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Michael Wiggins De Oliveira

About the Author Michael Wiggins De Oliveira

Michael Wiggins De Oliveira specializes in deep value, with a relentless focus on companies which generate strong free cash flow.

Tesla’s (TSLA) Stock Leaves Investors with Close to No Room for Error


Investors looking for the next information edge on Tesla (NASDAQ:TSLA) should look no further than Buffett’s Rule Number 1. Buffett often describes his large accumulation of wealth as having avoided permanent losses of capital and never speculating on stocks.

Nevertheless, reading through Tesla’s Q2 2018 results and I became truly passionate and hopeful that Tesla succeeds in its endeavour even while pigheadedly advocating that investors stay on the sidelines of its stock.

Recent Results

Tesla’s Q2 2018 update was filled with green shoots of optimism, that Tesla’s financials woes might soon become a thing of the past. Musk resolutely reaffirmed several times that Tesla would be cash flow positive starting Q3. While previously I would have been highly dismissive of Musk’s claims, this time the CEO’s confidence was particularly striking.

Not only did Musk straightforwardly assert that Tesla had no plans to raise equity, Musk also put a spotlight on Tesla’s senior notes, which are due in March 2019. Also, Musk stated point blank that Telsa would repay these convertibles and not refinance them.

Moreover, Musk spoke out several times how Tesla would start to significantly benefit from positive operational leverage. That Tesla’s manufacturing inefficiencies could be ironed out and costs should drastically come down over Q3 and Q4 timeframes. Additionally, Musk remained adamant that Model 3’s 25% gross margin should be right around the corner and that Musk would be ‘shocked’ if the Model 3 didn’t carry a 25% gross margin by Q2 2019.

Finally, although no less weighty was the news that Model 3 continues to gain market share, and pulling in customers not only from premium sedans, but mainstream midsized sedans owners which are trading up. One thing is certain, there is huge demand for Tesla cars.

New Forecast for 2018

Particularly noteworthy, are the strides which Tesla is taking to prudently use capital. For instance, in the quarter Tesla’s working capital use improved substantially, as shown by Tesla’s stretching of payables. When questioned about this tactic, CFO Ahuja downplayed Tesla’s financial engineering and continued to reiterate that while Tesla did benefit from delaying paying suppliers, that investors should also note Tesla’s large sales volumes and the higher gross margins on the model 3.

Another takeaway this quarter was that Tesla’s full-year capex requirements have once again been trimmed, as Tesla continues to look everywhere to improve efficiencies. As of Q1 2018 investors were told to expect full year 2018 capex requirements to came down to less than $3 billion and then, within 90 days, once again, capex requirements have been trimmed down to less than $2.5 billion.

Valuation

Now, for its valuation – a whole different story.

Source: author’s calculations, morningstar.com

Without any convoluted thinking, we can spot one company in the table above which is an outlier. Investors might argue that Tesla P/Sales ratio is currently trading for less than half its 5-year average. However, when we compare Tesla with the rest of its peers, it indicates a strong level of optimism which being priced into Tesla’s stock.

We know that the car industry is highly competitive, with strong manufacturing capabilities not only in North America but in Europe and Asia too. Unlike its peers, Tesla has a spotty history of successfully mass producing vehicles, at a high scale to consistently generate GAAP cash flow from operations.

Also, by looking in the table above we can see how its peers are not only cash flow generative, but more cheaply valued too. Additionally, we should note, that many of in the industry’s risks and opportunities available to say, General Motors, are mostly the same as those available to Tesla, so there is no material reason for Tesla to be priced 10 times more expensively than General Motors.

Takeaway

Making serious returns is not about making a speculative gamble on stocks like Tesla. The best returns are often made by investing in boring companies when they are undervalued and under the radar; which Tesla is neither of.

We make no attempt to pick the few winners that will emerge from an ocean of unproven enterprises. We’re not smart enough to do that, and we know it.

– Buffett

 

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