Tesla: At A Crossroads

Summary:

• Tesla, Inc. is encountering unprecedented business challenges.
• With the EV industry approaching maturity, competition is intensifying, customer demand is declining, and substitutes are becoming popular.
• Tesla has responded by doubling down on the EV pricing war it initiated in late 2022.
• In addition, the firm appears to be accelerating the development of its FSD platform and the launch of its Robotaxi service.
• We remain Bullish on Tesla, Inc. shares. Reiterate $492/share Price Target and Buy Rating.

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Investment Conclusion

It is not Tesla, Inc.’s (NASDAQ:TSLA) world anymore. The company is encountering its most intense competition ever. Customer demand for electric vehicles (EVs) in key markets is declining. In addition, hybrids and plug-in electric vehicles are gaining traction.

However, TSLA’s response to the challenges is fitting. The firm, supported by the low-cost structure associated with its EV operations, is doubling down on the EV pricing war it initiated in late 2022. It slashed prices of its 2024 Model Y to below that of internal combustible engine (ICE) vehicles and has made available its updated 2024 Model 3 on lease for $299/month. Across the board, following the release of 1Q24 financial results, TSLA reduced prices of its EVs in the U.S., China, and Europe. In addition, the firm’s economy EV dubbed Model 2 with a driving range of 300 miles and a price tag of $25K is expected to be launched in a couple of years.

Further, in our opinion, the break-neck speed at which updates to TSLA’s full self-driving (FSD) version 12 are being released, a fully automatic, low-cost Tesla that can drive itself is not far away from being introduced. Moreover, we believe that TSLA because it anticipates solving FSD over the near to medium term, is debuting its Robotaxi EV in August. We believe that given the type of technology the firm’s FSD is based on, TSLA is likely to dominate what thought leaders project will be an $8 trillion autonomous taxi market in America.

Overall, TSLA is shifting towards becoming a provider of low price autonomous EVs. In addition, in our assessment, the strategy is to generate a significant fraction of its earnings from its high margin FSD platform. Further, considering that TSLA’s FSD system is controlled by end-to-end neural networks, once fully functional, FSD assisted Teslas can drive themselves anywhere in the world. Therefore, we anticipate solid demand for Tesla smart cars, once Teslas are fitted with the final version of FSD. With expected tens of millions of Teslas on the road eventually, the FSD system is poised to become a cash cow, for TSLA.

The above is all about TSLA’s automobile business. However, TSLA is more than a car company. The firm’s business includes a profitable and growing battery storage platform, and its humanoid robot, Optimus, which is under development. Both segments are likely to generate strong long-term earnings for TSLA. Overall, although the TSLA story has shifted, the company’s potential appears better today than it did over the prior year. Therefore, we are maintaining our $492/share Price Target, which incorporates a 10-year normalized revenue growth rate of 50%, a profit margin of 10%, operating cash flow margin of 18%, annual capital expenditures of 2%, average cost of capital of 7%, and a perpetual growth rate of 3%. Reiterate Buy Rating.

Investment Thesis

Although the majority of EVs sold in 1Q24 were Teslas, at ~387K, while BYD and Volkswagen accounted for ~300K and ~136K of the volume mix, on a year-over-year basis, TSLA’s Model 3 and Model Y deliveries declined by 10%, production decreased by 2%, and revenues declined by 13%, during the period. In addition, TSLA’s EV industry market share fell to 51% in 1Q24 from 62% in 1Q23. The company associated the downturn with seasonality, macroeconomic pressures, the Red Sea attacks, and a slower than demand ramp in production of the updated Model 3 and Cybertruck.

However, in our judgment, the predominant elements that reflected in the slowdown in TSLA’s automobile business in 1Q24, were the declining demand for battery electric vehicles (BEVs) in the U.S., China, and Europe. Regarding customer demand, year-over-year EV sales growth associated with the U.S., China, and Europe during the first came in at 2.6%, 14.7%, and 1.6%, significantly below growth levels witnessed during similar periods, over prior years. Domestically, on a sequential basis, EV sales declined by 15.2%.

In the European EV market, the low growth in EV sales is likely a long-term phenomenon, as we believe that folks that were inclined to purchase an EV have already bought one. Regarding the Chinese EV market, we anticipate that as the runaway sales growth in EVs over the recent few years gets absorbed over upcoming quarters, a strong rebound in EV deliveries is likely. In the context of the U.S., in our opinion, the easily achievable goals of two car families that deploy their EVs for about town rides and their ICE cars for road trips, has been captured. The addressable market has shifted towards the median income, single car owner, whether urban or suburban, who is focused on the prices of EVs, the average range of EVs, and out-of-the-city battery charging infrastructure. Consequently, the premium pricing associated with most medium range EVs, and limited density of battery charging stations, beyond city limits are gating factors for EV sales, in the country.

