Tesla: Q3 2023 Review, Musk And Co. Are Stuck In A Vicious Cycle

Summary:

• Tesla’s Q3 2023 financial performance was weaker than expected, with revenue of $23.35B and non-GAAP EPS of $0.66, missing consensus estimates.
• The company’s margins have been compressed in recent quarters due to aggressive price cuts and a shift in product mix towards lower-priced models. This negative trend continued in Q3.
• Tesla’s relative valuation (forward P/E >70x) appears completely out of whack with reality, and the stock is essentially a binary bet on the success of FSD [autonomous vehicle] technology.
• With Tesla looking stuck in a vicious pricing cycle, I suggest long-term investors to hold out for a better entry point to initiate or increase bullish positions in this counter.

Introduction

After reporting a double miss for Q3 2023, Tesla, Inc. (NASDAQ:TSLA) stock is down -3.5% to $234 per share in the after-hours session at the time of writing. Given Tesla’s recent delivery miss and series of price cuts throughout 2023, the weaker-than-expected financial performance in Q3 was unsurprising. And, in my view, Mr. Market’s negative reaction to Tesla’s earning miss is justified.

As the demand for autos has come under pressure in a rising interest rate environment, Tesla’s leadership has strategically prioritized unit volume growth at the cost of margins. Naturally, Tesla’s margins have compressed in recent quarters, and the negative trend continued in Q3 2023. With auto gross margins of ~16.1% coming in well below street estimates of ~17.6%, Tesla is seeing a sharp contraction in free cash flows, which narrowed to ~$0.8B in Q3. While Tesla is the only profitable EV maker out there, the company looks stuck in a vicious pricing cycle, and pricing/margins [profitability] could come under further pressure in upcoming quarters if interest rates remain higher for longer and the macroeconomic environment deteriorates from here.

Interestingly, Tesla’s management seems to be hanging onto their 1.8M vehicle production target for 2023 [Q4 production of >470K] and Cybertruck deliveries are on track to begin before the end of this year.

In this note, we will briefly review Tesla’s Q3 2023 report and re-examine its technical setup. Furthermore, we will take a look at Tesla’s absolute valuation (long-term risk/reward) to see if the stock is a buy, sell, or hold in the $240s.

Reviewing Tesla’s Q3 2023 Report

For Q3 2023, Tesla reported revenue of $23.35B and non-GAAP EPS of $0.66, missing consensus estimates [revenue est.: $24.14B, EPS est.: $0.73]. As I shared in my Q2 2023 earnings review:

Due to rising interest rates, big-ticket items like cars tend to get more expensive for consumers, and reduced affordability means lower demand. In order to grow volumes through this period, Tesla has opted for aggressive price cuts over the last several months. And while these price cuts have enabled Tesla to stoke demand in a rising interest rate environment, Tesla’s recession playbook is creating immense margin pressures.

In Q3, Tesla’s GAAP gross margins fell to 17.9% (vs. 18.7% in Q2 2023) [below management’s guardrail of 20%]. While lower vehicle ASPs and a shift in mix towards Model 3/Y are hurting revenues and gross profit margins (offsetting relatively strong delivery volume growth of +27% y/y), a sharp increase in operating expenses (+43% y/y) is driving a sharp contraction in operating income and free cash flow production [down -74% y/y].

During Q3 2023, Tesla delivered ~435K units (up 27% y/y) at an average selling price of $45.1K [lower than the average price of a new car in the US]. According to Tesla’s management, the EV giant is still on course to meet its 2023 vehicle production goal of 1.8M units despite producing only ~430K units in Q3 [pre-planned factory re-tooling outages].

Despite still growing vehicle deliveries at a rapid clip, Tesla’s revenue growth is decelerating rapidly and profitability is deteriorating, with operating margins nosediving in recent quarters. As of Q3 2023, Tesla’s y/y revenue growth and operating margins stood at 9% and 7.6%, respectively. And both of these key financial metrics are now below that of the average revenue growth and operating margins for S&P 500 (SPX) companies and Tesla’s automotive industry peers!

Given a sharp deceleration in revenue growth and vicious margin contraction, Tesla’s relative valuation looks completely out of whack with reality! Now, in my view, Tesla is not just a car company, but given its auto-centric revenue mix and deteriorating margin profile, one may easily assume this to be the case. Honestly, I wouldn’t be surprised if bearish investors/traders start labeling Tesla as “just another car company” in light of these disappointing Q3 earnings and call for a de-rating in TSLA to an auto stock valuation.

