Tesla Inc. (NASDAQ:TSLA) is an up and coming, currently loss making, electric car company with huge ambitions. Even assuming the company achieves its grand plans without a hitch, there are serious reasons to doubt that its stock is a good investment. It’s appears priced for more than perfection. Studying the rest of the car industry shows why.
Last night I decided to scrutinise Tesla by comparing it to the rest of the car industry. I don’t own the stock, nor do I have a short position. It’s just intriguing to see the stock of a fast growing – but loss making and capital intensive – manufacturing company trading with a distinctly high price-to-sales ratio (P/S) of 8.5.
This morning I got stuck into some data gathering. A few hours later and the Tesla stock price has fallen 4%, to US$357 at the time of writing.
No matter, it’s just a blip. It doesn’t change my conclusions.
I’m not going to spend a lot of time worrying about whether Tesla has great products. It probably does. Or whether it can increase production by a factor of 10 or 20 in coming years without massive problems with quality control. Or whether it does enough testing before rolling out new models.
Or whether, irrespective of Tesla’s future production capacity, there’s enough customer demand to sell all the potential inventory. Or the ability to install chargers across the world’s cities, on every street, or in the parking garage of every tower block. Or how stiff the competition will be from other electric car producers – such as the Chinese, or BMW.
I won’t even wonder about how long it will take for Tesla to run out of cash again. Or how many more shares will have to be sold to keep Tesla afloat, thus diluting existing shareholders.
No, none of that. I’m going to assume Tesla will be a roaring business success.
To work out what that success is likely to mean, I’ll look at the rest of the car industry. After all, those are the giants that Tesla seeks to slay. For Tesla stock to make sense, the company has to eat a big chunk of its competitors lunch, and be profitable while it’s at it.
Tesla is a tiddler
I’ve looked at 23 of the largest vehicle manufacturers that I could think of, or get data for, including Tesla. Between them they had revenues equivalent to almost US$1.9 trillion in 2016. They currently have a combined market capitalisation of US$888 billion. (Market capitalisation is value of an entire company at the current share price.)
Here’s a chart that shows them in order of the size of their 2016 revenue, converted to US dollars and from largest to smallest. It also shows current market capitalisation for each company.
Tesla is second from the bottom, with US$7 billion of revenues last year from sales of 76,000 cars. However, Tesla’s market capitalisation (the pink bar) is a massive US$59.8 billion. That’s not far behind BMW’s market cap of US$62.1 billion. By comparison BMW had revenues of US$108 billion, or 15.4 times Tesla, and sold 2.4 million cars, or 31 times Tesla. Clearly, the Tesla stock price reflects hopes of massive growth and future profits, from a loss making position today.
There are quite a few names in that list that you probably haven’t even heard of, in particular the ones from China like SAIC. Also there are a couple of omissions like Subaru, which is part of a much larger industrial group, and Chery Motor, which is owned by the Chinese government.
By the way, Chery has a 50/50 joint venture with Jaguar Land Rover (JLR), which is based in England. In turn, JLR makes up the vast bulk of Tata Motor – so the latter is not really “Indian” at all.
Obviously there are lots of smaller car companies around the world, but I think I got all the main ones. I’m pretty confident this group makes up the vast bulk of the industry. (But let me know if I missed anything substantial.)
Here’s how market share of global sales breaks down, with Tesla highlighted in red text:
Yes, tiny Tesla has a share of just 0.37% of the revenues of this group. In other words, it has a serious mountain to climb before it’s a serious player.
Of course that’s what it’s aiming at. In the first quarter 2017 Tesla delivered 25,051 cars to customers. But that’s just from the S and X models. The more mainstream (cheaper) Model 3 comes into production in July. The company said in its first quarter results statements that it will produce 10,000 per week of that model “at some point in 2018”.
Of course it’s still got to sell them. But this points to production capacity – including the earlier models – north of 600,000 in 2019, or about a quarter of BMW’s current production.
