It’s well known in the market that good stories sell. People love to dream about growth stocks and imagine all the wonderful possibilities.
Investors are no different, and are willing to pay a premium. They also tend to ignore storm clouds.
It’s human psychology and it’s manifested itself in many forms throughout time, from the Tulip Mania of the 1600s to the Dotcom Bubble in the late 1990s.
Story Stock
While many investors think Tesla (TSLA) is a sound company with incredible fundamentals, the simple truth is that Tesla is a pure “story” stock, in my opinion.
It has a very devoted following centered on a leader, Elon Musk, who’s done tremendous things in a short time.
That enables the company to carry a valuation that is far in excess of its competition on almost every metric, in my opinion.
And with this higher valuation comes an ability to literally print money by issuing new shares at inflated multiples to fund operations.
Even when the results go astray, the story is so good that investors are willing to overlook the problems and focus on the future business opportunities instead.
Tesla has morphed into more than just an automotive manufacturer and has now become a one-stop shop for rooftop solar power, battery producer, and electric car maker.
Real World
While Tesla is able to have the investment community ignore the economics involved in business cycles, other auto companies such as Ford (F) and General Motors (GM) aren’t so lucky.
Both Detroit automakers are valued at levels that factor in an imminent recession, with forward 2017 price-to-equity ratios (PEs) of 6.7x and 5.5x respectively.
The market has discounted the prices for the whole auto manufacturing sector on the basis that we have already hit “peak” auto sales in this expansionary cycle, and the future recession will take auto sales substantially lower.
In my view, the prices of these real world auto manufacturers are discounting that probability.
Reality Bites
While most Tesla investors prefer to have the company continue to be funded by an ever-increasing pool of new investors, at some point that will no longer be the case, in my view.
Tesla has plenty of creative growth plans, but eventually it has to execute.
And make no mistake, the company faces real competition on every front.
Mass Market
Tesla operates primarily in an industry that will compete hard for market share in the areas where money is made.
It is one thing for Tesla to sell a beautiful high-end sports car. It is quite another to sell a mainstream vehicle for the masses.
Not only does it have to produce it at a price point that is profitable, but Tesla is also facing competitors with far stronger balance sheets.
GM and Ford have the backing of dealership networks, suppliers, politicians, and bankers.
Cage Match
If we look at the stock prices for GM and Ford, we see analysts are predicting US car sales have topped out and the total pie of cars sold will get smaller.
In order for Musk to deliver on his promises, Tesla will have to gain a significant market share from rivals in a market that is shrinking.
In good times that would be a challenge, but in tough times you can bet that Detroit and its respective allies will fight for every dollar of profit.
Fundamentals
Let’s look at some fundamentals. (Stock prices and market cap figures are as of August 30.)
Tesla
- Price: $211
- Market Cap: $31.4 billion
- Automotive Net Cash: $0 (excludes Finance subsidiary)
- Earnings Estimates: -$0.84 (2016) $1.71 (2017)
- 2017 PE: 130x
- Total Est 2016 Revenues: $8 billion
- Total Est 2016 Automotive Units Sold: 75,000
Ford
- Price: $12.55
- Market Cap: $49.8 billion
- Automotive Net Cash: $14 billion (excludes Finance subsidiary)
- Earnings Estimates: $1.88 (2016) $1.86 (2017)
- 2017 PE: 6.7x
- Total Est 2016 Revenues: $140 billion
- Total Est 2016 Automotive Units Sold: 7 million
GM
- Price: $31.67
- Market Cap: $49.4 billion
- Automotive Net Cash: $20B (excludes Finance subsidiary)
- Earnings Estimates: $5.85 (2016) $5.77 (2017)
- 2017 PE: 5.5x
- Total Est 2016 Revenues: $159 billion
- Total Est 2016 Automotive Units Sold: 9.5 million
The Stats
In my opinion, when looking under the hood, several issues should be noticed.
First, Tesla is expected to produce 75,000 cars. Ford and GM produce 7 million and 9.5 million cars, respectively.
Tesla has very little experience in “mass producing” millions of cars and this is a very big risk investors often overlook.
Ford and GM have a production infrastructure that gives them economies of scale.
Valuation
Secondly, Tesla’s market market cap is almost 60% of its bigger brothers.
If you look at the almost every metric, this simply doesn’t make any sense.
Tesla burns cash, has no capital cushion against bad times, and relies on the generosity of the market to fund its stock sales at ever increasing price levels.
Cash Cushion
Meanwhile, Ford and GM have $14 billion and $20 billion to cushion their cash burn in the event of recession.
Stated another way, the investors in Tesla don’t anticipate anything bad happening in the future, while Ford and GM investors are braced for Armageddon.
Finally, in my opinion, Tesla needs to grab a lot more market share to justify its valuation. Its sales of $8 billion are roughly 1/20th that of Ford and GM.
Recession Risk
GM and Ford are far better positioned to weather any future recession.
Trading in mid-single digit PEs now will cushion the blow later, because they are trading at roughly 1/3 of the rest of the market.
While we would expect the earnings to fall in a recession, the key question will be how far the earnings actually drop.
We are confident that both GM and Ford have anticipated this likelihood, and thus we believe the market will be pleasantly surprised when the worst comes and these two companies demonstrate how they’ve changed.
Risk Factors
Tesla, in my view, may have a tough time in an economic downturn. It needs to compete for market share in a much tougher mass market segment.
In a downturn, it would also be more difficult to raise money at attractive valuations in the stock market.
Tesla could even find itself in a vicious cycle of having to issue more and more shares to fund its struggling operation, thus depressing the company’s stock price with each successive issue.
Summary
In my opinion, Tesla is a story stock that is headed down a path towards true competition.
While investors like to dream of what could be in the future, sometimes it is best they take a hard look at the reality. Both Ford and GM are signaling that the auto market is at a top and heading lower.
Tesla is reliant on a funding model that could be a disaster for current shareholders if times get tough, in my opinion.
Photo Credit: OnInnovation via Flickr Creative Commons