Consequently, during 1Q24, in the U.S., hybrid EVs, and PHEVs, which utilize both gasoline and electric batteries, to provide greater fuel efficiency, and lower emissions, experienced a growth of 46% and 70%. Similarly, in China, sales growth associated with hybrids and PHEVs, outstripped that of BEVs, during 1Q24. Net-net EV substitutes are becoming increasingly appealing to EV customers. Both hybrid EVs and PHEVs, are fitted with ICE engines. However, PHEVs which need to be plugged-in to recharge the electric battery, have two fuel flaps, one each for petrol and electric power. PHEVs provide a driving range of between 20 and 50 miles, on a single charge. Hybrid EVs are 100% gasoline fueled. The electric battery in a hybrid EV recharges by the energy produced due to the pressing of the vehicle’s brake. As propulsion is divided between petrol and electric power, the hybrid is called an EV. However, the only fuel utilized is gasoline.

Toyota (TM) introduced EV hybrids ~25 years ago, with the Prius. Benefiting from the cooling customer interest in BEVs, during FY23, the firm sold ~3.4 million hybrid EVs, including a significant volume of hybrid EVs associated with its Lexus luxury brand. In addition, driven by growing customer demand, Ford’s (F) hybrid EV sales increased by 36% in 1Q24, compared to 1Q23. Further, over the last twelve months, the company managed to sell 400K hybrid EVs. Separately, General Motors (GM) debuted its PHEV models, the Buick GL8, and the Equinox, at the Beijing Auto Show, earlier this year.

Overall, despite the recent popularity of hybrid EVs and PHEVs, we believe that customer demand for BEVs will surge, as less expensive models with reasonable driving ranges are introduced, and battery charging infrastructure supported by government incentives and policies, is sufficiently available across America.

Concerning increasing competition thwarting sales of Teslas, it is notable that although the challengers are as never before ramping on EV production and substantially improving margins on their EV business based on improvements in scale, commodity pricing, and volume mix, their EV production and delivery figures are diminutive compared to that of TSLA. Nevertheless, a considerable number of new EV models from competitors are expected to debut in 2024.

GM is opting to focus on luxury EVs, typically larger long-range vehicles with premium features and functionality. The strategy is driven by the company’s assumption that luxury EVs are likely to evidence higher customer adoption and resiliency versus the broader EV market. Accordingly, GM is scheduled to launch several luxury EVs in 2024, including the long-range Chevrolet Equinox in 2Q24, and the Cadillac OPTIQ and Cadillac Escalade in 2H24. In addition, over the same period, the company indicated plans to debut more affordable trim series for its Chevrolet: Equinox EV, the Blazer EV, and the Silverado EV. It is notable that GM’s long-range luxury pick-up trucks, the GMC Sierra EV Denali, and the Chevrolet Silverado EV RST, are highly anticipated launches in the segment.

Overall, based on projections provided by the firm, despite the ramp in EV production, GM is expected to manufacture a measly 200K to 300K EVs over 2024.

Stellantis (STLA) has indicated plans to launch 18 new and updated BEVs in 2024, including its economy EV, Citroen ec3 and several C segment BEVs, such as the high-performance long-range Peugeot E3008, with a range of up to 700 miles on a single charge. In addition, the company, is preparing to introduce a top-tier EV version of its RAM REV in the BEV truck segment. Cumulatively, STLA is targeting the introduction of 25 new vehicle models in 2024, 18 of which will include EV versions. Overall, it appears, that the firm uncertain about customer propulsion choice is hedging its bets and introducing sufficient new and updated models of EVs and ICE vehicles. In regard to STLA it is noteworthy that the company has a significant presence in the commercial EV segment, accounting for 33% of the market in the category.

Although F’s EV market share increased 3.4% to 7.5% over 1Q24, the firm is cutting back on its EV plans in response to the global decline in BEV sales growth in 1Q24, as well as margin pressure associated with the ongoing pricing war afflicting the segment. Given that decreasing the price of its Mustang Mach-E EV by 17% reflected in a 141% increase in sales volume, F indicated plans to introduce smaller economy BEVs, typically addressing urban markets.

Even though Toyota previously announced plans to develop a significant presence in the BEV segment, BEVs accounted for ~1% of the company’s global sales in FY23, with 117K BEVs delivered, considerably below the target of 202K vehicles. Consistent with its typical focus on hybrid EVs rather than BEVs, T expects to deliver 171K BEVs in FY24

TSLA’s response to the declining customer demand, the growing popularity of substitutes, and intensifying competition is a continuing pricing war. Following the release of its 1Q24 financial results, the firm reduced prices of Teslas in the U.S., China, and Europe. In the U.S., its updated Model 3 with a range of 341 miles is available for lease for $299/month (MSRP is $39K). It is important to note that given its mileage of 25.3 kWh/100 miles versus the Mustang Mach-E’s 32.7 kWh/100 miles, Model 3 is the most efficient dual motor EV in the price range. In addition, TSLA decreased the price of its 2024 Model Y SUV with a range of 310 miles to $29K.

