Introduction
I had a thesis about Tesla, Inc. (NASDAQ:TSLA) with a "Strong Buy" recommendation, shared in early March. The stock price has declined by 2.5% since my previous publication about the stock, compared to +4% from the S&P 500 (SP500). The environment continues to be challenging for automotive companies due to high interest rates. Macro headwinds were reflected in the company's Q1 report, as automotive margins are deteriorating and sales stagnating.
However, the broader economy and interest rates are cyclical, which means that the challenges Tesla faces are temporary. On the other hand, Tesla continues pursuing its long-term goals and the company is striving to maximize its potential to capture favorable secular trends. The valuation is still very attractive, and I am inclined to reiterate a "Strong Buy" rating for TSLA.
Fundamental analysis
I believe that the headlines regarding intensifying competition is one of the biggest reasons why Tesla's stock has experienced a tough 2024 with a 29% YTD dip. As an investor who relies solely on fundamentals, I want to start with sharing my insights about the "intensifying competition."
The competition in the broader electric vehicle ("EV") industry might be intensifying indeed, but Tesla appears to be on another level. Its Model Y became the world's best-selling car in 2023, outperforming long-term leaders manufactured by Toyota (TM), the Corolla and RAV4. This achievement is special because Toyota Corolla and Toyota RAV4 are internal combustion engine ("ICE") models, meaning that despite all the controversy, EVs can be more appealing than ICE cars. My point that Tesla is on another level among EVs is underscored by the fact that there is no other EV model in the below 2023 Top-10 bestsellers chart. What competition?
There is another big reason why I believe that "intensifying competition" is an exaggeration. While it was certain to me that Chinese EV manufacturers' export potential is quite limited due to the Cold War between the West and the East, it was just my expectations backed only by my judgment. However, in May, President Biden introduced a 100% tariff on Chinese-made EV vehicles. This means that Chinese OEMs are quite unlikely to enter the American market because it will be unrealistic to compete on pricing with a 100% tax burden.
I think that the probability of the same move from Europe is also quite high. According to the source, there are around 2.4 million direct manufacturing jobs in the automotive industry across the European Union ("EU"). This represents around 8.3% of the total EU manufacturing employment, a significant portion. Therefore, it is highly probable that the EU will seek for opportunities to protect its automotive industry from Chinese exports as well. On the other hand, Tesla looks protected from these potential regulatory changes as it already has mass production in Europe, at its Giga Berlin. Its current capacity is modest compared to Shanghai's factory, but Tesla has near-term plans to expand the capacity to a million EVs per year.
It is also vital that Tesla is poised to improve its competitive position further. The absence of a low-cost model appears to be the only weakness in the company's model line; however, there is a light at the end of the tunnel. According to Elon Musk, the affordable $25,000 model is on the horizon. The new, entry-level model is expected to be introduced next year, which also adds to my optimism. I think that when Tesla's management announces a $25,000 price, it apparently indicates that the new model is planned to overtake Toyota Corolla's leadership positions. Currently, the Toyota Corolla starts at $23,145 in the U.S.
Furthermore, many people forget that Tesla is not just an automotive company. Apart from selling the "hardware," the car itself, Tesla also invests heavily, maximizing its potential from capitalizing on its cutting-edge software. A lot has been told about the vast potential of Tesla's Full Self-Driving ("FSD") Capability, and I will not waste readers' time on reading the same information. It appears that Tesla is still hungry enough to expand its AI endeavors beyond the FSD.
Recent news suggests that Elon Musk plans to build a "Gigafactory of compute" by Fall 2025, powered with 100,000 Nvidia (NVDA) H100 GPUs. Last week, Elon Musk's xAI raised $6 billion to develop its Grok chatbots. While xAI is a separate entity that is unlikely to become Tesla's subsidiary, I believe that under common control Tesla will be able to leverage generative AI capabilities developed by Grok in the future. Microsoft (MSFT) with its early investments in OpenAI is a great example of how a hyper scaler can enjoy technological synergies with a disruptive startup.
As I said before, TSLA is not purely an automotive company. Its Energy Generation and Storage business demonstrates strong growth, fueled by its Megapack and Powerwall products. The segment continues demonstrating revenue growth. What is more important is that this business's gross profit expanded significantly YoY, from around 11% to around 25%. That said, the business benefits from increased scale and further profitability expansion can be anticipated. The industry is expected to observe a 16.3% CAGR by 2029, which is another solid secular tailwind for Tesla.