Despite seeing the financial logic behind this bearish argument, I continue to believe that Tesla’s reality is somewhere in between that of an auto and tech/AI company. Here’s what I have said about TSLA in the past:

While Tesla bulls may argue that TSLA deserves a premium due to faster growth at the EV giant and potential FSD-driven margin expansion, bears would contend that Tesla is a CAPEX-intensive manufacturing business with far lower profit margins compared to other big tech companies. In my view, both bulls and bears have a defensible argument.

This stance is based on my understanding of Tesla’s futuristic generalized AI offerings [FSD (autonomous driving) + Dojo (computing) + Optimus (humanoid robot)]. Yes, Tesla generates the bulk of its revenues from EV sales; however, I think there’s a non-zero chance Tesla ends up building a massive SaaS business with FSD in the long run.

Here’s what Musk said in his opening remarks during Q2 2023 earnings call:

In the long-term, autonomy we think is going to just drive volume through the ceiling next level. And our sort of future robotaxi products — dedicated robotaxi products we think have like quasi-infinite demand. The way we’re going to manufacture robotaxi is, is also itself a revolution. So, it’s revolutionary design made in a revolutionary way. It’ll be by far the highest units per hour of any vehicle production ever. So, very excited about that. With respect to Autopilot and Dojo, in order to build autonomy, we also need to train our neural net with data from millions of vehicles. The more — I mean, this has been proven over and over again. The more training data you have, the better the results. And, I mean, there are times where we see basically — in a neural net, basically it’s sort of at 1 million training examples, it barely works; at 2 million, it slightly works; at 3 million, it’s like wow, okay, we’re seeing something, but then you get like 10 million training examples, it’s like — it becomes incredible. So, there’s just no substitute for a massive amount of data. And obviously, Tesla has more vehicles on the road that are collecting this data than all of the companies combined by, I think, maybe even an order of magnitude. So, I think we might have 90% of all — or a very big number. So, the success in AI endeavors is a function of talent, sort of unique data and computing resources. And we have outstanding capabilities in all three arenas.

And I really just don’t know how anyone could do what we’re doing, even if they had our software and had our computer, if they did not have the training data. So, speaking of which, our Dojo training computer is designed to significantly reduce the cost of neural net training. It is designed to — it’s somewhat optimized for the kind of training that we need, which is a video training. So, we just see that the need for neural net training — again, talking — speaking of quasi-infinite things, is just enormous. So, I think having — we expect to use both, NVIDIA and Dojo, to be clear. But there’s — we just see demand for really vast training resources. And we think we may reach in-house neural net training capability of a 100 exaflops by the end of next year. So, to date, over 300 million miles have been driven using FSD beta. That 300 million mile number is going to seem small very quickly. It’ll soon be billions of miles, then tens of billions of miles. And FSD will go from being as good as a human to then being vastly better than a human. We see a clear path to full self-driving being 10 times safer than the average human driver, so. And between Autopilot, Dojo computer, our inference hardware in the car, which we call sort of Hardware 3, 4, but it’s really dedicated. It’s a high efficiency inference computer that’s in the car and our Optimus robot, Tesla’s clearly at the cutting edge of AI development.

Source: Tesla Stock: A Case Of Good Not Being Good Enough

As we know, Tesla has been developing each of the four main technology pillars needed to solve autonomy at scale in-house: an extremely large real-world dataset, neural net training, vehicle hardware, and vehicle software. Tesla’s vertical integration advantage is what sets it apart from competitors in the race for autonomous vehicles, and I can see Tesla’s lead expanding in the near future. In Q3, Tesla nearly doubled its compute capacity, with FSD Beta miles growing exponentially.

In the Q3 earnings call, Musk mentioned getting closer to end-to-end autonomy with FSD 12.0 and reiterated the possibility of Tesla becoming the most valuable company in the world powered by generalized AI – full self-driving (“FSD”) [autonomous driving] and humanoid robots. That said, achieving full autonomy and getting over regulatory hurdles could still be a few years out. In my mind, Tesla is turning into a binary bet on FSD due to its dangerous recession playbook (sacrificing margins to prioritize unit volumes), and Q3 2023 results served as further evidence of this stance. While FSD’s success is not guaranteed, Tesla’s future is heavily reliant on it. Hence, I’ll continue to closely monitor progress on this front over the coming weeks, months, and quarters.

As we know, Tesla is already looking into licensing deals for FSD:

We are very open to licensing our full self-driving software and hardware to other car companies. And we are already in discussions with — early discussions with major OEM about using Tesla FSD. So, we’re not trying to keep this to ourselves. We’re more than happy to license it to others.

