Tesla TSLA has a chance to be the dominant electric vehicle company in the long term. It is a leading autonomous vehicle player as well as a vertically integrated sustainable energy company with energy generation and storage products. However, we do not see it having mass-market volume this decade. Tesla’s product plans for now do not mean an electric vehicle for every consumer who wants one, because the prices are too high. The Model X crossover released in late 2015 starts at about $80,000, the Model S sedan’s starting price is $69,420, the Model 3 sedan starts at $37,990, and the Model Y crossover starts at about $50,000. Tesla’s U.S. customers no longer receive the federal tax credit. Our $306 fair value estimate puts the shares solidly in 1-star territory.
Tesla’s gigafactories may become terafactories as the company seeks to expand its cell capacity to 3 terawatt-hours by 2030 from 0.1 terawatt-hour in 2019. A new factory in Shanghai, wholly owned by Tesla, opened in late 2019 with capacity as of fall 2020 for 250,000 Model 3 units and another 150,000 Model Y units online in 2021. Gigafactory Berlin (3 and Y) is under construction until 2021 as is a Texas plant for the Cybertruck and Y. Tesla’s global vehicle capacity as of fall 2020 is about 850,000. The company sold about 368,000 vehicles globally in 2019; by 2030 or earlier, CEO Elon Musk targets annual volume of 20 million, about double the size of Toyota and VW Group. We think global mass adoption of pure electric vehicles is still years away, but Tesla is the leader in the space.
Tesla will have growing pains, recessions to fight through before reaching mass-market volume, more competition, and needs to pay off debt. It is important to keep the hype about Tesla in perspective relative to the company’s limited, though now growing, production capacity. Tesla’s mission is to make EVs increasingly more affordable, which means more assembly plants must come on line to achieve annual unit delivery volume in the millions. This expansion will cost billions a year in capital spending and research and development and will be necessary even during downturns in the economic cycle.
Brand Cachet and Cost Advantage Lead to Moat Upgrade Our October upgrade to a narrow moat rating for Tesla came from two of our five moat sources: intangible assets and cost advantage. Tesla's brand cachet is not likely to be impaired anytime soon as other automakers move into the battery electric vehicle space because we expect the company to keep innovating to stay ahead of startup and established competitors. The Model S now offers over 400 miles of range, and the Plaid mode performance upgrade available in late 2021 will enable the sedan to do 0-60 mph in under 2 seconds and have over 520 miles of range. We think Tesla's autonomous program is also well ahead of many other automakers'. We think Musk was very smart to not only design a great-looking car, but also have Tesla right away sell vehicles at a premium price point. This created tremendous media publicity for Tesla beyond its customers, which we think created a halo effect for Model 3 and Model Y demand when they were introduced, as well as for the Cybertruck, which we think is ugly, but that ugliness is ironically part of its appeal. We think that if Tesla had started with a mass-market vehicle, it probably would have failed, as too few people would have known about the car and would have been willing to pay for the brand. We also think Tesla benefits from a first-mover advantage in electric vehicles that let it build factories and vehicles from scratch and create processes that legacy automakers will probably find hard to match.
The ability to possibly reduce battery cell costs by 56%, as outlined at the company’s September event, suggests a cost advantage that incumbent automakers could take years to catch or may never catch, as they won’t want to build many new factories from scratch as Tesla is doing. Legacy automakers are gradually transitioning to BEV production from internal combustion, but we expect they will be saddled with legacy internal combustion engine costs and people costs for a long time. Our assumptions for Tesla’s return on invested capital are well above our weighted average cost of capital even in our bear-case scenario. Our moat rating upgrade assumes Tesla continues to grow; we saw low risk of material value destruction and more reasons to upgrade the moat than keep waiting for further improvement.
We think Tesla’s gross margin, all else constant, would have a negative mix shift over time as the cheaper Model 3, Model Y, and planned $25,000 vehicle become the vast majority of volume, but battery costs should also decline significantly. These reductions and adjusted gross margin calculations we’ve done comparing Tesla with German automakers--along with Tesla’s unique factory-owned stores enabling the company to get retail pricing rather than wholesale pricing--are in our view a cost advantage over other automakers and lay the groundwork for the moat widening once Tesla’s volume allows more scale of its R&D and overhead expense. A similar scale argument can be made for the energy business. Though long term there’s nothing stopping an ICE company from becoming a BEV-only company and narrowing Tesla’s cost advantage, we see legacy companies as having legacy cost structures around ICE vehicle programs that cannot be eliminated overnight as these programs are needed to keep those companies profitable while also developing BEVs.
