Tesla - Driving the electric vehicle (EV) revolution, but at a cost (2024)

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Equity Insights

By Hashmeel Suka

Tesla was founded in 2003 by engineers Martin Eberhard and Marc Tarpenning, with the goal of bringing a fully electric sports car to the automotive industry. Current CEO and board director, Elon Musk, joined the company a year later with a multi-million dollar investment, which supported the development and production of the pioneering Tesla Roadster model. Over the years, the company has shifted its strategy to meet the demands of a broader target market, introducing other EV variants such as sedans, crossover SUVs and even trucks.

Additionally, Tesla offers renewable energy solutions to residential and business customers as well as to a few US power utilities. These solutions include battery energy storage (such as Powerwall and Megapack), solar panels, solar roof tiles, and all related electrical components. The company owns its entire manufacturing, sales, and service network, but its overall impact extends beyond just its product offering - Tesla maintains a significant influence on the global transition toward electricity-based.

Beyond its primary EV offering, Tesla sells electric powertrain components and batteries to other automobile manufacturers. Innovative efforts in these technologies have driven major names in the industry towards adopting electric and hybrid functionality, with the company having formed strategic partnerships with the likes Daimler (Mercedes-Benz) and Toyota. Other traditional manufacturers such as Volkswagen and Ford have also since jumped onto the EV bandwagon.

Operating segments
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Tesla operates through two main segments namely, Automotive (~90% of revenue) and Energy Generation and Storage (~5% of revenue), with the remainder of sales generated from the Service and Other offerings. The company is headquartered in Texas where it operates its largest manufacturing facility and has Gigafactories in the US (Nevada and New York), Germany and Shanghai. Another Gigafactory (based in Mexico) is expected to open in 2026 and will support the launch of new models as well as improved production capacity.

EV growth prospects remain promising, though Chinese manufacturers pose a threat

Data from Bloomberg shows that there were ~30 million passenger EVs (including battery-electric and plug-in hybrid vehicles) globally at the beginning of 2023, with this number set to rise to over 57 million by the end of 2024. Total EV sales for the current year are forecast to grow ~20% y/y, which is much faster than the expected growth rate for total passenger vehicles of ~3% y/y (per S&P Global Mobility).

Sales of traditional internal-combustion vehicles have come down significantly since peaking in 2017. Conversely, the cumulative number of EVs globally are expected to reach ~100 million by 2026. For reference, this market was valued at ~$368 billion in 2022, increased to ~$493 billion in 2023, and is projected to grow by over $1.5 trillion over the next 10 years.

In terms of company dynamics, the top 10 battery EV manufacturers around the world comprise over 65% of the entire market. Tesla remains a dominant force (~20% of market share) but is followed closely by BYD (~17%), which notably outsold the company in 4Q23 (526 000 vs. 485 000 deliveries). The Chinese EV giant is set to surpass Tesla in sales in 2024 as demand continues to sway. Other key players within the market include Volkswagen (~5% market share), BMW (~4%), Hyundai (~3%) and Mercedes-Benz (~3%).

According to Bloomberg, China is currently the largest market in the world for EVs, accounting for just under 60% of total volumes. The US market (~12%) is second in the running, followed closely by Germany (~7%), while the Nordics, the UK, and France account for ~3% each.

More than 14% of all new vehicles being sold around the world are electric. Among the world's largest EV markets, China and Germany both have a penetration rate of ~30%, while the US is sitting at ~8%. Interestingly, Norway is currently leading the charge toward eliminating internal-combustion vehicles from its roads - EV's in the country have consistently accounted for more than 80% of total sales over the past three years and the region is targeting a complete phase-out of internal combustion engines by 2025.

Self-Driving functionality and support from AI

A key differentiator for Tesla is its focus on AI-related functionality such as full self-driving (FSD). The company's sizable footprint of vehicles can gather substantial data on driving behaviour as well as mapping of the environment. This data is trained using machine learning and AI, to develop the company's leading autonomous features, enabling driverless capabilities for its EVs. Through its "Phantom" mode, Tesla vehicles are also able to collect data while being operated by users (i.e., when not on autonomous mode). The long-term outlook for the company's FSD features is particularly encouraging given the prospects in AI and room for further enhancements.

Financial Review

Growth over the past five years has been quite strong, with revenue increasing ~35% (on a compounded annual basis) since FY18. FY20 was a momentous year for Tesla as it finally became profitable, generating pre-tax income of ~$1.3 billion and adjusted earnings per share (EPS) of $0.24 (compared to losses of $370 million and $0.32, respectively, a year before). The company saw a further acceleration during FY21, however, growth since then has moderated sharply.

