Tesla has managed to clock in a full year of GAAP earnings for 2020 which have led to their inclusion in the S&P 500. A requirement is to have 4 quarters of profits that Tesla was able to achieve. Tesla main business is in the auto industry focusing primarily on electrical vehicles. You could check out my previous article written on it whereby with their current valuation, it is viewed as more than a normal auto company.
Today’s article focuses is on evaluating their earnings and prospects from a look into their financial statements. I believe this has been widely covered whereby Tesla was able to turn in profit over the past few quarters is not due to the sale of EVs or their solar energy division: the secret sauce was the sale of renewable credits.
The Secret Sauce
Renewable Credits is the byproduct of their manufacturing of EVs, so it is reasonable to assume their profit margin could be close to 100%. This is indeed lucrative. It is the government’s (US and Europe) incentive to push automakers to go carbon-free through this scheme. There will be penalties if they are not able to meet the minimum requirement of certain zero-emission vehicles production. To avoid the penalty and fines, automakers such as Ford, GM and Fiat Chrysler have to buy the renewable credits from Tesla who have excess.
You could see the exponential growth in this segment for Tesla (Almost triple the figures in 2019) from the screenshot of their revenue and profits below. What is notable was Tesla has been recognizing a portion of their renewable credits as trade receivables which they did not do so initially. This was highlighted by David Einhorn who has a short position on Tesla. My thoughts would be they could be window dressing the numbers to qualify for inclusion into the S&P 500.
However, the initial kickstart and skyrocketing price of Tesla and other players (Nio, Xpeng and Lee Auto), has provided the impetus for other established automakers to up their game in this sector. Therefore, the lucrative profits from renewable credits could be a thing of the past in the next few years as many would have met the minimum requirements from the manufacturing of EVs. This optionality effect would cease and Tesla has to prove themselves in turning in core business profits.
Show me the Numbers
Looking at their cash flows and margins, Tesla could be well on track to be profitable in its core business soon. Their margins compared well with the other main automakers as could be seen from the chart below. They have also been generating free cash flow which shows the viability of their business model. Coupled with the almost 20 billion raised from their share placements, they have a good war chest for huge expansion.
Source: Tesla Shareholder Deck
Source: The Motley Fool
Nonetheless, the current valuation would not justify if it is just a profitable auto company as it dwarfs over the other players’ many folds. So my point is the market might have been getting ahead of themselves in their perceived valuation of Tesla. Moreover, there are sure going to be execution hiccups in their new factories in Germany and Texas while they are ramping up their production.
Yup there could be the other divisions such as auto taxis (Alphabet have a running Robotaxi model in Phoenix), solar energy, battery sales (Panasonic was not able to turn in a decent profit from their battery manufacturing over the past few years as Tesla’s partner), etc to drive the path to insane profits for Tesla. But looking at reality, it seems far-fetched and is just a vision at this juncture.
Conclusion
In a nutshell, my main concern will be the valuation of Tesla. If they can make 2 billion dollars GAAP profits which I think is attainable. Throw in a 200x PE to factor in their huge potential to spread the messianic brand to other sectors. We come up with a valuation of 400 billion dollars which equates to a price of around $420. This coincides with NYU’s Professor Aswath Damodaran valuation in a blue-sky scenario. This was also the price it was trading at before the inclusion to the S&P 500 that sends it to the moon. Therefore, the current valuation of 810 billion dollars and the price of $850 certainly seems rich and excessive.
But animal spirits would be hard to predict but if history will be a good gauge, there could be a mean reversion around mid of the year as the EVs parabolic rally reaches the 1.5-year mark. It is the usual timeline that was exhibited by the Solar and 3D printing bubbles earlier.
Therefore, given the chart of Tesla where the path of least resistance is obvious, we could potentially see the $1000 magical level. After which, it could be the endgame and things could come back to reality; just like the Gamestop saga.
Disclaimer:
The content here is for informational purposes only and should NOT be taken as legal, business, tax, or investment advice. It does NOT constitute an offer or solicitation to purchase any investment or a recommendation to buy or sell a security. The content is not directed to any investor or potential investor and may not be used to evaluate or make any investment. Do note that this is not financial advice. If you are in doubt as to the action you should take, please consult your stockbroker or financial advisor.
