Tesla Makes Progress but Has a Long Road Ahead

 Tesla (TSLA) reported a first-quarter adjusted loss of $3.35 per share, beating consensus of a $3.48 loss. Total company revenue increased 26.4% year over year (up 3.7% sequentially) to $3.4 billion, beating consensus of $3.2 billion. We are leaving our fair value estimate in place but will continue to monitor Model 3 deliveries and adjust our vehicle delivery projections, which can affect our valuation. We think the long-term story on what Tesla can achieve in electric cars, trucks, mobility, and energy generation and storage will ultimately determine the value of the company. We believe the stock trades on option value that, if realized, is still many years away, and therefore we do not think any single quarter’s results are critical to the investment thesis.

Vehicle deliveries increased year over year by 19.7% to 29,997, with the Model 3 sedan constituting 8,182 of the total. Management continues to expect a Model 3 weekly production rate of 5,000 in about two months’ time. Tesla Energy’s revenue nearly doubled year over year to $410 million, with storage revenue growth of 161% more than offsetting a 50% decline in energy generation megawatts to 76 MW. Also encouraging is cash sales’ continued increase as a percentage of total residential solar deployments (66% in first quarter versus 54% in fourth quarter and 31% in the first quarter of 2017), which helps cash flow compared with the old leasing format under SolarCity.

We expect a dramatic improvement in profit and cash flow soon, in either second-quarter or--more likely--third-quarter results, due to a large jump in Model 3 deliveries later this year. Management also has high expectations, as it expects Tesla to be profitable on a GAAP basis and have positive cash flow for the third and fourth quarters. We calculate adjusted free cash burn of $942 million for the first quarter of 2018 compared with cash burn of $181.9 million in the fourth quarter of 2017 and $436.1 million in the first quarter of 2017.

Although we remain concerned about Tesla’s debt levels, immense key-man risk, cash burn, and much more premium battery electric vehicle competition coming from the German automakers and other companies, the looming increases in Model 3 production and CEO Elon Musk on the conference call teasing a large 1-gigawatt energy contract announcement soon give reason for optimism. We caution, however, that euphoria over Model 3 accomplishments may be short-lived because there are many growth projects still needing investment. Musk said on the call that the Model Y crossover will start production in 2020 and the location is not decided yet. Model Y spending will be significant next year, according to Musk. He said Model Y production will not be in Fremont, California, because there is no room, which is not shocking to hear. Tesla expects to make a second assembly plant announcement late this year. Musk also said a gigafactory in China is coming (not surprising, given China’s recent announcement that it will lift caps on foreign joint venture ownership for electric vehicles starting this year) and all future gigafactories will also have vehicle assembly. Currently, Gigafactory 1 in Nevada manufactures battery packs and then ships them to Fremont for all vehicle assembly.

Other growth projects beyond the Model Y include autonomous ride-hailing possibly starting in late 2019, Tesla Semi starting next year, and the second-generation roadster in 2020. Musk said the pickup truck is going to be great but provided no timing. The company did reduce its 2018 capital expenditure guidance to under $3 billion from $3.4 billion in 2017. The change is to focus more on immediate projects, and management’s comments on the call suggest that the Model 3 is by far the top priority--as it should be, in our view.

These are all exciting projects, but it will take billions more in capital spending, which we think will eventually require additional capital raises. These raises could be delayed if the capital markets are closed due to a downturn or due to cash flow fears, as Tesla’s 5.3% coupon 2025 bonds experienced in early April with their effective yield rising to over 7.5% due to cash flow concerns. Musk said on the May 2 call that if stock investors do not like volatility, they should not buy Tesla’s stock. We agree with that statement; given that Tesla is still operating in the capital-intensive auto industry, the stock could fall severely in a recession. We do not see a downturn this year, but we also believe Tesla is not immune to the cyclicality of the auto industry, despite its tech image.