Tesla’s growth and a dive into its profit drivers and potential valuation (Part 1 of 2)
Tesla’s growth and a dive into its profit drivers and potential valuation (Part 1 of 2)
Tesla, given its wide variety of products and services, has become very hard to define as a company. Tesla already sells high powered electric vehicles, energy storage products, solar products and insurance as working its way to autonomous driving and humanoid robots. It’s been a few days since Tesla released its 2nd quarter earnings and I will try to breakdown it’s various lines of business and the future growth for each of them. Ultimately, I will make try to make a case for a relative area of fair valuation for the stock price. First, I will cover business segments that have gone relatively unseen, explore the future revenue streams that are still speculative and finally look at the macro conditions and technical indicators that are affecting the stock. Through these areas, I will comment on the relative valuation of Tesla and the future variables that will determine its future profits.
As of July 21st, the stock closed at $260 which is a 110% return year-to-date. The stock started the year at around $100 and soared all the way to $280 before earnings. The company has multiple potential profit drivers coming up in the next year or two that could cause Tesla to command a greater valuation in the future. These include the introduction of the Cybertruck, the burgeoning energy storage business, an expansion into the Indian market, a future cheaper “Model 2” vehicle, and most importantly of all the introduction of everything required for FSD (Full Self Driving). I will dive into each of these in detail.
The company’s first major update is the production of the Cybertruck. There have been reportedly 1.5 million reservations for the truck and assuming the truck is priced at around $50,000 and taking Tesla’s production estimates with a grain of salt the vehicle could lead to a lot of revenue. [1] Elon Musk mentioned he expects 250,000 vehicles per year on the lower end but mentioned it could also be higher than that.[2] Assuming Tesla delivers 150,000 vehicles in 2024, that would be $7.5 billion in new revenue. Tesla’s operating margin for the quarter was 9.6%. Assuming because the Cybertruck is new that it overall has an 7% operating margin in the first year this would lead to $525M growth in operating profit for the year. As Tesla improves its production process for the Cybertruck as it has done with the Model 3 and Model Y, costs will come down and production numbers will go up. This new stream of cash flow commands a higher valuation for Tesla I believe assuming they can deliver a large amount of cars in 2024. The truck is nothing like any other truck on the market, and nothing like Tesla’s other vehicles and that I think is a good thing. The 1.5 million reservations I believe are coming from nontraditional truck owners. These folks have simply put in a $100 reservation, but the production timing will be the limiting factor here as Tesla claims to be ready for mass production in 2024 whatever that quantity will entail.
Another line of business that is overlooked by most investors is Tesla’s rapidly growing energy storage business and its future potential for Tesla. Tesla’s revenue from the energy generation and storage segment grew 74% YoY from $866 to $1.509 Billion after Q2 2023. The actual deployments grew 222% YoY to 3.7GWh.[3] There is still an ongoing increase in production at the first dedicated Megapack factory in Lathrop, CA. The energy storage market is expected to rapidly grow from a recorded 56 Gwh (Gigawatt hours) to 1,194 Gwh by 2030 according to BloombergNEF.[4] That is an expansion of almost 15x and given Tesla’s rapidly growing deployments, I suspect they will have an opportunity to grow their profits in the segment. The limiting factor for the time being will really be how quickly more megapacks can be produced. The larger their revenue and earnings from energy storage gets, the more attention Wall Street will pay to Tesla, and this could absolutely justify a higher valuation in the future.
Finally, the biggest profit driver for the stock as most are aware is the approval and technological advancement for full self-driving (FSD) for its vehicles. Tesla is getting started with implementing its new supercomputer Dojo and is gaining more data as time goes on.
“Artificial Intelligence Software and Hardware Four main technology pillars are needed to solve vehicle autonomy at scale: extremely large real-world dataset, neural net training, vehicle hardware and vehicle software. We are developing each of these pillars in-house. This month, we are taking a step towards faster and cheaper neural net training with the start of production of our Dojo training computer.” – Tesla Investor Slides Q2 2023
Given this quote from Tesla, we know that the rapid increase in deliveries will allow them at the very least to have a massive amount of data very soon. Their Dojo training computer will speed up the process of neural net training as well. While I am not knowledgeable in artificial intelligence and the requirement for autonomous vehicles. The sheer amount of Tesla’s on the road leads to a gigantic revenue opportunity whenever Tesla solves the vehicle autonomy puzzle and gets government approval. Musk has floated the idea of a robotaxi fleet and licensing FSD to other automakers which would both be large streams of cash flow. For now, investors should keep an eye for updates with FSD in terms of technological advances and government regulation. This one profit driver will be the largest of them all and as years have gone on and Musk’s expectations have been tempered, I don’t think the stock market has completely priced this in just yet.