FY23 marked a significant slowdown for the EV manufacturer:

Revenue increased 19% y/y to $96.8 billion, which looks impressive at first glance, but represents a marked slowdown from the previous two years (FY21: +71%, FY22: +51%). The sharp deceleration was due to a notable decrease in vehicle average selling prices (with discounts in the high-teens on certain models) as well as a less-than-optimal sales mix (tilted toward lower-margin models).
Price cuts have been somewhat beneficial for volumes, however, with Tesla achieving its target of more than 1.8 million deliveries during the year. Notably, the company delivered over 1.2 million Model Y units, awarding it the title of world's best-selling vehicle of any kind.
Operating profit for the year fell 35% to $8.9 billion, impacted by a heavy contraction in the gross margin (due to the afore-mentioned price cuts), an uptick in costs along the supply-chain, as well as higher R&D and AI-related spend, particularly for its autonomous driving features.
This led to a subdued bottom-line performance (adjusted EPS: -23% y/y to $3.12), and ultimately, weaker cash generation (cash flow from operations: -10% y/y to $13.3 billion).
Tesla has seen an uptick in capex (+24% y/y) amid the roll-out of Cybertruck vehicles and the construction of its new factory in Mexico, which has severely impacted free cash flow (-42% y/y). Current capital expenditure as a share of revenue was 9.2%.
Investment into the Automotive business will likely remain elevated given management's plans for expansion. Nevertheless, the company still has sufficient cash resources on hand (cash and cash equivalents: $17.2 billion), while debt remains at a sustainable level (debt-to-equity: 15%, interest coverage: 57 times). This strength in the balance sheet should support operations going forward.

Recent production and delivery data has been a bit concerning - Tesla noted a 2% decrease in production as well as a 10% decrease in deliveries across the Model 3/Y platform during 1Q24. This, according to the company, is a result of a small shift in focus toward a production ramp-up of the updated Model 3 (at the Fremont factory in California) as well as unplanned factory shutdowns due to supply-chain delays and an isolated arson attack (in Berlin).

Investment case

EV's are a secular growth theme, particularly with the integration of autonomous driving and other related AI technologies.
The global EV market is still growing and a rebound in Chinese demand could further aid sales. Public sentiment and support for EVs continues to improve.
Underpinned by significant manufacturing capacity and strong brand reputation, the company's vehicle production and delivery growth has outpaced that of the sector.
Tesla continues to be a major player in the EV market, pushing the boundaries of electric transportation and sustainable energy solutions. The company has revolutionised the automotive industry with its commitment to sustainable transportation.
Tesla also has a sizeable footprint in the energy sector, producing batteries and contributing to the development of renewable energy infrastructure.
The next-generation vehicle platform will aid its expansion into new segments of the market. The new platform is also expected to meaningfully improve gross margins.
The company's Gigafactories, designed for large-scale battery and vehicle production, solidifies its position among EV automakers.

Risks

Tesla has implemented sizable price cuts in response to dwindling demand and lower federal EV subsidies - this has been detractive to margins.
Despite being a pioneer in the industry, Tesla's market share is slipping due to stiffer competition from both legacy automakers (who are adopting more EV offerings) as well as other established EV manufacturers, particularly in China.
Staying abreast on new technological developments and market trends is crucial in defending market share. Any signs of stagnation relative to competitors could be quite detrimental.
The company is exposed to labour and raw material shortages as well as supply-chain constraints across its manufacturing facilities around the world.
If customer demand is not forecasted accurately, Tesla could suffer from either bloated inventory levels or volume shortfalls, which are both costly to the bottom-line.
Regulatory intervention (regarding manufacturing, the environment as well as exports) remains a concern.

Consensus outlook and valuation

Bloomberg consensus is currently neutral on Tesla with 44% of sell-side analysts recommending a "hold" on the stock. About 33% of analysts have a "buy" recommendation on the stock. The 12-month aggregate target price of ~$192. This is 9% above current levels (~$177).

For FY24, revenue is forecasted to grow 8.7% y/y to ~$105 billion, though adjusted EPS is set to fall around 9.1% y/y to $2.84. Growth over FY25 and beyond is expected to be quite strong:

Tesla's forward PE multiple is well below its long-term historical average, though the rating (at a face-value of 57 times) remains quite elevated. The company is evidently still valued as a tech stock, which typically commands a higher price multiple due to strong growth prospects associated with ground-breaking innovations and trends, as well as industry disruptions (as is the case with renewable energy and EVs).

In addition to this, the stock continues to trade at a substantial premium relative to automaker peers such as BYD, Volkswagen and Ford. This is perhaps due to its emphasis on advanced technological features such as autopilot and full self-driving - which have a lot of growth potential given the emergence of new AI-related tools. The company's attached premium is also likely due to CEO Elon Musk, who is known to have a large cult-like following. We expect the valuation to continue developing closer to that of a traditional automaker as the growth outlook over the near-to-medium-term is reigned in.