Buy This Apple of the Auto Industry

Masam is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Tesla Motors (NASDAQ: TSLA) has received a lot of attention lately after its Motor S sedan was selected 2013 Car of the Year by Motor Trend. The stock continues to be shorted in large quantities as people seriously doubt the production facilities of the company. The company has not generated a single cent of profit since its inception and the company’s profitability largely depends on its ability to ramp up its production facilities in 2013. At a production rate of 400 cars/week, the company is expected to start making profits in 2013.  

The Investment Case

While the broader clean technology industry continues to face headwinds attributed to continued reliance on diminishing government support, Tesla Motors has not only emerged as a clear innovator in the emerging electric vehicle (EEV) industry, far surpassing preconceived performance expectations for EEVs, but is a legitimate contender in the premium automobile market as evidenced by its recent awards and notable industry rankings. In my view, 2013 should be the year that Tesla transforms from an innovative upstart to a sustainable and profitable operating entity, clearly differentiating it from the broader clean technology space.

The Business Drivers

I believe that Tesla’s most compelling competitive advantage is the company’s technological prowess, which has enabled it to deliver the first all electric premium sedan that doesn’t compromise on any performance characteristics when compared to its traditional internal combustion engine vehicles, but also provides a number of added benefits to the consumer (i.e. increased room, superior handling, and a lower overall total cost of ownership).

It is important to note that the Model S does not have a demand problem. By the end of the third quarter, the company had already registered 13,500 pre-orders for the Model S. The company has targeted production of 20,000 Model S in 2013.  

Competition for the Model S

EEV is not a new concept. Time and again, major OEMs have ventured into this territory, though not a single EV has achieved as much praise as the Model S. General Motor’s (NYSE: GM) Volt is regarded as a cheap electric car by most of the people. However, it comes with the problem of a short range and poor acceleration.  It covers a distance of only 35 miles in a full battery charge. Also, it takes nine seconds to accelerate to 60 mph, more than double the time taken by the Model S to reach the same speed.

Ford (NYSE: F) has not been popular in the EV market. However, its C-Max hybrid has won massive success by the green energy lovers. C-Max hybrid is considered to be the fastest selling hybrid launch ever. The following table shows the features of the Model S compared with other cars, both EV and non-EV:

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Many people have rightly claimed that the Model S is not a conventional electric car that comes with all sort of compromises. Therefore, it does not compete with the Volts and Leafs of the auto world. Rather it should be compared with the Porsches, BMWs and Audis of this world. 

In looking toward 2013, steady execution of the company’s production ramp up should drive improved operating metrics (margins, cash flow generation) while its investments into a broader distribution network (both in the U.S. and abroad) should begin to bear fruit, driving broader awareness of the Model S’ compelling and differentiated value proposition. This, coupled with tangential benefits associated with vehicle ownership (i.e. free use of the company’s nationwide supercharger network) should lead to improved market penetration.

Upside Scenario

Tesla’s ability to hit its internal targets as well as garner additional OEM business beyond its current partners could support upside to the CY14 estimates to north of $3.00 per share. Further multiple expansion driven largely by its growth profile supports the bullish case of a share price of $65.

Downside Scenario

Given Tesla’s binary nature, the company’s inability to execute its production schedule could ultimately lead to a cash crunch. A potential liquidation of its assets provides the downside case of ~$5 per share assuming liquidation value in the range of $500 million - $1.0 billion.

Valuation Analysis

In my view, the combination of technology leadership, healthy demand, and the company’s focus on the high end market supports the bullish case. The price target of $38 equates to a multiple of 16x with a CY14 EPS estimate of $2.35.

Currently, 49% of the total float has been shorted by investors. Given that the company has already achieved a production rate of 290 cars/week and was narrowly cash flow positive, the shorts should be careful that the stock might be ready for a rally. In the scenario of a short-squeeze, it will take around 29 days for the short positions to clear (short ratio is 29 days).  

AnalystX has no positions in the stocks mentioned above. The Motley Fool owns shares of Tesla Motors. Motley Fool newsletter services recommend Tesla Motors . Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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