Tesla doubters scored their best vindication yet last year. The electric carmaker’s market value dropped by almost two-thirds in what was the worst, and only the second ever, annual loss for the former stock market darling since it listed in 2010. But fourth-quarter earnings figures have added fuel to a tentative resurgence in the share price. Since January the group has regained 35 per cent, and just over 20 per cent in value was added in the two trading sessions after the latest results were released last week. Has Tesla reached an inflection point? Don’t bank on it.
The buyout of the social media giant Twitter by Elon Musk, the Tesla boss, has superseded the enduring debate over whether the electric vehicle group can both build the production capacity and then find the mass audience required to achieve the heady profit expectations baked into its multibillion-dollar market. Dangling the prospect of up to two million vehicle deliveries this year, double the number of cars produced in 2021, together with hints that demand has not cratered as some sceptics expected, has refocused some attention back on to Tesla’s actual earnings prospects.
The risk recession poses to global demand for EVs is inescapable. An increase in capacity compared with just three years ago, for Tesla itself and international rivals such as the Chinese automotive manufacturer BYD, means any slackening in demand will show up more easily. Orders in year to date are the strongest in our history, Musk told investors last week, at about roughly twice the rate of production. But four weeks hardly makes a reliable barometer for what lies ahead this year. Added caution is reflected in a weaker valuation. An enterprise value of just over 24 times forecast earnings before interest, taxes and other charges is still towards the bottom end of the ten-year range.
The car market is in contraction, “price really matters”, Musk says. At the start of this year Tesla cut prices globally, by as much as 20 per cent in the US and Europe. Prices in China were lowered in October, amid concern over the strength of demand in the world’s largest car market.
Average selling prices have been sliding for years, halving between 2017 and last year, as production shifts towards the cheaper Models 3 and Y. The squeeze on big-ticket spending that emerged last year has placed greater urgency on addressing the affordability barriers that stand in the way of pushing sales volumes higher. Rising interest rates increased the price of cars in the US by nearly 10 per cent, said Zachary Kirkhorn, Tesla finance chief.
What does Tesla hope to gain in the long term? An expansion in the operating margin that could be afforded by greater scale. Last year the operating margin came in at 16.8 per cent, against a negative 14 per cent five years earlier. Building scale is crucial to fully capitalise on the advantage of manufacturing the batteries and other components in-house. The relative simplicity of Tesla’s model compared with traditional carmakers — offering just four models, limited colours and direct-to-consumer distribution — enhances that scale benefit.
Reducing prices for growth naturally means sacrificing gross margin in the immediate future: part of the reason, along with higher raw materials costs, that this metric edged lower in the fourth quarter and missed analyst expectations. Tesla doesn’t expect to get back to its previous record low for production costs, of about $36,000 per car, this year. The price of lithium used to make batteries is a challenge. Analysts at the US investment bank Goldman Sachs cut their gross margin forecast to a little under 22 per cent, from 24 per cent they previously had pencilled in; and also lower than 24.3 per cent that the margin had slid to in during the fourth quarter.
Stalling profitability
Naturally, Tesla’s sensitivity to production volumes could well work to its detriment. The number of cars delivered last year was below the potential of its installed capacity, an inevitable consequence of lockdowns in China and lingering supply chain disruption. Those are risks that have not entirely dissipated.
Underusing its Berlin and Austin factories cost the equivalent of $2,000-$2,500 per car in the fourth quarter, Tesla estimates. If demand falters it could sap profitability again. Tesla has the potential to deliver two million cars this year, Musk has said. But he prefers to stick with guidance of 1.8 million, with one eye on supply chains that have yet to straighten out. The lower of the two figures would represent an annual increase in deliveries of 37 per cent, below a growth rate of 40 per cent clocked up last year. But the top end? That would see Tesla take the first step towards hitting a medium-term target of growing deliveries at a yearly compound rate of 50 per cent.
The existential challenges associated with Musk’s Twitter deal have not disappeared. This week Twitter was said to have made the first interest payment to lenders on the $12.5 billion in debt used to fund the takeover of the social media giant last year, amounting to roughly $300 million.
In November Musk sold an additional $4 billion of Tesla shares to help finance the deal, taking his total share sales to $36 billion over a 12-month period. The prospect of him selling more Tesla stock to help plug earnings losses at Twitter remains an overhang to the carmaker. A potential deterioration in advertising spend in a macroeconomic slowdown could pressure Musk to spend even more on Twitter.
As far as Tesla’s own cash generation, the group is generating enough dollars from sales of its cars to fund the build-out of its existing production facilities, increase its sales teams and the development of the Cybertruck, which is due to begin production this year. Last year it recorded free cashflow of $7.6 billion, after shelling out capital expenditure. Analysts at Goldman Sachs forecast capital expenditure of $7.8 billion, against $18.3 billion in cash generated by the business.
Analysts expect profit to move higher again this year, even if at a slower pace, to a net income of $14.7 billion, squeaking ahead of the target $14.1 billion. Still, the banana skins ahead of Musk in delivering on expectations are numerous: slower demand; the need to cut prices more aggressively; logistical challenges; and failure to recover cost inflation as much as anticipated. A cheaper market value needs to be seen in the context of those potential challenges, as well as the prospect of interest rates that stay higher for longer.
ADVICE Avoid
WHY Uncertain demand, supply chain disruption and more stock dumping could hold the shares back
