Investment Thesis
We believe in Elon. During childhood, he dealt with an abusive father, was bullied and beaten in school, and on growing up couldn’t find employment, despite two bachelors degrees, in physics and economics, from the esteemed, University of Pennsylvania. Undoubtedly, he has great genetics, hailing from an accomplished family. However, that does not explain how Elon constantly beat the odds, and founded Zip2, SpaceX, The Boring Company, and xAI, and cofounded Tesla, Neuralink, Solar City, OpenAI, and X Corporation (now PayPal).
In regard to Tesla, Inc. (NASDAQ:TSLA), CEO Elon Musk has successfully surmounted numerous challenges to its survival as a company. In 2008, when TSLA was on the brink of bankruptcy, he plowed significant capital (from the $180 million he received as his stake, on the sale of PayPal to eBay) into the firm, going almost broke. In 2018, he once again steered TSLA from Chapter 11, when production and logistical issues linked to the initial ramp of the company’s Model 3 cars, reflected in a significant scarcity of resources.
More recently, during the last quarter of 2022, Elon began to opportunistically offer heavy discounts on Teslas, to counter the negative effects of the rise in interest rates on the final price customers paid for the cars, to remain competitive with Chinese EV brands which are typically the cheapest in the market, and to ignite demand to balance the major growth in supply of Teslas as production ramped substantially. The maneuver ensured that despite delivery of 1.8 million Teslas during 2023, the vehicles are currently back ordered.
There is a method to Elon’s madness. He pursues high complexity problems that support large scale, vertically integrated, closed design organizations. In addition, he deploys ethos, pathos, and logos, to draw investors in. In total, Elon has raised $34 billion in capital, across his companies. Given his demonstrated leadership abilities, particularly in regard to TSLA, we believe that Wall Street should extend the benefit of doubt on TSLA’s future to Elon. In our opinion, TSLA investors can rest easy, knowing that he will opportunistically deploy resources, capital, competitive positioning, and government regulation (supporting the planet’s electrification) to continue to deliver strong growth in revenues and earnings.
Now, on to fourth quarter and full year financial results, reported on Wednesday. Over both periods, TSLA outperformed, driven by strong growth in automotive production and deliveries, that fueled solid revenue expansion. Significantly higher revenues, on a year-over-basis, were equally supported by the continued growth in the battery storage and services revenues, which far outstripped that associated with Teslas. Operating margins contracted over both periods, due to spending on vital projects, including ramp in production of Cybertrucks.
Nevertheless, compared to their respective prior periods, both fourth quarter and full year net income more than doubled. Consequently, earnings per share associated with both durations, came in considerably higher versus the Q4 2022 and full year 2022 figures. Overall, we are pleased with TSLA’s financial performance, despite eroding margins, as absolute dollar profits doubled. We prefer higher revenues, margin contraction, and increase in net income, over lower revenues, margin expansion, and lighter net income. Net-net, delivering more Teslas at lower prices, appears to benefit the bottom-line.
Considering TSLA’s financial outperformance during the fourth quarter and full year, we are confident that the company is positioned to achieve the revenues and cash flow estimates that underpin our 10-year Discounted Cash Flow (“DCF”) model, which incorporates a 10-year normalized revenue growth rate of 50%, a profit margin of 10%, operating cash flow margin of 18%, annual capital expenditures of 2%, average cost of capital of 7%, and a perpetual growth rate of 3%. Therefore, we are reiterating our $492/share Price Target and Buy Rating for TSLA’s stock.
Separately, we agree with TSLA and industry thought leaders, that 2024 is likely to be a softer year in EV sales growth, as the market digests the outsized EV sales, that unfolded over 2023. Undoubtedly, revenue growth associated with Teslas will come in below 2023 levels. However, we anticipate that average cost of production/Tesla is likely to continue to decline, driven by design innovation and lower commodities/software costs.
Beyond 2024, we expect Tesla sales growth to accelerate substantially, as the company ramps production on a lower priced economy model, scheduled to begin production, during the back half of 2025, at the Austin Gigafactory. We view the potential rollout of economy Teslas (expected to be priced at ~$25K) to be a game changer for the company and its industry. For TSLA, the potential development will open up an additional addressable market which targets customers that would typically purchase lower priced internal combustible engine vehicles, such as the Toyota RAV4, Toyota Corolla, and Honda Civic.
We expect production and delivery volumes associated with the economy cars to far outstrip that linked to Model 3/Y vehicles. Further, we believe that the new model will feature prominently in TSLA’s push to achieve the 20 million cars/year production target set for 2030. Moreover, given the imminent expansion in the export of Chinese EVs to Europe and Asia, we view TSLA’s foray into the economy car market as opportunistic.
