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US Auto Industry

Tesla Motors: The Car is Electric, The Stock is Not

By Elliott H. Gue, on Mar. 24, 2014

If you’ve held shares of Tesla Motors (NSDQ: TSLA) over the past year, you might regret that you don’t own more.

After all, the electric-vehicle pioneer is one of the hottest momentum stocks on the board; the shares have returned more than 550 percent over the past 12 months and about 50 percent since the beginning of 2014.

The stock has confounded the bears, shrugging off a series of negative articles in financial publications and crushing the legions of short sellers betting against the company.

To be clear, investors shouldn’t sell Tesla Motors short. As of last count, short interest in the stock stood at almost 40 percent of the innovative carmaker’s total float, setting the stage for a vicious short squeeze.

This phenomenon occurs when a bit of positive news (and too much pain) prompts short sellers to cover their positions en masse, forcing them to buy shares in the open market. This wave of purchases pushes the stock price higher, ratcheting up the pain on short sellers who maintain their positions.

Although these dynamics have propelled shares of Tesla Motors to impressive near-term gains, the odds are stacked heavily against investors who hold the stock as a long-term bet on a widespread shift away from the internal combustion engine in favor of electric vehicles.

At this juncture, the easy money has been made; investors still in the stock are picking up dimes in front of a steamroller. If Tesla Motors’ sales fall short of lofty expectations, the stock price could easily be cut in half.

Even worse, if you own shares of Tesla Motors, you placed your bet on the wrong horse.

A revolution is under way in the auto industry, as new materials, innovative designs and technological improvements produce cars that operate with greater fuel efficiency. These vehicles still run on gasoline or diesel and won’t necessarily cost you an arm and a leg.

One of our favorite plays on this trend, BorgWarner (NYSE: BWA) turbochargers and transmission that can improve an engine’s fuel efficiency by as much as 30 percent. This winner has delivered a total return of 45 percent since we added the stock to our Wealth Builders Portfolio.

And in the most recent issue of Capitalist Times Premium (subscription required), we highlighted a name that stands the benefit handsomely as automakers seek to produce lighter-weight vehicles without making concessions to performance. This stock could deliver a 40 percent to 60 percent gain by year-end.

Insane Valuations: More Pain than Gains

Shares of Tesla Motors trade at about 14 times the company’s past 12 months of revenue and almost 8 times the Bloomberg consensus estimate of the firm’s 2014 sales.

The company’s enterprise value, which includes all outstanding shares and net debt, clocks in at about $29 billion. Based on this metric, Tesla Motors isn’t too far removed from established automaker General Motors Company’s (NYSE: GM) enterprise value of $38 million.

Nevertheless, the upstart carmaker sold a grand total of 22,477 vehicles last year, compared to the 9.75 million autos sold by General Motors.

The track record of stocks that fetched such lofty valuations isn’t encouraging.

After screening the universe of US-listed stocks with a market capitalization of at least $5 billion that traded more than 7.8 times their trailing 12 months of sales, we created a hypothetical portfolio of names that met these criteria over the past 15 years.

We ran this screen for each year, eliminating stocks that no longer met these criteria and adding any new names. We also rebalanced the resulting portfolios, assigning each name an equal allocation.

An investor who purchased this portfolio of expensive, large-cap stocks would have posted a loss of about 3 percent over the past 15 years–well short of the almost 100 percent return delivered by the S&P 500 over the same period.

And if you had purchased an equal-weighted portfolio of all US-listed stocks with a market cap over $5 billion each year, you would have earned a total return of 153 percent over the same time frame.

Stocks trading at nosebleed valuations also tend to entail far more volatility and risk–as measured by standard deviation–than the average large-cap name.

An equal-weighted portfolio of US stocks with a market cap that exceeds $5 billion exhibited a standard deviation of 17.73 percent over the past 15 years.

Meanwhile, an investor who bought the portfolio of large-cap stocks with a high price-to-sales ratio lost money and endured the volatility associated with a standard deviation of more than 28 percent.

And how about large-cap stocks with a low price-to-sales ratio?

We created a third hypothetical portfolio of stocks with a market cap of more than $5 billion and a price-to-sales ratio in the lower one-third of our investable universe. Rebalancing this portfolio annually with equal weights generated a return of about 263 percent over the past 15 years. This approach resulted in a standard deviation similar to the one exhibited by an equal-weighted basket of all large-cap stocks.

Buying value and selling hype has been a consistently solid strategy over the long-term.

However, richly valued stocks can outperform in some years. Over the 12 months ended Feb. 28, 2000, technology stocks powered the high price-to-sales portfolio to a 70 percent gain, while the basket of stocks with a lower price-to-sales multiple gave up about 15 percent of its value.

In the ensuing bear market, however, these high flyers tumbled while their cheaper peers soared.  