The other cost advantage comes from the customer side via total cost of ownership, as the cost of electricity for a year versus the cost of gas is not even close. Model S owners’ electric costs are a fraction of what ICE owners pay for gas, per our calculations. Our annual cost calculation done in January 2020, defined as electricity or gas, insurance, and maintenance, shows the Model 3’s cost per mile at about 15% less than a BMW 330i.
Uncertainties Are Many Investing in Tesla comes with tremendous uncertainties due to the future of electric vehicles and energy storage. In a recession, investors may not want to hold the stock of a company whose story will not play out until next decade, or Tesla could fail to raise capital when it needs it. Until an electric vehicle far cheaper than the Model 3 goes on sale in mass volume, there is no way to know for sure if consumers in large volume are willing to switch to an EV and deal with range anxiety and longer charging times compared with using a gas station.
Tesla is fighting a state-by-state battle to keep its stores factory-owned rather than franchised, which raises legal risk for the company and could one day stall growth. If the company’s growth ever stalls or reverses, we would expect a severe decline in the stock price because current expectations for Tesla are immense, in our opinion. With a young, growing company, there is always more risk of diluting shareholders or taking on too much debt to fund growth. Tesla also has customer concentration risk, with the United States and China constituting about 64% of 2019 GAAP revenue, up from 56% in 2015.
We see immense key-man risk for the stock, as Tesla’s fate is closely linked to Musk’s actions. Should he leave the company, or if the Securities and Exchange Commission--which has already barred him from holding the chairmanship for three years--bans him from running Tesla, we would not be surprised to see the stock fall dramatically. Also, Musk has 18.5 million Tesla shares as collateral for personal debt. Selling this block of shares quickly may cause a rapid fall in Tesla’s stock price.
Tesla will soon have formidable EV competition from German premium brands, as well as GM and Ford, that it’s never had before. Also, it’s uncertain if Tesla vehicle owners will also want solar panels and batteries in sufficient volume to justify buying SolarCity. Given the many uncertainties regarding Tesla today, our fair value uncertainty rating will remain very high for a long time.
Growing Cash Pile Since its 2010 initial public offering, Tesla has used convertible debt financing as well as frequent secondary equity offerings and credit lines. At year-end 2019, the company has $3 billion in unused committed amounts under credit lines and financing funds. At times, the stock has been so popular that we think the company could dilute shareholders at those times and the stock would not suffer. Three offerings in 2020 totaling over $12 billion support that premise. The stock also increased in value after the August 2015 announcement of an equity offering, likely due to cash burn concerns being eased. Offerings like the $2.3 billion stock sale in February 2020 and $10 billion in late 2020 add to the company's expanding cash pile, which gives the market optimism that Tesla can keep growing.
Total debt at year-end 2019 was about $12.5 billion of principal, with $4.6 billion of that amount nonrecourse debt mostly backed by SolarCity’s asset-backed security issuances and a warehouse line secured by cash flows from vehicle leasing contracts. Recourse debt maturities between 2020 and 2024 total about $6.1 billion. No major maturities occur in 2020, but 2021 maturities total $1.4 billion with a $1.38 billion convertible bond maturing in March 2021. Management said some convertible debt will be put to the company in the fourth quarter due to the stock’s upward run. The conversion price of the 2021 notes is $71.97 per share. In August 2017, Tesla issued $1.8 billion of senior unsecured notes due in 2025 at only 5.3%. The deal was the company’s first straight bond offering. Musk said in 2018 that Tesla will pay its debts off rather than refinance, which if achieved would alleviate our balance sheet concerns, but the May 2019 debt offering delays Musk’s debt reduction goal. Tesla has raised over $12 billion of stock in 2020, so we think for now the balance sheet is in good shape with $14.5 billion of cash as at Sept. 30.