During the market pullback last week, many growth stocks including Tesla (NASDAQ:TSLA) were hit hard. As a result, it had decline 20% from its market high of 883 USD just a month ago, effectively evaporating most of Tesla’s gains this year. With the price coming down, is it cheap to buy Tesla shares now?
Let’s take a look at the good and bad of Tesla.
Reasons to buy Tesla
Consistent Revenue growth
Over the last 4 years, Tesla was able to increase its revenue from 11,759 million in 2017 to 31,536 million in 2020. In 2020 alone its revenue grew 46% year on year. This is a positive sign that the company is doing well.
Tesla has also released profit guidance for the following years, it expects to achieve 50% average annual growth in vehicle deliveries over a multi-year horizon, depending on equipment capacity, operational efficiency, and the stability of the supply chain. In addition, the company expects Tesla Semi deliveries to start this year. If what Tesla says materialize, it would definitely give its earnings a boost
For 2020, Tesla’s gross profit margin is around 20% which is way higher than Volkswagen’s average of 12%. A high-profit margin is a healthy sign as it means Tesla is able to effectively control its costs and sell its car at a significantly higher price than its cost.
Strong cash position
As of 31 December 2020, Tesla’s cash and cash equivalents stand at $19,384 million, up from 6,268 million one year ago. The huge increase can be attributed to Tesla issuing more shares into the market. In 2020 alone, proceed from issuances of common stock came in at $7,282 million.
With lots of cash on its hands, Tesla has a healthy current ratio of 1.88. For every $1 in short-term debt, it has $1.88 in liquid assets to cover them. This provides a clear sign that Tesla has the ability to pay short term liability.
A positive free cash flow of $2,786 million also means that Tesla has additional money that can be used to reinvest into its business and keep its competitive advantage.
Way ahead of its competitors
Although Tesla is relatively new to the automotive industry, it is believed that Tesla is 6 years (at least) ahead of its peers.
While other auto manufacturers have the potential to catch up to Tesla in a short amount of time, what sets them back is not the technological hurdles but the worry that doing so may disrupt its current supply chain. Many of Tesla’s competitors produce Internal combustion engine (ICE) vehicles, and transiting to EVs production would require significant changes to their supply chain.
Apart from its development in battery technology, some future developments Tesla is exploring include robotaxis, Powerwall, HVAC systems, and many more. The future for Tesla sounds exciting for its shareholders.
Positive outlook for EV market
The EV market has been growing and will continue to grow into the future. According to Deloitte, the global EV market is forecasted to grow at a compound annual growth rate of 29% over the next 10 years. This would take total EV sales of 2.5 million in 2020 to 31.1 million by 2030 (approximately 32% of the total market share for new car sales).
If Tesla can retain its current market share of EVs of around 25% and keep up with the market growth, it would mean the company could potentially grow close to 29% year of year.
Reasons to avoid Tesla
Unsustainable revenue from Regulatory credit
Regulatory credits are credits given to companies that contribute zero pollution to the environment. Since Tesla manufactures emission-free EVs, it has been receiving lots of regulatory credits from the authorities. These credits are then sold by Tesla to other auto manufacturers that require it to meet the emission standards set by the state government in the US. In 2020, of the $2,066 million in gross profit, $1,580 million comes from the sales of regulatory credit. This is around 76% of Tesla’s total gross profit.
The dependence on sales of these regulatory credits is not sustainable for Tesla. Tesla regulatory credit will run out at some point as other automakers start to produce their own EVs, they may not have to buy regulatory credits from Tesla anymore.
If Tesla wants to survive, it will have to find other ways to increase its profit margin else we may see its profit going back into the red.
Share price tied to Bitcoin
Tesla has recently revealed that it has purchased $1.5 billion of Bitcoin and is planning to accept Bitcoin as a form of payment for its product in the future. If you are a believer in crypto, you would be pleased by this news as you can purchase Tesla shares and ride through the gains of bitcoin with it. However, the bad news is the increase in volatility. As if Tesla is not volatile enough, given that bitcoin is still not a stable crypto asset, the addition of Bitcoin to Tesla’s balance sheet will make its share price much more volatile.
Based on Tesla’s latest Balance Sheet, its total current assets is around 26.7 billion, which means its Bitcoin holding only makes up around 6% of its current assets. This is a healthy holding in my opinion. However, as Tesla would be planning to accept payment in the form of bitcoin, we could potentially see this allocation increase significantly.
Stiff competition ahead
While Tesla has the first-mover advantage in the EV space, it still faces strong competition from its incumbents who hold massive shares of the respective market that Tesla is attempting to penetrate. From the figure below, we can see that its global market share has been increasing but it still under 1.5%
To add to this already overcrowding industry, we see non-automaker like Apple joining in. In China, Tesla faces tough competition from rivals includes Nio, Xpeng Motors, and Li Auto to name a few. In my opinion, the EV space is getting too crowd, whether Tesla continues to capture market share is hard to say.
While Tesla seems to be ahead of its peers in terms of its technology especially in its battery which is much superior compared to its competitors, it is not clear if they could keep this advantage for long as companies like Toyota, Volkswagen, and others have been pouring billions of dollars into developing better EV batteries.
Growth story has been priced in
Tesla has managed to capture many investors’ eyes. With its tremendous growth over recent years and arguably selling one of the best EVs in the current market, many investors have bought into Tesla in hopes that it would keep up with its current growth rate.
As it stands now, Tesla’s trailing Price to Sales ratio (P/S) is 22.58. In other words, for every $22.58 invested in Tesla, it is making $1 in revenue. A look at traditional automakers Volkswagen’s P/S ratio of 0.42, it is clear that Tesla is way overvalued. Even if we were to take Tesla as a technology company and compare it to tech companies like Apple, we could still see that Tesla is overpriced. (Apple P/S ratio is at 7.15)
However much exciting Tesla’s growth story is, it may have been priced into the stock already.
*Price to Sales ratio (P/S) has been used instead of Price to Earning ratio (P/E) as Tesla has only recently turned profitable.
My thoughts
I have listed some reasons to buy Tesla and also the risk as a shareholder, now you would have to make your decision if you would like to enter.
For me, while Tesla’s share is currently at 20% discount from its all-time high, it is still a very expensive stock. Tesla still has a lot of growth potential and I am sure this company will do well in the near future. However, with the high valuation and the vast number of competitors in this industry, I do not see Tesla having a good moat in the long run. As such, I am still reluctant to invest in Tesla for now.
Disclosure: I have no position in Tesla and have no plans to enter any time soon.