‘There Are Some Horses’: Maintaining Tesla With A Buy

Summary:

• I’m maintaining Tesla with a buy for mid-term investors after 3Q24 earnings made the stock close 22% higher on Thursday.
• GAAP gross margin impressed at 19.8%, significantly above consensus, marking the second consecutive margin expansion after six quarters of decline.
• Management forecasts vehicle production to increase by 20%-30% in 2025, and Cybercab production to dramatically increase by 2026.
• I think the company is better positioned to benefit from its longer-term secular tailwinds, and that includes global EV adoption, a more friendly interest rate environment, and U.S. backing.
• I hereon share my positive sentiment on Tesla and why I see more upside into FY25.

Investment thesis:

Tesla (NASDAQ:TSLA) (NEOE:TSLA:CA) stock closed 22% higher for the day. It rallied 11% before the bell Thursday after the company reported 3Q24 earnings the evening before, with revenue up 7.8% year-over-year to $25.18 billion and EPS at $0.72, above the consensus of $0.60. I think what really impressed investors is the GAAP gross margin at 19.8%, significantly over the consensus of 16.8%, accounting for the second consecutive gross margin expansion after declining for 6 quarters straight. I last wrote on Tesla before the call, when CEO Elon Musk said the record quarter was accompanied by the production of its 7th million vehicle.

On that note, management forecasts vehicle production to increase by 20%-30% in 2025, and Cybercab production should dramatically increase by 2026. With the stock surge, Tesla has added more in market cap than the market caps of General Motors (GM) and Ford Motor (F) combined and is now the 12th most valuable company in the U.S., surpassing Broadcom (AVGO), Walmart (WMT), and JPMorgan Chase (JPM). On the call, Elon shaded Waymo and made the following distinction: “Waymo’s entire fleet is less than – they’ve less than a 1,000 cars. We make 35,000 a week.”

I’ll be honest: After the miss on the recent Robotaxi event, investor confidence was low, and I think that’s part of why the stock experienced that dramatic increase. I am maintaining my buy on Tesla, and the earnings report only furthers my positive sentiment on the company. In my last call, I anticipated that either the Robotaxi event or the Q3 earning results would boost the stock. While the first didn’t play out, this week proved that the second did. The results had a staggering positive influence on investor confidence.

I am maintaining my thesis for the mid-term, which states:

I’m writing on Tesla with two things in mind that make Tesla a mid-term outperform, in my opinion. The first is the company’s longer-term secular tailwinds involving global EV adoption and a better rate environment materializing for 2025. The second is more of a regulatory factor, which involves the U.S. government backing American EVs over Chinese ones.

Earnings rundown:

In my last note, I talked about total GAAP gross margins, as they’re a vital reflection of general profitability in relation to the cost of production. I expected 3Q24 “gross margins will beat year over year due to the easier year-over-year comparison from 2H23 as gross margin started declining in 3Q23,” and not only was it up year over year but also quarter over quarter. Below is the same chart from my last article, showing the improved margins with respect to total deliveries and total production.

	2Q23	3Q23	4Q23	1Q24	2Q24	3Q24
Total deliveries	466,140	435,059	484,507	386,810	443,956	462,890
Total productions	479,700	430,488	494,989	433,371	410,831	469,796
Total GAAP gross margin	18.2%	17.9%	17.6%	17.4%	18.0%	19.8%

Click to enlarge

Total revenue increased 8% year over year in the quarter to $25.2 billion, and that’s a reflection of several things. 1. Growth in vehicle deliveries to 462,890, 2. Growth in energy generation and storage is 52% year over year at $2,376 million, 3. Growth in Services and other revenue was 29% year over year at $2,790 million, among other things.

