Tesla, Inc. (TSLA) is a company known for its electric vehicles that were early pioneers of the future of the automotive industry, electrification, and clean energy. Tesla operates in two segments: Automotive, and Energy Generation and Storage.
In 2021 shares of Tesla have been witnessing two extreme paths. Until late September 2021, and more specifically at the close of the last trading day of September 2021, shares of Tesla were trading at $775.48, having gains of about 10% compared to the closing price of $705.67 on December 31, 2020. So, this automotive stock was underperforming compared to the S&P 500 performance.
October 2021 and November 2021, at least until November 5, 2021, have been phenomenal months as TSLA stock soared to new all-time highs, having a one-month return of 57.06%. The company surpassed the $1 trillion market capitalization mark and advanced to a new 52-week high price of $1,243.49. I am bearish on TSLA stock as I consider its valuation to be too pricey, and completely disconnected from its true fundamentals.
TSLA Stock: Huge Rally in Late 2021
TSLA stock started making a rally upon the release of a very strong Q3 2021 earnings report.
The automotive maker reported that “the third quarter of 2021 was a record quarter in many respects. We achieved our best-ever net income, operating profit, and gross profit. Additionally, we reached an operating margin of 14.6%, exceeding our medium-term guidance of ‘operating margin in low-teens.'”
There were also record vehicle production and deliveries in Q3 2021, with automotive revenues increasing to $12.057 billion or a year-over-year increase of 58%, net income attributable to common stockholders (GAAP) rising to $1.618 billion or 389% year-over-year, and free cash flow rising to $1.328 billion or -5% year-over-year. I want to focus on the large increase of capital expenditures reported to be $1.819 billion, representing an increase of 81% year-over-year.
Tesla has a strong balance sheet, and according to Gurufocus has a Debt-to-Equity ratio of 0.37 and a Cash-To-Debt ratio of 1.59. The automotive company had the fiscal year 2020 that shined in key financial metrics, such as revenue, profitability, and free cash flow compared to previous years. 2020 was a pivotal year for Tesla, being the first year to report positive net income.
News that Tesla had an agreement to sell 100,000 EVs to Hertz (HTZZ) was enough to fuel the stock rally for shares of Tesla. This massive order, estimated at $4.2 billion, sent Tesla to make daily new historic highs. However, some comments by Elon Musk that this large contract would have “zero effect on our economics” and that the deal was not officially signed yet, spurred some doubts. I argue that the factors worth focusing on now are mainly two: the cost analysis and trend, and the valuation of Tesla.
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Analysis of Costs as Tesla Increases Production
In Economics, there is a simple but very important rule. As each company increases its production, its total fixed cost remains constant, but the total variable cost and total costs increase. The average cost and average total cost decline and make a bottom at a certain level of production, where they are minimized, but as long as production increases, the costs rise.
Tesla will soon launch its Gigafactory in Berlin to serve the needs of the European market. I expect the costs and capital expenditures to rise substantially over the future quarters and years, so we must monitor the trend in profitability. If profit margins start to decline, then this will be negative news for TSLA stock.
Valuation: Too Extreme Now
Shares of Tesla trade now at 39x its revenue for the fiscal year 2020. With a market capitalization of $1.23 trillion, Tesla has a capitalization larger than the total summed capitalization of General Motors (GM), Ford (F), Toyota (TM), Daimler (DDAIF), and Volkswagen (VWAGY). This fact is very odd and unjustifiable.
Investors consider that Tesla will be a leader in the automotive industry in the future. Yet its valuation is beyond any logic now.
If we examine the relative valuation of Tesla stock, compared to some key financial metrics of the Consumer Discretionary Sector and Auto & Truck Manufacturers Industry, the results show a very large premium for Tesla.
I will refer to the Price to Sales (Q3 TTM) ratio of 29.29, 4.07, and 3.1 for Tesla, its industry, and the sector, respectively. Or to the Price to Book (Q3 MRQ) ratio of 50.73, 21.07, and 12.36 for Tesla, its industry, and the sector, respectively.
This huge premium cannot be justified either by the sales and profitability, or vehicle deliveries. It is fully disconnected from reality, and TSLA stock is now a fight between bulls and bears, investors who neglect valuation completely. This is a too risky investment behavior.
Wall Street’s Take
Tesla has an average consensus of Hold, based on 10 Buys, 6 Holds, and 6 Sells. The average Tesla price target of $835.53 represents a -31.63% change from the last price of $1,222.09.
Disclosure: At the time of publication, Stavros Georgiadis, CFA did not have a position in any of the securities mentioned in this article.
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