The Tesla share price has rallied strongly as the company has replenished its cash buffers and delivered a second consecutive quarterly profit on the back of record car deliveries. At one point, Tesla shares topped $960 – although they’ve since fallen back to around $730 – and with a current market cap above $100bn, Tesla is now the world’s second-biggest carmaker by market cap (after Toyota with a market cap over $200bn).
Tesla has performed well since its difficult period early last year. Its sales have continued to grow, it has started to generate positive cash flows, and it has resolved the production issues that plagued the rollout of its mass-market Model 3 sedan. Its future line-up includes a promised Model Y crossover SUV, as well as a revamped Roadster, its proposed Cybertruck pickup truck, and the long-awaited Tesla Semi haulage truck. Further down the line, Tesla promises a fleet of self-driving robotaxis.
Some may argue that this performance emphatically refutes the naysayers who believe that Tesla is overvalued. However, there is plenty of reason to worry that Tesla’s valuation is inflated. After all, while Tesla delivered a record 367,500 cars in 2019, VW sold almost 11 million, Toyota sold almost 10 million, and Renault/Nissan sold over 9 million.
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Tesla’s share price and market cap are, in short, already pricing in a huge amount of upside for the electric vehicle (EV) manufacturer.
Share price ups and downs
The Tesla share price is volatile. The chart below from the WSJ shows how the price spiked after its fourth-quarter results were released. Between January 31 and February 3, the share price rose by 50%, before falling over 20% between February 4 and February 6. That kind of volatility implies that investors have very different ideas about how risky Tesla is, with good reason.
Capital spending
One major reason for worrying about Tesla’s valuation is its capital expenditure (capex) trajectory. As Tesla has focused on improving its cash flows, it has been slashing its spending. One of the casualties has been capex. At the beginning of 2019, Musk predicted capital spending of between $2bn and $2.5bn, but Q4 results indicated annual spending of just $1.3bn. That substantially down from 2018’s $2.3bn, and well below its five-year average of $2.2bn. As the FT points out, this is also on the low end of industry norms (see chart below).
This is a surprising spending trend given that Tesla is positioned as a growth company and given its ambitious slate of new products. One would expect a company that is opening new factories in China, Germany, and the US to be investing heavily in capacity. One would also expect a company unrolling multiple new products – Cybertruck, Model Y, the new Roadster, and the Semi, as well as fully autonomous cars – to be opening the spending taps, not closing them. After all, in 2017, Tesla’s capex was over $4bn. Today, it’s less than half of that. If the company wants to grow, it needs to invest – manufacturing is not a low-capital endeavour.
About that robotaxi dream…
Many Tesla fans expect a future robotaxi fleet to deliver massive growth and cash flows. I think there’s plenty of reason to be very doubtful about this promise. Consider, for example, Uber’s recent announcement that – although it plans to be the world leader in self-driving taxis – it doesn’t plan to actually own any self-driving cars. It’s very easy to see why Uber would shy away from owning a fleet of autonomous cabs. Owning a fleet of cars is expensive. Cars require maintenance, refuelling, cleaning, and storage.
An autonomous fleet could, theoretically, be driven 24 hours a day. But in reality, demand for taxis is not constant throughout the day. To meet peak demand, the fleet would have to be very large, but the excess cars would have to be idled when demand slumps during off-peak periods, so storage (parking) is a factor. The alternative – keeping the cars on the road all the time – would mean very high maintenance and fuel costs (even if the fuel in question is electricity – that stuff ain’t free). Cars used by paying passengers would need to be cleaned – and autonomous cars would probably need more cleaning than traditional cabs, where the driver can yell at you to pick up your coffee cup.
Then there are insurance costs – an unknown factor for self-driving cars – and the additional costs of autonomous driving, namely software maintenance and development, and repairs to the hardware that makes self-driving possible (radar and lidar systems, etc.). Uber wants to shunt those costs off onto other investors and cream a profit off each ride for linking passengers and cars. This model seems a little far-fetched to me but is an indication of the challenges Tesla’s Robotaxi fleet will face. Plus there’s the fact that there are no current self-driving systems with regulatory approval and the fact that Tesla is not even considered a top-three player in self-driving tech (probably because it just isn’t investing as much as companies like Google, GM, and Ford). Those anticipating a cash bonanza from a Tesla self-driving taxi fleet may be in for some disappointment.
Bottom line
The bottom line is this. Tesla is on its way to being a serious contender in the auto-manufacturing space. Provided it accelerates its capital spending, it is likely to continue to grab market share from competitors (the global auto market is growing quite slowly, in line with global GDP growth, so car companies are mostly competing for the same, existing pool of drivers).
Over time, Tesla could well be selling several million vehicles a year. However, its margins are likely to compress – its bottom-line margin was 1.4% in the fourth quarter on a GAAP basis (with limited capex). As it becomes a mass-market player, its margins will probably land around the industry average of around 3%.
Autonomous fleets are a very long-range proposition and the economics look pretty shaky. With other carmakers investing aggressively, the space will be competitive and profitability will be limited by the significant capital costs (remember, Uber still doesn’t run a profitable taxi business and it currently outsources all of its capital costs to its drivers).
If you consider Tesla coldly, as a car company with an attractive and innovative offering in a competitive marketplace, it looks overvalued. Musk has many dreams for the company and his vision is exciting. But so far, it’s hard to see where the revenues and profits are going to come from to justify the share price.