What’s a decent car company worth?
Now let’s dig further into the industry’s financials, by which I mean profitability and stock valuation multiples. For this next part of the analysis I’ve left out Mitsubishi, since it’s loss making. Along with excluding Tesla itself that leaves 21 large car producers.
Of that group, the median (mid-point) price-to-sales ratio (P/S) is 0.47, median price-to-earnings (P/E) is 9.0 and median price-to-book ratio (P/B) is 1.1.
For each company I’ve derived post-tax profit margin by dividing P/S with P/E, which is E/S (expressed as a percentage). I’ve also derived return on equity (RoE) by dividing P/B with P/E, which is E/B (expressed as a percentage). Median post-tax profit margin is 5.8% and median RoE is 12.5%.
Also I’ve added up total market capitalisation, sales, post-tax profits and net book value (also known as net assets or shareholders’ equity) for the group. These come to US$818 billion, US$1,853 billion, US$92 billion and US$772 billion respectively.
[This means that if the entire car industry was one giant company the P/E would currently be 8.9, P/S would be 0.4 and P/B 1.1. Also post-tax profit margin works out at 5.0% and return on equity is 11.9%.]
Armed with this information we can start to see whether Tesla’s stock price makes any sense. I’ll look at an “industry average scenario” valuation, and also at a scenario where Tesla winds up much more profitable and highly valued than the industry as a whole – the “premium scenario”.
In a perfect world, what’s Tesla stock worth?
Last year BMW’s top line sales, divided by cars sold, worked out at US$45,400 per car. There’s quite a bit of finance related interest income in there, but let’s be generous and assume a future state Tesla can earn average revenue of US$50,000 for each car sold.
In other words, I’ll assume that Tesla sits firmly in the premium segment of the market along with brands such as BMW, Audi and Mercedes. It may not in future, but let’s assume it does.
Now let’s say a future Tesla, on the back of much larger volumes, manages to achieve the current median post-tax profit margin of 5.8%. Also that, once the company has matured and is growing more slowly, the stock has a P/E of 9, which is also the current median of the group analysed. This is the “industry average” scenario. That would give the stock a P/S ratio of 0.52, or 10% above the median.
The “premium scenario” means it does much better than this. Profit margin is set 50% higher, at 8.7% (note: considerably higher than BMW’s 7.8%). P/E is also set 50% higher at 13.5 (compared with BMW’s current 7.4). This gives P/S of 1.18, which is 148% above the current median (and more than twice BMW’s current 0.58).
Next, with these inputs, I’ve looked at what Tesla would be worth if it sold 600,000 cars in a year, or 1.2 million or 1.8 million. As a reminder, BMW – with its many decades of experience and growth, global presence and excellent premium brand – sold 2.4 million cars last year. So any of these sales volumes would be a big achievement for Tesla if reached them any time soon.
Here’s what the whole company valuations come to under these combined scenarios:
What’s Tesla currently worth in the market? That’ll be US$59.8 billion. In the table above only the most optimistic version of the premium scenario is greater than that.
In other words, for Tesla’s stock price to make any sense at all, the company needs to quickly sell millions of cars, at an unlikely level of industry beating profitability (instead of the massive current losses), whilst the stock price continues to enjoy generously high valuation multiples in the market (implying ongoing high growth from an already high base).
Does that sound likely to you? It certainly doesn’t to me. That’s why I have to conclude that Tesla’s stock is clearly overpriced.
Oh yes, and did I mention that BMW is launching an all electric version of its highly popular 3 series later this year, which will compete directly with the Tesla Model 3? And that BMW already sells a wide variety of hybrid cars, as opposed to Tesla’s narrow, all-electric range? It’s not like Tesla’s trying to sell its cars in a competition vacuum.
That said, could the Tesla stock price resume its climb higher in the short term? Of course. There’s never a lack of people looking for a bubble to throw their money at. But I strongly recommend you leave this one well alone.
Stay tuned OfWealthers,