Chinese EVs, although lacking in safety standards (compared to EVs produced by major American and European car manufacturers), are technologically advanced and feature design elements, comparable to those observed in premium priced EVs. As Chinese EVs are priced substantially below the typical EVs marketed in Europe and Asia, they represent a potential threat to EV sales associated with the competition in those regions. In that respect, it is notable that lower-priced EVs from major car companies appear inferior relative to the typical EV, lacking in appearance and efficiency. Therefore, despite widespread availability, customer demand for these vehicles, has remained sluggish.
Given TSLA’s penchant for excellence, we anticipate that the firm’s economy model, despite being relatively less expensive, is likely to feature superb design and functionality. Therefore, we expect the vehicle to be well received by customers, and derive strong demand out of the gate. In the context of market opportunity, the International Energy Association (IEA) projects that in 2030, the number of EVs delivered/year will expand to 40 million, with sales derived from China, the U.S., and Europe accounting for 40%, 20%, and 25% of the total. By 2050, the agency envisions that EVs will represent between 29% and 54% of the global new vehicle market, with China and Europe accounting for between 58% and 77% of those EV sales.
In regard to TSLA’s battery pack segment (which evidenced revenue growth of 54% during 2023), a majority of sales associated with the firm’s Megapacks are likely to derived from the Organization for Economic Co-operation and Development (OECD) countries (primarily the U.S., Canada, countries of the European Union, and Australia). The rest of the world, aside from a few Middle Eastern countries, is poor. They cannot afford sustainable energy – infrastructure has to be developed, thousands of miles of transmission lines laid out, and grid storage established. Based on estimates, electrification of the planet will require ~$30 trillion in funding. Most Global South nations, are likely to consider switching to green energy prohibitively expensive. They are likely to continue to utilize thermal energy, particularly derived from indigenously produced coal and imported oil and gas to power their respective electricity grids. Therefore, Megapacks are unlikely to catch on in non-OECD countries.
In the context of Megapack demand associated with Europe, it is noteworthy, that following the Russian aggression against Ukraine, and the subsequent cessation of oil and gas supply from Russia to Europe, the region embraced sustainable energy, implementing large scale projects to harness wind and solar power. In the U.S., the Inflation Reduction Act has earmarked significant funding for green energy projects. Existing Megapack projects include battery parks in East York in the U.K., in Lessines in Belgium, in Texas, Hawaii, and Alaska, in the U.S., and in Queensland in Australia.
Overall, existing demand expectations for Megapacks associated with OECD countries is sufficient to absorb supply from megafactories located in California and Shanghai, which are equipped to each produce 10,000 Megapacks/year. Indeed, Megapacks are back ordered through the fourth quarter of 2024. Given market dynamics pointing to an imminent major expansion in the number of battery farms, TSLA has indicated that plans are underfoot to launch additional megafactories, over the near to medium term. In regard to earnings potential, Megapacks are priced at $2.4 million, with a expected profit margin of 10%/unit. Considering that each Megapack supports an energy capacity of just 3.9 MWh, hundreds of units are required to populate battery farms, to provide a reasonable amount of power.
Net-net, considering the above narrative, it appears that Elon has developed TSLA in a manner that ensures solid revenue growth, decades into the future.
Bottom Line
What came first, the chicken or the egg? Did Elon get fixated on saving the planet and invest in Tesla, or did he rack his brain to identify opportunities that would render him insanely rich, and settled on climate change artifacts – probably the latter. Nevertheless, he has pioneered the global EV industry, developing TSLA into the largest automobile company in the world, in terms of market capitalization. Whatever, the eventual plight of the climate change movement, EVs are here to stay.
Beyond OECD countries, where EVs are now mainstream, the automobiles are likely to find homes in developing nations which will be glad to replace precious foreign exchange funded imported gasoline for battery power. To underscore how accepted the disruption of the automobile industry by EVs is, even Exxon Mobil (XOM), the world’s second-largest oil and gas company has jumped on the bandwagon, launching a lithium mining endeavor, that is expected to produce enough lithium to power batteries for a million EVs/year, by 2030.
Tesla, Inc. is a key beneficiary of the assured continued success of the EV industry, well positioned to prosper more than the competition. In addition, with a 21% ownership stake in TSLA, Elon’s fortunes are firmly entwined with that of the company. Therefore, he is likely to do his best to not compromise TSLA’s leadership of the EV industry. The selloff in TSLA’s stock is an opportunity to double down on shares. Buy, Buy, Buy.
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