Comparable BEV models include the BMW i4 with a range of 307 miles, priced at $52K, the Fiat 500e with a range of 149 miles, tagged at $34K, the Volkswagen ID.4 with a range of 275 miles coming in at $39K, and the Mustang Mach-E with a range of 310 miles with a MSRP of $43K. Regarding PHEVs, Kia Sportage with an electric range of 34 miles and MPG of 35 miles is priced at $40K, the Volvo Luxury PHEV with an electric range of 40 miles and MPG of 31 miles, comes in at $52K. With respect to hybrid EVs, the Toyota Camry with an MPG of 52 miles is priced at $29K, the Hyundai Tucson with a 38 miles MPG is tagged at $33K, and the Lexus luxury hybrid with an MPG of 39 miles comes at a MSRP of $43K. ICE car options priced at between 20K and 25K include the Honda Civic, the Toyota Corolla, the Kia Forte, the Hyundai Asante, and the Nissan Sentra.

Comparably, at a MSRP of $29K, the 2024 Tesla Model Y, with the IRA tax credit of $7,500 comes in at $22K, which is at parity with lower priced ICE vehicles and significantly below PHEV and hybrid EV prices. Given, the low-cost structure associated with Teslas, due to innovation related to powertrains, drive units, battery production, thermal systems, interior components, and LV controllers, TSLA believes it can remain cash flow positive, even it decides to further intensify the EV pricing war.

In addition, TSLA intends to ramp on production of its Model 2 economy EV in late 2024 or early 2025. The compact EV is expected to have a range of 300 miles and an MSRP of $25K. The company has indicated that production will begin at its current manufacturing facilities in Fremont, Austin, Berlin, and Shanghai. Further, we expect additional production of Model 2 to unfold at the Mexico factory, once the facility is functional. Considering that the Mexico factory is possibly integrating the unboxed manufacturing method, which underpins a 40% reduction in footprint size, and considering a potential 50% lower cost/unit relative to the Model 3/Y due to innovations in subsystems, margins associated with Model 2s produced at the plant are likely to be higher, compared to those assembled at the firm’s alternate facilities. Overall, despite the relatively less expensive MSRP on the Model 2, margins associated with the model are unlikely to be compromised.

Further, TSLA is accelerating production of its FSD platform. Updates to FSD version 12 are being released rapidly, since the end of March, when the software’s status advanced to supervised from Beta, following the shift controlling the application to end-to-end neural networks from computer programs. FSD is the most recent version of TSLA’s Autopilot, which is included in every Tesla, and supports self-parking, lane changes, and traffic navigation. In the U.S., distribution of FSD version 12.3.6 is underway. In China, following approval by Chinese authorities and an agreement with Baidu that will provide TSLA with high-resolution maps of roads in the nation, the roll-out of the most recent FSD version on Teslas in China is expected shortly.

Considering that TSLA halved its FSD subscription price in the U.S. and Canada to $99/month, and reduced the outright purchase price of the application to $8,000 from the prior 12,000, FSD miles for neural network training are likely to come in fast and furious. Additional FSD miles growth will be derived from the rapidly advancing global fleet of Teslas, which is estimated to advance from six million at the end of March to seven and a half million by YE24. This dramatic acceleration in FSD miles utilized for neural network training will intensify the development of the FSD software, in our assessment.

The opportunity for monetization of TSLA’s FSD platform goes beyond simply Teslas. Considering that the software can be integrated with original equipment manufacturer vehicles easily by deploying only FSD platform-specific cameras and inference computers, we believe there is likely to be substantial uptake of TSLA’s FSD software by vehicle manufacturers seeking to turn their product into smart cars.

In addition, TSLA has indicated that it plans to operate an autonomous taxi network once its FSD software is fully functional. The Robotaxi service will deploy TSLA’s own Robotaxi models and permit Tesla owners to add their autonomous Teslas to the service when their vehicles are not being utilized. Given that TSLA’s FSD application is based on neural net training not mapping technology, Teslas fitted with the software, can drive themselves anywhere in the world with few adjustments for local driving customs. Therefore, the addressable market for TSLA’s Robotaxi network is global. In the U.S., data demonstrates that the autonomous taxi industry could potentially derive trillions in revenues by 2030. Considering that the scope of autonomous taxi services currently operating domestically is limited owing to their reliance on expensive mapping technology, while Teslas will be equipped to drive themselves anywhere in the world, TSLA appears well positioned to dominate the Robotaxi market.

Overall, although TSLA’s alternate current and potential businesses appear appealing regarding earnings potential, it would be erroneous to conclude that TSLA’s automobile segment’s best days are behind it.

Bottom Line

With the shift of control for TSLA’s FSD platform to end-to-end neural networks, a fully functional FSD application appears more likely to turn into reality than ever before. When that reality sets in, TSLA’s vision to drive most of its earnings by monetizing its FSD platform, will come to fruition. The company’s battery storage business, and the potential Robotaxi service, and the Optimus humanoid robot will provide additional earnings backup.

Nevertheless, considering that TSLA’s long-term earnings strategy is dependent on its FSD system, investors with a considerable time horizon, that are skeptical that the firm will solve FSD should not purchase TSLA shares. For all others, TSLA appears to be a low-risk high-growth asset likely to generate asymmetrical returns over the long term. At current levels, Tesla, Inc.’s shares are a steal. Buy, Buy, Buy.

Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.

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Analyst’s 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.

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