Regarding profitability, operating income increased year over year to $2.7 billion, backing up a 10% increase in operating margin. The operating income was a reflection of several factors, most importantly of which is the lower cost per vehicle, including “lower raw material costs, freight and duties and other one-time charges.” This also showed in operating expenses, down 6% year over year to $2,280 million, and income from operations, up 54% year over year to $2,717 million. Free cash flow increased 233% year over year to $2,742 million, and net cash provided by operating activities was up 89% year over year to $6,255 million.

Valuation:

I am taking the same approach with this valuation as with my last, and I’m pinning Tesla against the large-cap peer group, aka industry leaders. According to data from Refinitiv, Tesla’s EV/Sales ratio for C2024 is up from 7.5 two weeks ago in my last article to 8.1, higher than the peer group average of 7.6. I think Tesla is still fairly valued at current levels, according to data I’ve gathered on Refinitiv. I continue to think that with the rate cuts underway, macro headwinds should also ease into 2025, and consumer spending on luxury should rebound. The P/E ratio is now significantly lower than it was weeks ago. On my last note, the P/E ratio was 106, and now it’s slightly up to 107.9. The market sentiment is cautiously positive, which is fair. Over 13% of Street analysts give the stock a strong buy, and over 26% give it a buy. Around 35.8% of Street analysts are on the sidelines and give the stock a hold, with 17% as a sell and only 7.5% as a strong sell.

I think Tesla’s market sentiment perfectly reflects the stock movement over the last few months, too. The PT median for late July was $215.8 and surged to $220 in August. It maintained an upward trend slightly through September at $220.5 and now stands at $221. The PT mean also maintained the same upward trajectory at $205.9 in July, up to $208.1 in August, $210.6 in September, and $213.7 currently. I continue to think that Tesla is undervalued as an auto company, and that its focus on affordability gives it more of a perk over its Chinese competitors.

What’s next: Affordability & its risks

The cost of goods sold per vehicle is down to its lowest level ever and is now at ~35,100. Tesla is now more focused on affordability and is on track to deliver cheaper models, straying early next year. In my opinion, the reduced costs really should get more attention because it’s interesting how Elon brought those numbers down. I think Elon explained it best. On the earnings call, he expressed frustration about not having movies about heroes who got 20% of the cost of the car. And I agree. There should be. And maybe Tesla is our next hero. Q3 witnessed the lowest cost per micro; according to management, that is a trend they’re focusing on.

But if there’s one thing we all know about the process of squeezing costs out of a car, let alone an EV, it’s that there is a certain level of difficulty. From deleting parts and getting the cost out of things, Elon said it’s like

game of thrones but pennies. First approximation, if you’ve got if you’ve got 10,000 items, in a car, very rough approximation, and each of them cost $4, then you have a $40,000 car. So if you want to make a $35,000 car, you’re going to get $0.50 on average out of the 10,000 items.

Further rate cuts should help with demand growth next year. I expect that to show on Tesla’s top line in 2025, but not before then. In Q3, automotive margins improved quarter over quarter, reflecting growing volume in production and delivery for the quarter and a big chunk of deliveries being localized, thus resulting in lower freight and duties. I think expecting the company to sustain the margins in Q4 would be asking for a lot, especially with the management of deployment and inventory. Q3 witnessed a decline in deployment, but Q4 is expecting sequential growth, and management is forecasting to end the year with more than double that of last year.

There’s a lot of promise in Tesla, but I don’t think it’ll necessarily be a straight lineup for the stock. I think it’s going to be a bumpy road instead while the company works to sustain the jaw-dropping results it reported this quarter, to keep up with competition coming out of China, and get all the government approval for its autonomous taxi plans. I also am buy-rated on NIO (NIO) and BYD (OTCPK:BYDDF) and think they’ll share in the EV market growth and could pressure Tesla. Since investor confidence in Tesla is back, there are going to be heavy expectations for Elon to really build the vision for the future that he pitched and hit the growth numbers he mentioned. I think Tesla is going to be able to navigate the Chinese competition while trying to build the (affordable) future of autonomy. So, I continue to be optimistic about Tesla for the mid to long term.

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