House View – Tesla Inc – Published 13/09/18

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Company Overview:

Tesla Inc, previously Tesla Motors Inc, designs and manufactures fully electric vehicles and energy storage systems. It also installs, operates and maintains solar and other energy storage products.

The company operates in two segments. One being the Automotive, which makes electric cars, and the other being the energy generation and storage segment. Energy generation and storage houses the solar business as well as the battery development operation that is key for Tesla cars.

Summary:

Tesla shares will likely cost owners more than their original investment over the coming years.

A successful investment is contingent on current and forthcoming model launches meeting market expectations that currently price substantial sales growth over a very short time horizon.

We see risks to consensus expectations for sales growth and the bottom line during the years ahead, but are of the view that progress is already sufficient enough for Tesla to ensure dominance in the EV market.

Due to frequent share issuance and risks around current market expectations, we advocate building positions in Tesla stock over time, deploying a buy on dips and subscription strategy.

That is to say, investors should buy on weakness and take up any subscription rights they are afforded in new share issuances.

It’s happening. Electric cars are coming.

Increasing environmental awareness among consumers and government tax policies on emissions provide a financial incentive for consumers to want to adopt electric cars.

This is while governments are beginning to commit to further action, beyond simple tax policy, in order to drive adoption further. A case in point is the July UK government proposal to ban the sale of combustion engine cars from the year 2040 onward.

While there are several flaws in the government’s plan, not least of all an absence of capacity to support forecast increases in demand for electricity, the commitment to drive adoption is clear.

A more coercive approach toward the adoption of EVs is a mechanism through which public policy makers can work toward carbon reduction targets laid out in the Paris climate accords.

The majority of traditional OEMs (original equipment manufacturers) are investing in some way to produce electric and autonomous vehicle technology.

Electric cars are all the rage but Tesla has the edge

Electric cars are the buzzword of the day among traditional OEMs, or legacy manufacturers, but years spent already in the game give Tesla competitive advantage that could see it capture substantial market share – upending the established order as far as tomorrow’s auto-market goes.

While most OEMs are developing an electric offering, the bulk of these have begun by developing hybrid models, which rely dually on combustion and electric engines – deferring production of fully electric vehicles to a later date.

This approach by existing mass market manufacturers suggests a disconnect between the OEM view on the future of road travel and that of the market. It will be the middle of the next decade before a traditional OEM has a fully electric vehicle that is ready for mass market distribution.

Not only does this approach leave OEMs further behind the curve when it comes to technological development, it also risks seeing some develop a bottle neck of work, costs and risks associated with the adaption of production facilities and supply chains.

The competitive moat gets wider beneath the waterline

A critical success factor that will determine the rise and fall of EV manufacturers is their intellectual property base in battery technology.

EV batteries are comprised of two parts a) the fuel cells and b) the battery pack. Fuel cells deal with the storage of electrical energy and are the preserve of traditional battery manufacturers but battery pack technology is where Tesla draws another competitive advantage.

Battery packs are responsible for controlling power supply and engine temperature. It is the effectiveness of battery pack technology that determines the overall performance and worth of electric vehicles and therefore, it is intellectual property in this area that provides true competitive advantage.

With more than 14 years of research and development under its belt, which will be two decades by the time traditional OEMs reach the mass market, Tesla has an opportunity to seize a meaningful share, if not dominant share, of the electric car market.

Financials & Valuation

Consensus suggests sales of more than 600,000 units in 2019, up from 76,000 in 2016, with revenue growing from $7 billion to $35 billion.

The bottom line is forecast to swing from a loss of $675 million to a profit of $501 million during this period. Tesla stock currently trades at more than 100x 2019 earnings per share of $3.05.

Market expectations of growth reflect the projected outcome of a production ramp up and a release to mass market of the Model 3.

We are cautious of market forecasts and expect the production ramp up to be slower and a bumpy bottom line path toward profitability.

However, in the absence of a credible challenge from one of the OEMs we are minded to view bumps in the road and any concurrent weakness in the shares as an opportunity to build our position further.