Source: Tesla’s Q2 2023 Earnings Call Transcript

While I would prefer Tesla to build a walled garden akin to Apple (AAPL) if it solves FSD, I trust Musk and his leadership team to maximize future free cash flows for TSLA shareholders. And if they believe licensing FSD is the right approach, I would make peace with that strategy. Any announcements on this front could have a significant impact on Tesla’s stock, which looks primed for a massive move.

TSLA’s Technical And Quant Rating Analysis

In Tesla Stock: A $100 Move Is Imminent, I shared a cautiously bearish stance for TSLA with the stock trading at ~$270 at the time:

The bull-bear debate around Tesla being a technology or an auto company continues to rage on, with TSLA’s price action getting tighter and tighter in a triangle formation marked in the chart below –

Here are the two potential paths I see for Tesla:

1) An upside breakout above the $280-300 resistance zone could confirm the bullish “Inverse Head & Shoulders” pattern marked on the chart below:

The price objective of this bullish “Inverse H&S” pattern is ~$360, and if TSLA can retain bullish momentum, it can easily extend to new all-time highs above ~$400. In my view, a rise in daily RSI and MACD indicators since mid-August supports an upside breakout. TSLA stock is not overbought, and with 50-DMA well above 200-DMA, technical momentum is still looking strong here.

2) Conversely, a rejection at current levels or the $280-300 resistance zone could easily send Tesla shares tumbling back down to the $240 (neckline) level. And a breakdown of this level would confirm the bearish “Head & Shoulders” pattern marked on the chart below:

The price target of this bearish “H&S” pattern is ~$180, which coincidentally happens to be my fair value for Tesla. Negative divergence on daily RSI and MACD indicators since June supports a downside breakdown. As of today, both of these patterns are still in play, and Tesla stock could move ~$100 in either direction (up or down) when it breaks out of the massive triangle formed on its chart.

From a technical perspective, TSLA stock is still stuck in no man’s land in the $215 to $280 range, with risk/reward being finely poised at current levels. Given the triangle formation, Tesla stock could break out to the upside or break down to the downside in the near future. Either outcome is possible, but we can be sure that it’ll be a big move!

As of now, I would avoid taking any new near-to-medium-term position in Tesla shares. However, if I had to take a position, it would be on the short side with a tight stop-loss. So, this hypothetical position would be “Short Tesla at $270 (downside target: $180-200, reward: $70-100), with a stop-loss at $305 (risk: $35)”.

My rationale for having a cautiously bearish stance is quite simple:

• Tesla’s sales growth is decelerating and margins are contracting amid a tough macroeconomic environment. With interest rates likely to remain higher for longer, and auto loan delinquencies on the rise, I expect auto prices to come under further pressure in the foreseeable future. While Tesla is leading the auto industry’s price-cutting exercise, such rapid margin deterioration is never ideal.
• Given Musk’s recessionary playbook (prioritizing sales over profits), Tesla is essentially a binary bet on FSD achieving full autonomy (which may or may not happen).
• At >70x forward P/E, Tesla carries a demanding valuation. According to TQI’s Valuation Model, Tesla remains overvalued:

• As per my model, Tesla’s intrinsic value is ~$180 per share. With the stock trading at ~$270 per share, it is currently overvalued by ~30-35%. Now, I am happy to pay a premium for a high-quality company like Tesla; however, the risk/reward isn’t attractive enough to justify an investment here.

• Assuming a base case P/FCF exit multiple of 25x, I see Tesla hitting $436 per share by 2027. As can be seen below, Tesla is projected to deliver CAGR returns of ~10.5% for the next five years, which falls well short of my investment hurdle rate (min. required IRR) of 15%.

With all of this said, I am not forced to take a new position in Tesla stock. Also, I don’t short individual names ever, so establishing a short position in Tesla is not even a contemplation for me.

From a long-term risk/reward perspective, one might argue that buying Tesla with an expected CAGR return of ~10% is fine. And maybe it is fine for some investors; however, I am laser-focused on long-term risk/reward, and TSLA failing to meet my investment hurdle rate of 15% renders it a “Hold” for me at current levels.

As you may know, I hold a long position in Tesla [accumulated in late 2022: Tesla Stock: An Asymmetric Buying Opportunity Arises Out Of Insider Selling, Demand Concerns, And A Scary Recession Playbook]. And as of now, my plan of action for Tesla hasn’t changed:

• If we see a quick move to the $360-400 range, I will book partial profits on my long position.
• Conversely, if we drop down to $180, I will restart accumulation and add to my long position.

Source: Tesla Stock: A Case Of Good Not Being Good Enough

Key Takeaway: I continue to rate Tesla “Neutral/Hold” at ~$270 per share.

