cars this year.

Considering the company’s great performance in recent months, shorting Tesla’s stock is a very risky endeavor in which we have no plans to participate in, despite the fact that the majority of our portfolio consists of short positions with an attractive risk/return ratio. In this article, we want to explain why the market will continue to prioritize growth over value and push the company’s stock higher, and why bears have no moat when it comes to Tesla.

Building a Powerhouse Organization
After years of trying and failing, Tesla is finally on track to become a powerhouse in different industries, including energy and automotive. By leveraging its manufacturing capabilities to build an ecosystem of clean energy products, Tesla will help the world become carbon neutral in the next few decades and it will also be able to create additional shareholder value along the way.

As of today, its core products from the automotive industry account for the majority of revenues, and that’s not going to change in the foreseeable future. However, as we progress further, investors should expect the company’s battery and energy generation and storage businesses to play a bigger role inside the company.

Currently, Tesla’s cars continue to be in high demand across the world, and in the first half of the year, the company had a 28% market share of the global EV market. In addition, at the end of August, Tesla also had an 80% market share of the US EV market. While last year, the company delivered a total of 367500 cars, it’s now on track to deliver 500,000 cars by the end of this year and even more in 2021. All of this shows that Tesla is maturing and while it took it nearly two decades to achieve profitability and growth, it’s finally able to show meaningful results.

In Q3, Tesla’s total revenues were $8.8 billion, up 39% Y/Y, and above the Street consensus of $8.3 billion. If we exclude $397 million in regulatory automotive credits, then Tesla would’ve still met the analysts’ expectations. In addition, the company generated $1.4 billion in FCF, above the consensus of $1 billion, and its automotive margin increased to 27.7% against expectations of 24.1%. Considering such a good performance, Tesla is on track to have another record year.

The third quarter has also become the fifth straight quarter of profitability, as Tesla’s GAAP EPS during the period was $0.27. While the company’s income of $331 million was below the estimates of $391 million, the decline in income was due to $543 million in stock-based compensation, which was above the expectations of $330 million. Nevertheless, the fact that Tesla is now profitable on a constant basis makes it harder for bears to use the profitability argument to justify a short position in the company.

In addition, after the recent capital raise, Tesla now has the biggest cash reserve in its history. At the end of September, the company’s cash position increased to $14.5 billion, an increase of 69% Q/Q or 172% Y/Y. The excess of cash is likely going to be used to ramp up the company’s battery production in 2021, and to fund its expansion in the following months.

Tesla, The Car Company
As we mentioned at the beginning of this article, the automotive business will continue to account for the majority of the company’s revenues. Tesla will also continue to have a first-mover advantage in the EV space, and as the market for the battery electric vehicles matures, more value will be created. In Q3, Tesla manufactured a total of 145k cars and delivered 139.6k cars. In the following months, those numbers will continue to increase, as the production will be ramping up in the company’s Fremont and Shanghai Gigafactories. In addition, the opening of Tesla’s Gigafactories in Berlin and Texas will help the company to substantially increase its capacity by the end of next year.Source: Tesla

At this stage, it’s only a matter of time until the world becomes carbon neutral. Numerous surveys show that people are now more interested in purchasing a battery-electric vehicle instead of an internal combustion engine vehicle. As more environmental regulations, like the ban of diesel cars, will kick in around the world, more people will begin to drive environmentally-friendly vehicles. In addition, just recently Germany decided to reduce its VAT rates on electric vehicles and at the same time increase the subsidies for purchasing them, while France also decided to incentivize the acquisition of BEVs instead of ICEVs.

We should also not forget that China, which is the largest automotive market in the world, aims to have 25% of its cars on the road to be environmentally friendly by 2025. This will help Tesla to increase its market share there. Also, after Xi Jinping’s announcement that China plans to become carbon neutral in the next four decades, establishing a stronger foothold there makes sense for Tesla. The company already built its Gigafactory in Shanghai two years ago and today Tesla Model 3 has become the best-selling EV in the region. As China continues to dominate the car market, being a leader there will only help Tesla to expand and drive growth for years to come.

Tesla, The Startup
With enough cash on hand now, Tesla is finally able to expand its operations and increase its presence in other fields, outside of automotive, which was its goal since the very beginning. While a lot of its projects like robotaxis are still in infancy, there are nevertheless several ambitious businesses in the energy field, which have the potential to create value in the long-term. While Tesla’s solar business, which includes the installation of solar rooftops, is currently unprofitable, investors shouldn’t worry about it too much since it represents only a fraction of the overall business. Also, its goal is to later become a part of the integrated home system business, which will include energy generation and storage, heating, and cooling services all in one plan. Until that happens, Tesla’s solar business will continue to expand into as many households as possible and grow further, so the losses in our opinion are justified at this stage.

Another value creation opportunity will come from the battery field. Recently, Tesla decided to build all of its cells in-house, which will help the company to improve margins of its other businesses and afford the creation of affordable cars for its customers. Also, by partnering with CATL, which is one of the largest providers of battery solutions in China and the world, Tesla will be able to substantially decrease its costs and achieve its goal of releasing a $25,000 car in the next few years.

