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Tesla: the future, in short order

Tesla: the future, in short order
August 16, 2017
Tesla: the future, in short order

A buy argument, or for that matter a sell argument, requires some numerical gymnastics. Let’s forget profits for a second, and consider Tesla’s enterprise value (the market capitalisation plus debt, or minus cash) to sales, a good multiple for a company that is focused on sales first, profits second: in this case, helping to build a new market altogether. On a historic basis, that multiple is at 6.7 times, against an average 1.5 times across the sector, according to S&P Capital IQ data.

But that metric does not factor in the growth profile. Tesla’s top line is expected to grow by 69 per cent this year, and 72 per cent over the next two years. That compares with a 3 per cent expansion, on average, across the other nine largest global players. At General Motors (US:GM), turnover is expected to shrink this year.

The major argument in Tesla’s favour, apart from sheer momentum, is the ramp-up in production of its mass-market Model 3 to 10,000 per week by late 2018. As first mover, it already dominates the US electric vehicle market by share, accounting for nearly half of sales between January and June this year. Moody’s Investors Service forecasts 300,000 Model 3 cars sold in 2018 as a whole, with a gross margin of around 25 per cent.

Achieving this is important to maintain the rating on its corporate bonds, with which it raised $1.8bn (£1.4bn) at a yield of 5.3 per cent, according to reports last week. That’s impressive for a company with free cash outflows in the billions for 2017 and 2018, as a result of huge capital expenditure needed to achieve its targets.

There is a case for viewing disruptive companies such as Tesla like oil explorers: the only thing that matters is that they can get enough cash through to first oil, or in this case, the first 100,000 cars or so. But explorers, by contrast, have a right to that resource once they have got their hands on it. According to Moody’s, the car company “has no material proprietary technologies or processes that competitors will not be able to replicate or access”. Don't say you weren't warned.

Bears include broker JPMorgan Cazenove, which uses both a discounted cash-flow method, and an analysis based on working back from 2020 earnings and sales multiples, to support its argument that the current valuation is pricing in production expansion “well beyond” that forecast. Analysts also highlight an “above-average execution risk”. That’s putting it mildly.

The big question is how fast the larger players can catch up, such as GM, which we tipped earlier this year (3,683¢, 16 March 2017). Its current forward price-to-earnings ratio is among the lowest of the manufacturers at just six times. It has its slowdown in its home market, and challenges without. But its Chevrolet Bolt accounts for 16 per cent of the US electric vehicle market, according to those Moody’s figures; and if there is to be a mass-market surge, its dealership and infrastructure should be a better bet for scaling up.

But, as is usually the case with such market disruption, this will require a deeper change in culture and strategy for the incumbents. Is a dealership salesperson going to be minded to sell an electric vehicle that will not produce the same kind of aftersales revenue from repairs that the creaky old combustion engine can promise? Are the companies investing enough in charging points and other prerequisites?

As we considered with Amazon (US: AMZN), the market’s support of its singular digital vision allowed for the relentless expenditure that stole the march on the traditional booksellers. GM and the rest have a better chance of knocking down Tesla, but they will have to demonstrate a commitment to the cause.

Ian Smith is companies editor