Source: Tesla Stock: A $100 Move Is Imminent (September 2023)

As of today, Tesla stock remains stuck smack in the middle of the $215 to $280 no man’s land, with the price action getting tighter. As I see it, Tesla is a coiled spring ready to break in either direction:

If TSLA regains the $280 level quickly and then manages to break above the recent high of ~$300, I can see a run-up to the $360-400 zone. On the flip side, a breakdown below $215 would open up a move down to the mid $100s. With the risk/reward finely balanced (100-140 points up and ~60-100 points down), I fail to see any high conviction near to medium-term trade here.

And SA’s Quant Rating system agrees with this neutral stance:

Over the last six months, Tesla’s “Momentum” factor grade has improved from “B- to A+” on the back of an epic rally in the stock. While TSLA’s “Profitability” factor grade has held up firmly at “A+” (despite margin deterioration), the weakness in financial performance is driving “Growth” and (earnings) “Revisions” grades lower. Overall, Tesla is rated a ‘Hold’ [3.44/5] by SA’s Quant Rating system.

Given Tesla’s precarious technical setup and unsupportive quant factor grades, the near-term risk/reward for TSLA stock is not enticing enough for a new bullish position. However, is Tesla a good buy from a long-term perspective? Let’s get an answer using TQI’s Valuation Model.

Is TSLA Stock A Buy, Sell, Or Hold?

Despite Q3 2023 results coming in lower than street estimates, I am sticking to my pre-earnings assumptions for Tesla. And as such, there’s no change to our fair value estimate for the EV giant.

Here’s my updated valuation for Tesla:

According to our model, Tesla’s fair value is ~$180 per share. With the stock trading at ~$234 per share (as of writing), it is currently overvalued by ~23%. Now, I am happy to pay a premium for a high-quality company like Tesla; however, is the risk/reward attractive enough to justify an investment at current levels?

Assuming a base case P/FCF exit multiple of 25x, I see Tesla hitting $436 per share by 2027-28. As can be seen below, Tesla is projected to deliver CAGR returns of 13.25% for the next five years, which falls short of my investment hurdle rate (min. required IRR) of 15%. From a long-term risk/reward perspective, I continue to rate Tesla “Neutral/Hold” at current levels.

Concluding Thoughts

With higher interest rates (low affordability) the demand for new autos is waning, and Tesla is clearly feeling the heat, with revenue growth decelerating rapidly and margins contracting significantly in Q3 2023.

As of today, Tesla is still primarily an auto business, and despite experiencing (self-inflicted) margin pressures, Tesla is on track to hit management’s ~1.8M vehicle sales target for 2023. As Tesla’s factories in Berlin and Austin ramp up to full production, margin pressures should ease off somewhat. And newer products like Tesla Semi and Cybertruck would likely allow further scaling of Tesla’s auto business in 2024.

A sub-$25K vehicle is likely needed for Tesla to unlock the next big leg up in its auto market share, and as we know, the company is already working on its next-gen platform to build such a vehicle. Tesla has already announced a factory in Mexico [delayed / slowed as of Q3 2023 until macro environment improves], and there’s talk of another factory to be built in India for a $24K car. Despite suffering margin compression, Tesla is growing its market share across geographies and expanding its fleet size at a brisk pace in a challenging macroeconomic environment.

Overall, Tesla Q3 2023 results were weaker-than-expected and the stock is likely to come under pressure in upcoming days and weeks. Given Musk’s recession playbook of prioritizing vehicle sales over profitability and the upcoming Cybertruck launch (and subsequent ramp), Tesla’s margins are likely to stay under pressure in the near to medium term. Now, despite facing margin compression, Tesla is still generating positive free cash flow (“FCF”) and adding to its growing cash hoard of ~$26B, which should serve as a strong foundation for navigating through any economic downturn that may lie ahead of us.

From a technical perspective, Tesla is primed for a significant move in either direction as price action gets tighter in a triangle formation. From a valuation perspective, Tesla looks overvalued by ~25%, and at this point, TSLA is a binary bet on FSD.

In light of Q3 2023 earnings, my plan of action for Tesla remains unchanged:

• If we see a quick move to the $360-400 range, I will book partial profits on my long position.
• Conversely, if we drop down to $180, I will restart accumulation and add to my long position.

Key Takeaway: I continue to rate Tesla “Neutral/Hold” in the $230s.

Thank you for reading, and happy investing. If you have any questions, thoughts, and/or concerns, please share them in the comments section below.

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Analyst’s Disclosure: I/we have a beneficial long position in the shares of TSLA either through stock ownership, options, or other derivatives. 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.

Seeking Alpha’s Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.

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