Tesla Motors – Jump in for a Ride to the Top?

Mike 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) share price has increased by 76% since May 8, 2013, but has pulled back to under $100 from a high of $110.33. The pullback could be a buying opportunity before the stock resumes its rapid appreciation. However, the rapid rise could also be overblown for a company that does not make any money. Is the company going to beat the bear case?

Tesla is an electric car designer and manufacturer and also services and sells power train components for other electric vehicles, including ones from Daimler and Toyota. It started in 2003 in Palo Alto, CA. It introduced its first offering in 2008, the Tesla Roadster. Since then, the company started to deliver its first completely designed car, the Model S. Management indicated its plans to deliver 21,000 cars in 2013. It is a small but growing player in autos. For comparison purposes, normalized auto sales in the US are considered to be around 15 million vehicles. Also, Tesla is expanding its wholly owned sales and service centers from 34 to 50 by year end.

Tesla – Profitability and Demand Moving in the Right Direction

While Tesla has produced losses in years past, forecasts are for earnings to turn marginally positive in FY13 and to earn $1.03 per share in FY14 according to current consensus. Bookings and performance for the company’s Model S are considered a success at this point by the Street, contributing to the increase in share price. The next challenge for the Model S and Tesla is hitting margin goals. Management has set a 25% gross margin target.

The Model X is the next vehicle Tesla will introduce to mainstream production in 2H14. Interest also seems high and there is discussion of a need for more production capacity - a good problem to have. The Gen III vehicle will come next for Tesla in 2016 or 2017. There is some concern that without some breakthrough in battery tech, introducing it in its current form may not be possible.

Auto manufacturing is considered to be a high fixed cost business, meaning the contribution margin per incremental vehicle sold is high. If Tesla continues to see demand and can drive volume and limit start-up headwinds with new capacity, earnings could expand at a very rapid pace. The biggest challenges for Tesla will likely come from managing its supply base, controlling costs as many of its parts are sourced from a single supplier and increasing production without significant problems along the way. Each of these will likely negatively impact profitability at some point, but this is expected to a certain degree by the Street.

Other Mid to Long-term Challenges for Tesla

Tesla faces a few key challenges. First, the slow adoption of electric vehicles could become a headwind as production capacity at Tesla increases. Battery costs are also prohibitive for mass deployment of electric vehicles as is the availability of charging stations for them. The technology needs to get cheaper for larger scale adoption. This is a factor for Tesla’s Gen III vehicles, and a reason why management wants to have a $35,000 price point. Currently the Model S sells for about $72,000 after tax credits. It has a range of around 300 miles.

All of this sounds good for Tesla. Its competitors include the Chevy Volt (NYSE: GM) and Nissan Leaf (NASDAQOTH: NSANY.PK). It appears Tesla’s offering is outperforming these other electric vehicles. Even though GM and Nissan have massive resources, they cant keep up with Tesla in this niche. GM has $24 billion in cash and billions more coming in annually.  Nissan also has massive amounts of cash ($10 billion) and about $5 billion in net income annually.  Both of these vehicles underperformed versus market expectations. Challenges to broader electric vehicle adoption likely played a role. Tesla’s higher end offering seems to have helped it. Other competitors in the sector went bankrupt like Coda Holdings, Fisker, Think Car and others.

Conclusion

Being the best and only significant pure play electric vehicle manufacturer that is traded shows that Tesla has accomplished a lot so far. It is trading at just under 100x FY14 EPS. There is no other auto or manufacturing company that comes to mind to compare it to for valuation purposes. A DCF with the terminal value coming from the Gordon Growth method is probably the best approach to valuing Tesla. That said, the cash flows are not easy to determine. Factors that can drive the shares higher are improving industry fundamentals, beats versus consensus from earnings, and order activity.

Tesla's plan to disrupt the global auto business has yielded spectacular results. But giant competitors are already moving to disrupt Tesla. Will the company be able to fend them off? The Motley Fool answers this question and more in our most in-depth Tesla research available. Get instant access by clicking here now.


Mike Thiessen has no position in any stocks mentioned. The Motley Fool recommends General 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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