To sum up, I think that secular trends suggest that being bullish on TSLA is reasonable. The company continues investing in its strategic priorities, and headlines about intensifying competition appear to be a noise. There is a solid non-automotive potential as well.
Valuation analysis
Conducting peer ratios analysis for Tesla is quite challenging. The only pure-EV play of comparable scale is BYD Company (OTCPK:BYDDF), but it is a Chinese manufacturer, and they are inherently vastly undervalued due to significant political and geopolitical risks.
Therefore, I will compare Tesla's valuation ratios to American players like Rivian Automotive (RIVN) and Lucid (LCID). Both these companies are yet to achieve sustainable profits, and we can compare all three mostly based on metrics linked to revenues.
Tesla is much more expensive compared to Rivian, based on Price/Sales and EV/Sales ratios. However, compared to Lucid, Tesla's valuation is quite modest. That said, looking at peer ratios analysis does not give many answers.
The discounted cash flow ("DCF") approach will likely help to get more clarity. Future cash flows will be discounted using a 9% WACC, a slightly more conservative level than an 8.6% recommended level.
FY 2024–2026 revenues are projected by more than 30 Wall Street analysts, which I consider a representative sample. For the years after 2026, I incorporate a slight 50 basis points per year revenue growth deceleration. The constant growth rate is 7%, which some people might disagree with. However, it is difficult to argue that Tesla is at the forefront of the emerging and young industry with strong growth potential. Something like Microsoft (MSFT), Apple (AAPL), Oracle (ORCL), or Cisco (CSCO) thirty years ago. Therefore, let me show the revenue CAGR demonstrated by these four companies over the last three decades.
All of them delivered double-digit revenue CAGR over the last thirty years, which means that a 7% constant growth rate for Tesla's terminal value ('TV') calculation is fairly conservative.
The base year FCF margin is Tesla's last five years' average, with the expected 100 basis points yearly expansion. The conviction regarding the ability to improve FCF is high due to Tesla's stellar profitability and robust long-term revenue growth potential. According to Seeking Alpha, there are around 3.2 billion TSLA shares outstanding.
The discounted cash flow model suggests that the target price is $216, representing a 23% upside potential. I find such an upside for a stock like TSLA to be a compelling opportunity.
Mitigating factors
High interest rates appear to be the major headwind for TSLA's automotive business and since the U.S. economy is still strong and unemployment rates are low, the monetary policy might remain tight for a while. This uncertainty around the Fed's monetary policy is unfavorable for investors' sentiment and might be an obstacle for TSLA's rally in the near-term.
Ramping up production capacity and investing in innovation require substantial funds. Therefore, TSLA will need to invest massive amounts in R&D. This will likely undermine the company's financial position and put pressure on the stock price if these projects are not finalized on time.
Conclusion
This year's dip provides a compelling buying opportunity for Tesla investors. The valuation is very attractive despite Tesla's fundamentals improving rapidly. Therefore, I am aggressively adding more shares to my holding in Tesla.
Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.
KM Capital
Coming from an IT background, I have dived into the U.S. stock market seven years ago by managing portfolio of my family. Starting managing real money has been challenging for the first time, but long hours of mastering fundamental analysis of public companies paid off and now I feel very confident in my investment decisions. My hands-on experience shaped deep understanding of risk, reward and the delicate balance between these two variables. Driven by a desire to share my insights and contribute to the investor community, I embark on this new chapter with Seeking Alpha. My articles will be crafted with clarity and precision, devoid of jargon and fostering accessibility for investors of all experience levels. My background in IT grants me a valuable perspective, particularly when navigating the complexities of technology stocks. Yet, my pursuit of knowledge extends beyond the realm of silicon, encompassing diverse sectors and uncovering promising prospects across the economic landscape. Whether you are a seasoned investor seeking fresh perspectives or a nascent one embarking on your financial voyage, I extend a warm invitation to join me on this intellectual journey. Through collaborative exploration and insightful analysis, let us unlock the secrets of the market and chart a path towards shared financial success.
Analyst’s Disclosure: I/we have a beneficial long position in the shares of TSLA either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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