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By Valuentum Analysts
Tesla, Inc. (NASDAQ:TSLA) is one of the most followed stocks out there, and CEO Elon Musk has reached celebrity status thanks to his huge following on Twitter (TWTR) and his ability to find himself in the news one way or another. The bear case on Tesla has many facets, including an overdependence on tax credits, free cash flow that is supported by stock-based comp, and the list goes on and on.
For example, CNN Business reported that “Tesla buyers may be able to take advantage of new federal tax credits for electric vehicles next year…the credits can be as large as $7,500 for new vehicles and $4,000 for used vehicles.” We won’t know detailed guidance for the new rules until the end of 2022, but it’s a probability that Tesla may be eligible as certain caps are lifted on larger auto producers, and this may actually be a positive for Tesla.
Tesla’s stock-based compensation is a small part of cash flow from operations. (Image Source: Tesla)
Tesla’s stock-based compensation is a small part of cash flow from operations. (Image Source: Tesla)
Another part of the bear case against Tesla is that stock-based compensation is a large add-back to net income in deriving net cash provided by operating activities, but we’re not sure how big of a concern this should be either. For example, during its most recent third quarter (as shown above), stock-based compensation was $362 million, while net cash provided by operating activities came in at $5.1 billion, accounting for just 7% of Tesla’s operating cash flow.
We think a bigger concern with Tesla’s shares is CEO Elon Musk’s ownership of Twitter, which could serve as a distraction, especially as we can only imagine how difficult a firm Twitter is to run. However, in this note, we thought we’d take things in a bit of a different direction and provide what we think is an objective view on Tesla’s intrinsic valuation through our discounted cash flow process. With this background provided, let’s get down to what we think Tesla is worth on the basis of its balance sheet and future expectations of free cash flow.
Image Source: Valuentum
Image Source: Valuentum
Tesla’s strategy is to accelerate the transition to electric vehicles with a range of affordable electric cars. The Model S, the world’s first premium sedan to be engineered from the ground up as an electric vehicle, began deliveries in June 2012. CEO Elon Musk is dreaming big, but public relations missteps have impacted shareholder confidence at times.
Tesla CEO Elon Musk closed on its buyout of Twitter, and it seems that Twitter may be encountering some trouble, at least on the basis of Musk’s tweets. For example, he noted that Twitter may be losing over $4 million per day, and it remains to be seen just how long a company can operate privately with such cash burn, and how that may impact Musk’s other stakes, including the one in Tesla.
Tesla’s stock volatility is not for the faint of heart, as its shares have been on a roller coaster over the past decade. Its competition continues to grow and will only intensify from here on out. We’re still expecting substantial free cash flow generation at Tesla in the coming years, and the company’s ~$3.3 billion free cash flow performance during the third quarter of 2022 was simply astounding, and the best we’ve seen.
Tesla’s third quarter 2022 performance was solid almost across the board. (Image Source: Tesla)
Tesla’s third quarter 2022 performance was solid almost across the board. (Image Source: Tesla)
Tesla’s production capacity is growing robustly. At the beginning of the third quarter of 2012, Tesla was producing just five cars per week. By the end of that quarter, it was making 100 cars per week. Fast-forward to 2021 and Tesla delivered over 930,000 vehicles that year. Management is targeting the production of 20 million vehicles annually by 2030, and while that may be difficult to achieve, we like the target for continued growth.
Our cash flow model forecasts that Tesla will post double-digit annual revenue growth and meaningful margin expansion over the coming years. Should Tesla stumble for any reason, its intrinsic value would face serious pressure. Inflationary headwinds and supply chain hurdles are worth monitoring, but Tesla has a relatively strong balance sheet to lean on, with $21.1 billion in cash on hand, and just ~$3.6 billion in debt and finance leases at the end of the third quarter – good for a very solid net cash position.
The best measure of a company’s ability to create value for shareholders is expressed by comparing its return on invested capital (ROIC) with its weighted average cost of capital (WACC). The gap or difference between ROIC and WACC is called the firm’s economic profit spread. Tesla’s 3-year historical return on invested capital (without goodwill) is 56.7%, which is above the estimate of its cost of capital of 9.5%.
As such, we assign Tesla a Value Creation rating of excellent. In the chart below, we show the probable path of ROIC in the years ahead based on the estimated volatility of key drivers behind the measure. The solid grey line reflects the most likely outcome, in our opinion, and represents the scenario that results in our fair value estimate. Tesla is a strong economic value generator, and the firm noted in its recent third quarter report that it “achieved an industry-leading operating margin,” despite material cost inflation.
Image Source: Valuentum
Image Source: Valuentum
Image Source: Valuentum
Image Source: Valuentum
On the basis of our discounted cash flow model, which considers Tesla’s strong balance sheet and solid future expected free cash flow generation, we think Tesla is worth ~$312 per share with a fair value range of $203-$421. Right now, shares of Tesla are trading at the low end of our fair value range, so they look cheap and are backed by key cash-based sources of intrinsic value.
The margin of safety around our fair value estimate is driven by Tesla’s high Value Risk rating, which is derived from an evaluation of the historical volatility of key valuation drivers and a future assessment of them. We think a wide range is also appropriate in light of CEO Elon Musk’s buyout of Twitter, and the fast-changing auto landscape.
Our near-term operating forecasts, including revenue and earnings, do not differ much from consensus estimates or management guidance. Our model reflects a compound annual revenue growth rate of 32.9% during the next five years, a pace that is lower than the firm’s 3-year historical compound annual growth rate of 35.9%.
Our valuation model reflects a 5-year projected average operating margin of 22.1%, which is above Tesla’s trailing 3-year average. Beyond year 5, we assume free cash flow will grow at an annual rate of 11.8% for the next 15 years and 3% in perpetuity. For Tesla, we use a 9.5% weighted average cost of capital to discount future free cash flows.
Image Source: Valuentum
Image Source: Valuentum
Image Source: Valuentum
Image Source: Valuentum
Our discounted cash flow process values each firm on the basis of the present value of all future free cash flows. Although we estimate Tesla’s fair value at about $312 per share, every company has a range of probable fair values that’s created by the uncertainty of key valuation drivers (like future revenue or earnings, for example). After all, if the future were known with certainty, we wouldn’t see much volatility in the markets as stocks would trade precisely at their known fair values.
Our Value Risk rating sets the margin of safety or the fair value range we assign to each stock. In the graph above, we show this probable range of fair values for Tesla. We think Tesla is attractive below $203 per share (the green line), but quite expensive above $421 per share (the red line). The prices that fall along the yellow line, which includes our fair value estimate, represent a reasonable valuation for the firm, in our opinion. Tesla’s shares are trading near the low end of what we think is a fair value estimate range.
Tesla has revolutionized the auto industry, in our view, and CEO Elon Musk has powered through, despite all the criticism his firm has faced in recent years. The bear case on Tesla regarding tax credits and share-based compensation may not have that much merit, but running Twitter may be a difficult task to do while managing one of the most successful automakers in Tesla. We think the shares of Tesla are cheap, and our valuation is based heavily on cash-based sources of intrinsic value. Let us know your thoughts about Tesla below, and don’t forget to follow us!
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Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: Brian Nelson owns shares in SPY, SCHG, QQQ, DIA, VOT, BITO, and IWM. Valuentum owns SPY, SCHG, QQQ, VOO, and DIA. Brian Nelson’s household owns shares in HON, DIS, HAS, NKE, and RSP. Some of the other securities written about in this article may be included in Valuentum’s simulated newsletter portfolios. Contact Valuentum for more information about its editorial policies.