Key Takeaways:
· The Model S is a breathtaking car, and its positive reception well-deserved. Motor Trend’s 2013 “Car of the Year” doesn’t begin to explain how great this car truly is. We went to a dealership to check it out for ourselves.
· Tesla’s (TSLA) brand has low penetration. Considering the automaker will ship around 20,000-21,000 units this year (less than 0.1% of the US auto market), we think the company is still relatively unknown outside the finance and environmental circles.
· Battery Cost Issues? We think the bear argument that battery costs might not fall fast enough is valid. However, we tend to bet on innovation in the long run. In our view, Tesla will sort out the issue.
· The long-term potential of Tesla is fantastic. We believe the company could become the fourth large US automaker if it is able to achieve battery cost declines and/or improvements in battery technology. Tesla’s growth will encounter a number of obstacles, but we think the firm will prevail.
· There are a few companies that could benefit from Tesla’s success, but only marginally, in our view. Gentex (GNTX) and Magna (MGA) are among the publicly traded suppliers likely in the Model S.
· Tesla’s future is highly uncertain, which is reflected in our wide range of fair values. We demand a high margin of safety before investing in such a name. We wouldn’t become interested unless shares fell below $65 each (shares are trading north of $100).
· Ford (F) is our Best Idea in the auto sector. Shares have returned over 50% since we initiated our position, and we see further upside to $23 per share.
We recently more than doubled our fair value estimate on automaker Tesla (click ticker for report: ). Let’s walk through the logic behind our fair value increase.
The Model S Is a Breathtaking Car
Image source: Tesla Motors (Performance Model S shown)
Tesla’s Model S won Motor Trend’s “Car of the Year” for 2013, becoming the first electric vehicle (EV) ever to win the award. Consumer Reports gave the Model S a score of 99/100, and several other outlets have provided glowing reviews. Other than a public, messy feud over a negative review in the New York Times, the reception to the Model S has been universally positive.
The car’s performance is up-to-standard with other performance luxury sedans. The Performance Model S accelerates faster (0-60mph in 4.2 seconds versus 5.4 seconds for the standard 80kwh model) than the standard model, but this is consistent with competitors that have performance models (think BMW’s M5 or Mercedes CL 63 AMG).
Source: Company websites, Valuentum
Valuentum isn’t in the business of reviewing car aesthetics, but we think the Tesla is one of the best-looking cars we’ve seen in years. Designer Franz von Holzhausen is the man behind the design of the Model S. One can see inspiration for the vehicle from von Holzhausen’s previous efforts at General Motors (click ticker for report: ) and Mazda, but we think the car retains a unique look. We visited the Chicago dealership (Tesla’s Mid-Western hub) and can confirm the experience inside the car is just as great.
Image Source: Tesla Motors
Tesla’s proprietary center console control automatically links to a 3G network and essentially controls everything within the car. The operating system reminds us of iOS (Apple’s operating system) in the sense that it is highly-intuitive and easy to use. Due to the vehicle’s engineering, people inside the car will notice increased space and ample leg room. Since the car wasn’t retrofitted to become an EV, the entire interior layout seems natural and utilizes all of the space saved by eliminating internal combustion parts.
We think concerns that Tesla can’t build a fantastic automobile should be thrown out the window. There will likely be hiccups along the way—even legacy automakers such as Ford (click ticker for report: ) and Toyota (click ticker for report: ) deal with thousands of recalls annually—but we think Tesla will continue to manufacture attractive and useful products.
If qualitative reviews weren’t enough, let’s remember that Tesla carries virtually no inventory and cannot build cars fast enough to satisfy demand. The company produced 5,000 cars during the first quarter, but global demand is currently running above 20,000 units, meaning demand is outpacing supply. People want the Model S, and unfortunately, there is a backlog, so buyers have to wait to receive units. We posit if the firm could create even limited inventory supply, sales might be even better.
Tesla’s Brand Has Low Penetration
As much as Wall Street might hate to admit, the financial markets can obscure one’s view of reality. Look no further than the Apple (click ticker for report: ) situation: several pundits claim Samsung “destroyed” the iPhone, but real sales figures clearly state otherwise. We think Tesla suffers from the opposite problem: the stock has moved so far so fast that Wall Street assumes Tesla is a household name. That’s far from the case, in our view.
The firm has yet to spend a dime on marketing, meaning that all demand for vehicles is based on word of mouth and positive press. Unlike the legacy automakers which have dealerships lined up on strips across North America, Tesla has just 32 outlets, and a few states have prevented Tesla from opening up its direct-to-consumer stores. Of those existing stores, nearly one third are in California. We tend to believe the company may have hundreds of millions of consumers in North America alone that are relatively unfamiliar with the vehicle and the brand.
On top of low brand recognition, the company has hardly penetrated the US car market. If we assume Tesla sells 21,000 units in the US in 2013, and we assume a SAAR of 15.4 million units, Tesla would own only 0.1% of the US auto market! And, that market share comes with only one model, compared to the dozens of other available models at other competitors.
No one doubts that Tesla is ahead of the game in terms of EV production. Considering our long-term forecast for crude oil implies gas prices in the United States will remain elevated, we think the benefits of EVs could become even more pronounced during the next two decades.
With smaller, less expensive vehicles in the pipeline, it’s hard to know exactly what Tesla’s market potential is. However, if the company is able to grab just 1% of the US auto market (not accounting for international expansion opportunities) it could sell 154,000 units—or 630% more than it likely will in 2013. This would still label Tesla as a niche player.
Battery Cost Issues?
Perhaps the most compelling bear-case for the company centers on the cost of lithium-ion batteries, which are the focal point of Tesla’s product. Barron’s released a piece critical of CEO Elon Musk’s belief that the cost of lithium-ion batteries will fall by 20-30% by 2016. We don’t argue this point—cost savings projections that are made do not always live up to the hype. This could throw a serious wrench into Tesla’s plans.
But, Tesla isn’t strapped with the legacy costs and design constraints of the internal combustion engine. If a better battery technology emerges, Tesla will be flexible enough to adapt. Recent research suggests sulfur-based batteries might be better than lithium-ion batteries, and it could be the kick Tesla needs to make a mass market vehicle feasible. Further, if we’ve learned anything from technology during the past few years, we’ve learned not to underestimate the rate of change. If the profit potential for a product is large enough, we believe a solution can be found.
Want to see an example of innovation? Look no further than the fuel efficiency of the internal combustion engine. Over the last thirty years, the average fuel efficiency of new passenger cars has risen nearly 47% from 24.3 mpg in 1980 to 35.6 in 2012. Since 1980, the real price of fuel has risen 19% from $2.605 per gallon in 1980 to $3.111 per gallon in 2011 (note: nominal prices have increased 183% over the same time period). From 1980-2012, miles driven increased a dramatic 94%, meaning total fuel expenditures are up meaningfully for most consumers.
However, we can see that acceleration in fuel economy improvements occurred when prices bottomed in 1998. Consumers started feeling the pinch at the pump—a 233% price increase is a lot to stomach after nearly 20 years of nominal prices declining. As a result, the demand for fuel-efficient vehicles rose, so auto OEMs responded with more fuel-efficient vehicles. Today, even hybrids such as the Toyota Prius have internal combustion engines with just a kick of battery power. If manufacturers refused to improve fuel economy, the demand for alternative forms of automobiles like EVs and natural-gas powered cars might have taken off sooner, damaging auto OEMs, as well as the oil industry.
The Long-term Potential of Tesla Is Fantastic
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