The Bear Case
Despite all of those things, bears of Tesla do make several points that bulls need to consider in order to value the company in an unbiased way. First of all, while solar and battery businesses are promising, they still account for a fraction of the company’s earnings and, like with any other businesses, there’s no guarantee that they’ll succeed in creating value in the foreseeable future.

Another downside of Tesla is its stock price. Thanks to the injection of liquidity by the Fed into the markets earlier this year, Tesla quickly recovered from its bottom in March and now trades at a market cap of ~$400 billion, way above any other car manufacturer by a wide margin. Considering that Tesla has a forward GAAP P/E of over 300x, there’s no doubt that the company is overvalued by traditional metrics. However, in recent months we’ve seen that the current market prefers growth over value, so there’s every reason to believe that Tesla will continue to appreciate on bullish sentiment.

There’s also a risk that as the electric vehicle market continues to mature, more car manufacturers will enter the EV field and will slowly eat Tesla’s margins. The company already experienced a decline in sales in the first half of this year in Europe amid the growth of the rest of the EV market, as consumers shifted their interest and began to purchase cars from its domestic manufacturers. Also, several major competitors already started to pour massive investments into the EV field. Currently, General Motors (GM) plans to release more than 20 electric vehicles in the next few years and it’s already redesigning its Detroit plant to make sure that it’s on track to achieve that goal. In addition, Ford (F) also started to convert its Ontario plant to manufacture EVs, while Volkswagen (OTCPK:VWAGY) took it a step further and in addition to the improvement of its Chattanooga plant, it entered into several joint ventures with its Chinese counterparts to manufacture electric cars and batteries. As the competition intensifies, the risk that Tesla’s margins could depreciate remains.

The Other Side of The Story
One of the most vocal bearish cases says that without regulatory credits, Tesla is doomed, as it’s unprofitable. We don’t think that that’s the right approach at how to look at Tesla. For those who are unaware, in various countries around the globe car manufacturers need to create one electric vehicle for every gas-powered car that they produce. Instead of doing so, manufacturers of ICEV simply buy regulatory credits from EV companies like Tesla in order to comply with regulations. Since the whole world goes carbon neutral, it makes no sense to take those credits out of the picture and simply say that without them Tesla is unprofitable. After all, the environmental regulations are a major part of the car business now and they are only going to become stricter, so looking at Tesla or every other EV without including them makes no sense.

What’s also interesting is that from Q1 to Q3 regulatory credits for Tesla were in the range from $350 million to $430 million per quarter, while the company’s net income during the period increased from $16 million in Q1 to $331 million at the end of Q3. We could clearly see that while regulatory credits were nearly the same during the last three quarters, Tesla was able to substantially improve its profitability. This shows that soon it will be able to make a profit even if we exclude those credits (which is something that makes no sense doing in the first place).

Since legacy car manufacturers will not be able to fully dump their portfolio of ICE cars in the next few years, regulatory credits will continue to be a part of the game and Tesla will continue to benefit from them, whether you like it or not.

Another advantage of Tesla is that it has a loyal following, which will continue to support the company and believe in its mission of making a world free of CO2 emissions. Last year Bloomberg conducted a survey, which showed that owners of Tesla cars are the company’s biggest sales force, as they are the ones that will recommend the car to their friends and relatives, and will they also continue to buy the company’s products in the future. As the number of Tesla owners continues to increase, the company could expect its loyal following only to grow.

Also, while it’s true that Tesla began to lose ground in Europe this year, there’s no guarantee that that will be the case next year when the company’s Gigafactory in Berlin will be finished. Currently, Tesla ships its cars to Europe from Asia, which makes it hard for the company to have any pricing advantage against its peers. So while this year the battle in Europe has been lost for Tesla, it’s too soon to say that the company has lost its ground there. In addition, the reality is that even if other car manufacturers will decrease Tesla’s market share in the region, the increased adoption of EVs will offset the decline in market share, as the overall market will become bigger and it will continue to grow.

What’s Next?
When it comes to China, Tesla already established a strong presence there. As of today, the company’s Shanghai Gigafactory is able to produce 250k cars per year, which is an increase from 150k per year. In addition, the company believes that it will be able to produce 1 million cars in Shanghai Gigafactory in the future.

Before the Q3 report, the street expected Tesla to deliver a total of around 740k cars in 2021. However, during the conference call when answering to the analyst question, Elon Muck hinted at the possibility of delivering around 840k to 1 million cars in 2021. Considering how fast the company is able to expand its capacity, it’s safe to say that that will be a realistic goal for Tesla to achieve. The street already began to raise its price target after the conference call and it’s safe to say that as long as deliveries continue to increase, the stock will continue to rise.

In the next decade, the goal of Tesla would be to substantially increase its capacity and be able to deliver 20 million cars per year by 2030. No one knows whether that will be the case, but as long as deliveries continue to increase and profit starts to arrive, the market will continue to believe in Tesla’s growth story and will ignore the traditional valuation ratios. For that reason, we believe that shorting Tesla’s stock even at the current price makes no sense, considering how many big short sellers already lost their fortune betting against the company. The reality is that Tesla is one of a kind company that will continue to expand. Considering this, we believe that if you want to short something, then there are better ideas with a more attractive risk/reward ratio out there.