Tesla Motors: Good Company, Good Management, Bad Stock

Tesla Motors’ four-door Model S luxury sedan is an impressive vehicle that can accelerate from zero to 60 miles per hour in 4.2 seconds and can travel up to 265 miles on a single charge–by far the best-performing electric car on the market.

The Model S has received numerous accolades, including the prestigious Motor Trend Car of the Year Award for 2013. And in November 2013, the car received an unprecedented 99 out of 100 in an owner-satisfaction survey conducted by Consumer Reports.

Tesla Motors has struggled to meet demand for the Model S. After introducing the car in June 2012, the company sold 2,650 models by the end of the year and boosted the capacity of its California manufacturing plant to 400 units per week.

Management’s guidance called for the company to sell 20,000 cars in 2013; the firm moved 22,477 Model S units last year, including 6,892 cars in the fourth quarter–an annualized pace of about 28,000 units.

In 2014, Tesla Motors plans to expand its productive capacity to 1,000 Model S cars per week from about 600 units and has targeted 35,000 new sales for this year.

The Model S commands a premium price. Equipped with a 60 kilowatt-hour battery pack, the luxury automobile sells for $69,900, while the base model with the 85 kilowatt-hour battery goes for $79,900. Customers can step up to a performance package that sells for $93,400. Buyers receive a $7,500 federal tax credit for the purchase of an alternative-fuel vehicle, reducing the effective cost of each model by the same amount.

In addition, Tesla Motors offers a wide range of upgrades for the Model S, including a 17-inch touch-screen driver interface and 3G connectivity. In the company’s fourth-quarter earnings call, management indicated that an increasing number of purchasers have opted for the larger battery pack and additional features. With auto sales of more than $750 million during the quarter, the average sales price of the Model S came in at about $110,000.

Consumer demand for Tesla Motors’ Model S is impressive, considering the car’s lofty price tag. And the company’s profit margins on the luxury vehicle are sky high: Tesla Motors posted a gross margins of 25.2 percent, which eclipsed Daimler’s (Frankfurt: DAI, OTC: DDAIF) 21.6 percent margins.

Tesla Motors also has several promising growth initiatives on the table. In 2015, the company plans to launch its Model X, a seven-passenger sport utility vehicle that will feature a similar price point to the Model S. CEO Elon Musk expects the car company to sell more Model X than Model units per year.

The company plans to introduce a mass-market car in 2017 that will cost consumers less than $50,000 for the base model.

The consensus estimates that Tesla Motors’ batteries currently cost between $200 and $300 per kilowatt-hour to produce. Based on the midpoint of that range, the 85 kilowatt-hour battery pack in the Model S would cost $21,250.

For the proposed mass-market model, Tesla Motors would need to dramatically reduce the cost of its existing battery packs or cut the range that the vehicle can travel on a single charge.

Enter Tesla Motors’ recently announced “gigafactory,” a plant that will have the capacity to produce enough battery packs to power about 500,000 Model S vehicles by 2020.

CEO Elon Musk elaborated on this plan during Tesla Motors’ fourth-quarter earnings call:

The gigafactory is really there to support the volume of the third-generation car, and, yes that’s really – so it’s happening in parallel with the development of the third-generation car. We want to have the vehicle engineering and tooling come to fruition at the same time as the gigafactory. And yes, so that’s all really part of one strategy, one combined effort.

Constructing this plant will cost between $4 and $5 billion, with Tesla Motors contributing about $2 billion and the balance coming from its partners. But management estimates that this facility will enable the firm to reduce the cost of its batteries significantly by the time its mass-market model goes into production.

Management estimates these cost savings at about 30 percent or more, implying that the battery packs would cost about $10,000 to $12,000 to produce.

Tesla Motors’ recent success, coupled with the excitement surrounding its mass-market model, has pumped up investors’ expectations. A recent research report published by Morgan Stanley (NYSE: MS), for example, calls for Tesla Motors’ total sales to top 700,000 units by 2020 and 1 million cars by 2028.

The company’s billionaire CEO, Elon Musk, also has a lot of credibility and is considered a true visionary in Silicon Valley.

Musk co-founded PayPal, which was later purchased by eBay (NSDQ: EBAY). He’s also the brains behind SpaceX, the private rocket and spacecraft company that transported equipment and supplies to the International Space Station after NASA’s shuttles were retired.

To round out his resume, Musk is chairman of SolarCity Corp (NSDQ: SCTY), another big momentum stock of the past year. (You can read Roger Conrad’s take on SolarCity in The Smarter Bet on Solar Power.)

In short, there’s no doubt Tesla Motors is a great company with a successful product and a forward-thinking CEO. But good companies whose stocks trade at inflated valuations don’t make good investments.

Next week’s issue of Big Picture will delve further into Tesla Motors’ valuation and explore some of the investable trends in the auto industry that are creating real wealth for investors.

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