What's The Best Electric Car Investment?

Joseph Hogue's picture

Friday, April 8, 2016 - 12:30pm

by Joseph Hogue

Shares of Tesla Motors (Nasdaq: TSLA) have been unstoppable since its February earnings release, when Elon Musk forecast the company would be profitable by the end of 2016 and used the opportunity to announce the launch of the company's Model 3.

Even missing its goal of delivering 16,000 vehicles for the quarter (the company came in 1,180 short) when it released 1st quarter 2016 earnings last week couldn't stop the stock. Shares increased 3.4% on the day as the company affirmed its full-year delivery goal and analysts clung to estimates for $1.29 in per share earnings for the year.

But blind exuberance for future sales may be hiding some major risks for the company. Worse yet, a competitor may be about to beat Tesla to the punch for mass market electric cars... and it's trading at a 97% discount to the upstart company's valuation.  

Tesla "Books" $10 Billion In Sales On The Model 3
Investors and analysts have jumped back into Tesla, sending the shares 81% higher since the February low on the promise of profitability and the company's move into the mass market. The company started taking orders for the $35,000 Model 3 this month, reporting 276,000 pre-orders just in the first weekend.

Optimists point to the potential for more than $10 billion in revenue from these orders but that may be a dangerous assumption. While the pre-orders brought in $276 million at $1,000 each, those down-payments are fully refundable and the company will need much more capital to actually produce the cars before it sees the rest of the money. 

Many of those early buyers might find the 'mass market' price isn't as persuasive when the cars are delivered. The IRS is offering a $7,500 tax credit to Tesla buyers, but only the first 200,000 units purchased will qualify. Beyond the loss of the tax credit, any extra features will push up the standard price. The Model S starts at $70,000 but has an average selling price of $100,000 while Tesla admits that the average price for the Model 3 will probably reach $70,000 or higher.

The biggest hurdle may be raising the money and producing the Model 3 fast enough to meet the planned fourth quarter 2017 delivery. Current production at the Fremont plant is just around 1,000 cars a week. It would cost $5 billion to build out a new giga factory. 

There's little doubt that Tesla will need to raise significant capital for the factories necessary to meet its Model 3 production schedule. The balance sheet shows $1.2 billion in cash and the company burned through $524 million in operational cash flow last year. Long-term debt of $2.0 billion is already 2.5 times equity so there is a good chance the company may have to resort to a share sale to raise capital.

Other problems exist for the much-hyped automaker. The company still needs to build out its supercharger network and costs are rising. Operating expenses grew 54% last year against a 27% increase in sales. Tesla is marketing the new Model 3 as a less expensive version of the Model S with most of the same features which means there could be significant cannibalization of sales for the older model over the next year, threatening the company's hope to become profitable.

Tesla shares now trade for 198 times expected earnings this year of $1.29 per share. It's difficult to put a rational target on the shares since they trade entirely on investor sentiment. Morningstar has a fair value estimate of $220 and the average analyst estimate for the next year is $230 per share, both well under the current trade.

Tesla has yet to be profitable and loses about $20k on the Model S. How is it going to be profitable selling a car for less than half the price?

This Old Car Company Is About To Beat Tesla's New Car Smell
Exuberance for Tesla last week was lost on the rest of the industry as mixed results for March U.S. auto sales led to a selloff in manufacturers. Despite missing high expectations, U.S. sales of cars and light trucks are still up 3.4% on a year-over-year basis. Interest rates remain low and improving wages data points to plenty of consumer cash available to buy.

General Motors (NYSE: GM) moved up its schedule to release its own electric vehicle, the Bolt, to the last quarter of 2016. The car is expected to cost $30,000 after tax breaks and travel 200 miles on a single charge. Outside the hype over the future of electric cars, GM looks like a steal next to Tesla. The company is putting its recall problems in the rearview with a 2015 settlement with the Justice Department and the victims fund for $1.5 billion.

GM still has $5.5 billion left of its 2015-2017 buyback program and returns nearly $2.4 billion to shareholders each year through its dividend. That amounts to a cash yield of nearly 10% a year on a stock that trades for just 6.0 times trailing earnings, well under its five-year average of 13.0 times earnings. Expectations are for earnings to increase 8.7% this year to $5.48 per share though GM has beaten estimates by an average of 20% over the past three quarters. Even on expectations and a multiple of 7.0 times, the shares would be worth $38.36 for a gain of 31% including the annual dividend.

Risks To Consider: All auto stocks could weaken if interest rates rise more quickly than expected, decreasing credit availability and weighing on the economy.

Action To Take: Don't get caught in the hype around Tesla's new media extravaganza. Position in GM for valuation and stronger upside potential.

P.S. Be sure you take the time to read our latest report of the 10 Most Shockingly Profitable Predictions for 2016. Our previous predictions have given investors annual returns as high as 310%. And this year's group might still be our biggest money-makers yet. To hear the full list of predictions, including how to profit from Google's crazy new business venture, go here.

Joseph Hogue does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.