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Tesla - significant progress, but valuation still a question

Nicholas Hyett, Equity Analyst | 21 October 2021 | A A A
Tesla - significant progress, but valuation still a question

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Tesla Inc USD0.001

Sell: 711.98 | Buy: 712.60 | Change 2.71 (0.38%)
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Tesla reported third quarter revenue of $13.8bn, a 57% year-on-year increase and modestly ahead of market expectations. Growth was driven by a 58% increase in automotive revenues, to £12.1bn, as overall vehicle deliveries in the quarter rose 73% to 241,391.

Operating profits came in at $2.0bn, a 148% year-on-year increase but slightly less than the market had hoped. That was despite setting aside $190m for likely share based payment to Elon Musk in the quarter.

Tesla's share price was broadly flat following the announcement.

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Our View

Tesla's enjoying the benefits of a huge uplift in production. More cars rattling through the production line lowers per-unit costs, so margins and profits can come for the ride.

Increases in Model 3 and Model Y deliveries has more than offset the headwind from lower sales of premium Model S and Model X cars. Underlying gross margins, have risen to 30.5% as a result. That's all the more impressive given the lower average selling price from cars sold in China.

But Tesla has more work to do. It's 500,000 cars in 2020 pales in comparison to VW's 5.3m, 212,000 of which are electric cars.

Its answer is a huge factory building programme. The first European Model Ys are expected in 2021, with a new factory in Texas also due for completion this year. Despite various headwinds, such as the global semi-conductor shortage and disruption at ports, the group's existing factories are now steadily approaching full capacity - so new facilities can't come soon enough.

The third quarter of 2021 also saw a substantial decline in the value of regulatory credits the group receives. Tesla earns credits in recognition of its zero-emission vehicles and sells them to other manufacturers who need to offset their emissions. In the past Tesla has earned more credits as more vehicles have hit the road. These credits have been a valuable source of cash flow, but as rivals increase their electric vehicle output Tesla's credits have become less valuable. A few years ago the decline would have been a catastrophe, but its testament to how far the group's come that it can now shrug off the credit decline with ease.

However, for all the progress the group has made, our core concern with Tesla remains unchanged. The group's valuation, which at $857.2bn and a PE ratio of 122.4 makes it by far the most valuable automotive company in the world, is predicated on massive growth. But rivals are pouring billions into closing the technological gap, and competition in China is already hotting up. Seizing the necessary share of the electric vehicle market is a big ask, let alone doing so at sufficient margin to justify that kind of multiple.

Longer term Tesla hopes to reduce cost and increase its competitiveness via increased vertical integration - including manufacturing its own battery components - with the aim of ultimately manufacturing a profitable $25,000 car. The group is also banking on its self-driving technology - installing "Full Self-Driving" into cars in October, with "hundreds of thousands" of its cars able to drive themselves this year. Both do have the potential to change the competitive calculus for Tesla, but the company has made big claims before that took far longer than anticipated to deliver and there are no guarantees.

We would be remiss not to also mention that Tesla has taken a big bet on Bitcoin, with $1.3bn in the cryptocurrency in the balance sheet. Investors could argue that if they wanted to have exposure to Bitcoin they would have bought some themselves. We seriously question the rationale for the purchase.

In its core business Tesla has enjoyed a period of technological superiority, with a great brand and perhaps most importantly a great investment story. However, as the valuation has risen, so have expectations. Meeting those will be no easy feat.

Tesla key facts

  • Price/Earnings ratio: 122.4
  • 10 year average Price/Earnings ratio: 73.1
  • Prospective dividend yield (next 12 months): 0.0%

All ratios are sourced from Refinitiv. Please remember yields are variable and not a reliable indicator of future income. Keep in mind key figures shouldn't be looked at on their own - it's important to understand the big picture.

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Third Quarter Results

Reduced revenue per vehicle is a result of a change in mix from higher priced Model S/Xs to lower priced Model 3/Ys, as well as a 30% decline in automotive credits.

Improved operating margins reflects operating leverage achieved with increased production as well as cost reduction. Headwinds in the quarter included lower average sales prices, lower regulatory credit revenue and a $51m bitcoin related impairment.

Capital expenditure in the quarter was $1.8bn, up 81% year-on-year, as the group continues to invest in new factories in Berlin and Texas as well as ramping up production in Shanghai. Free cash in the quarter came in at $1.3bn, versus $1.4bn a year ago.

Tesla finished the half with net cash of $7.9bn, up from $846m.

The group continues to face challenges with semi-conductor shortages, congestion at ports and rolling blackouts that are preventing factories running at full capacity.

Find out more about Tesla shares including how to invest

This article is original Hargreaves Lansdown content, published by Hargreaves Lansdown. Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Refinitiv. These estimates are not a reliable indicator of future performance. Yields are variable and not guaranteed. Investments rise and fall in value so investors could make a loss.

This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research for more information.

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