Future products and limiting factors
In addition to the business segments above, Tesla has hinted at and indicated plans to pursue a large variety of future products and expansions. These include
- Further production of the Tesla Semitruck
- A mass production vehicle priced below the Model 3
- The Optimus Humanoid Robot
- AI Related Projects
- Tesla broke ground on its Texas lithium refinery in May to become the only Automaker to refine its own Lithium
- A factory in India and expansion of sales into India
What will determine the success of these initiatives is how quickly they take to come onto the market. Tesla already has proven that it can accomplish extraordinary goals given its industry leading margins despite the automotive industry being very capital intensive. Ultimately a maintenance of growth in free cash flow, a solid AI team, and continued cost reductions will allow Tesla to reach all these goals. These goals will all face macro-economic factors that could limit the potential success of the following projects.
Macroeconomic factors will play a large part in the earnings and progression of the company over the next few quarters. Specifically, the Federal Reserve’s previous interest rate hikes have had a large impact on demand for new vehicles given the interest on auto loans and the demand for new solar deployments. The increase of the federal funds rate to 5.25% from last June is the highest rate the US has had since 2007. [5] If Interest rates are cut to a lower level, it is likely that automotive demand will spike, and Tesla may see more demand for a wide variety of vehicles. The cost of raw materials is another factor that will affect Tesla’s operating margins. Lithium, a key material for Tesla’s batteries has a rapidly fluctuating price and a decrease in Lithium prices will be a boost for Tesla, along with a decrease in any of the other basic materials.
Valuation
With all these factors, it remains to be seen where the best buying point for Tesla stock is. Ultimately, Tesla is a complicated company to value. [6] I would not compare it to any other automaker given its industry leading operating margins, and its other revenue producing ventures such as energy storage, financing, autonomous vehicles, and AI. Furthermore, Tesla commands a high valuation because of Elon Musk and the management team’s openness and drive to venture into previously unexplored business areas such as building a lithium refinery, building a semitruck and now the attempt to build a humanoid robot. While a lot of the future is and Tesla often deliveries on expectations much later than initially projected, they have delivered on many of the goals they set out to achieve. Ultimately, I think Tesla’s profits will grow the major question is what price the stock is fairly valued at.
The stock over time will continue to be valued higher and higher as long as free cash flow is generated and if Tesla can meet production targets within reason. The more efficient production is in terms of cost reduction and timing of deliveries the greater the valuation the company will be able to command.
Tesla was valued at a price to earnings of over 100.00 back in October of 2022. I believe it is more reasonable to compare Tesla’s valuation to its previous valuations than competitors since it’s lines of business are so different than Google (an autonomous driving competitor) and other automakers. At a P/E of 73.66 Tesla is cheaper than last year (when interest rates continued to be raised) and more expensive than January when Tesla’s stock price bottom at $110. [7]
I believe after this earnings report, Tesla seems to be fairly valued at around $200-$230 a share however this will be contingent on the path of interest rates over the next 6 months. Given the federal reserve meeting on Wednesday the 26th. A further interest rate hike will send the stock moving further downward. Any positive updates on deliveries, production, and advances for the cybertruck, autonomous driving and other products will immediately send the stock price moving upward. On the other hand, if the economy displays cracks in its exterior and rates must be cut to the low interest rate environment of previous years I would not be surprised if Tesla and other big growth names move above $300 and to $400 possibly. In conclusion, the various business lines of Tesla could absolutely command a higher valuation in the future depending on the timing of production, macroeconomic factors, and superior technology and intellectual property. I will write a part 2 to this article with a great attempt to quantify the cash flows from the under observed business segments. Tesla has the potential to deliver outsized returns to investors if it sticks to its willingness to move into new business lines and can reasonably meet its timeline of expectations along with a friendlier macro environment.
Sources:
https://digitalassets.tesla.com/tesla-contents/image/upload/TSLA-Q2-2023-Update.pdf
https://about.bnef.com/blog/global-energy-storage-market-to-grow-15-fold-by-2030/
https://cleantechnica.com/2023/07/17/tesla-cybertruck-1-is-here-at-last/ (1.5 mill
https://www.bankrate.com/banking/federal-reserve/history-of-federal-funds-rate/ (interest rates)
https://ycharts.com/companies/TSLA/pe_ratio
[1] https://cleantechnica.com/2023/07/17/tesla-cybertruck-1-is-here-at-last/
[2] https://electrek.co/2023/06/08/tesla-plans-375000-cybertrucks-per-year-release-candidates-late-august/#:~:text=Now%2C%20Electrek%20gets%20more%20details,of%20375%2C000%20Cybertrucks%20per%20year.
[3] https://digitalassets.tesla.com/tesla-contents/image/upload/TSLA-Q2-2023-Update.pdf
[4] https://about.bnef.com/blog/global-energy-storage-market-to-grow-15-fold-by-2030/
[5] https://www.bankrate.com/banking/federal-reserve/history-of-federal-funds-rate/