Tesla Stock: Reiterating Strong Buy

Summary:

• In spite of its Q1 earnings miss, Tesla, Inc. continues to break its own records, and the company’s automotive models are becoming bestsellers across the globe.
• I see Tesla’s price war as a mighty weapon to unlock long-term sustainable cash inflows.
• My valuation analysis suggests Tesla stock is still massively undervalued.

Investment thesis

I shared my initial bullish analysis on the Tesla, Inc. (NASDAQ:TSLA) stock two months ago. The stock has underperformed the broad market since then, delivering a 7.72% decline compared to more than 5% growth for the S&P 500 Index (SP500).

The company faces headwinds due to the current harsh macro environment, but I am convinced they are temporary and not secular. In my new article, I analyze recent developments and update my valuation analysis to explain why I am increasing my position in the stock. TSLA stock is attractively valued, and Tesla has the strongest position among all automakers, both legacy (“ICE”) and electric vehicle (“EV”), to weather the current storm in the broad environment.

Recent developments

Let me start with the latest earnings, released on April 19, 2023. The company delivered a tiny miss in revenue and EPS, and TSLA stock responded with a more than 8% decline after the earnings release. The miss was ridiculously small, so the market overreacted, in my opinion.

Revenue increased 24% YoY and declined about 4% sequentially. Earnings showed a YoY decline sequentially due to weaker gross margin performance as the company addressed decelerating demand growth with discounts. I see discounts as an intelligent move by Tesla management, especially given the company’s strong pricing power thanks to best-in-class profitability metrics.

If we dig deeper into pricing power, I would also like to underline that Tesla is the only company with a net cash position, compared to major automakers with the strongest liquidity position.

For me, it is apparent that competitors cannot win in the price war initiated by Tesla if they do not want to go bankrupt. Thus, it is highly likely that Tesla will increase market share during this macro turmoil at competitors’ expense. If we consider the EV business nature, increasing sales and market share for Tesla is the most important, in my opinion. First, the company is aggressively ramping up production with long-term investments in CAPEX, so it is a long play to where the market leader will take it all. Second, the nature of EVs gives the company cross-selling opportunities like new software or superchargers. It is not just about getting profit from selling a durable product to customers. Still, it is about creating a base to unlock additional sustainable and forecastable sources of income apart from automotive sales. Thus, I am very positive about Tesla’s management decision to sacrifice margins over the short term to sustain more earnings potential over the long term.

There are signs that discounts are working well. For example, Model Y became Europe’s best-selling car in Q1 2023, according to Fleetnews. Model Y is also number one this year in Germany, looking at April’s normalized trailing quarter. Model 3 is very close to the top-3 in Germany, by the way.

We also have fresh April sales data from Australia, the world’s 13th-largest economy by GDP. Tesla continues to dominate the Australian EV market, selling more cars in the first 4 months of 2023 than during the whole of 2021.

For the full 2023, Elon Musk reiterated the target to deliver 1.8 vehicles, with a best-case scenario of 2 million, which represents almost 40% growth compared to 2022. Other important information from the Q1 earnings call regarding the automotive segment included plans to conduct a delivery event for Cybertruck during Q3 2023. According to Gary Black, Cybertruck can help Tesla to overperform in terms of base case deliveries goal to achieve total of 1.9 million vehicle deliveries in 2023. That can be the case, especially given an amazingly large backlog for the Cybertruck.

Other segments demonstrated impressive growth YoY, though Energy and Services segment sales represented less than 15% of total quarterly sales.

What I would like to underline is that Energy Generation and Storage segment sales increased 148% YoY, reflecting stronger Powerwall and Megapack deployments. During the earnings call, management said that demand outweighs production capacity. According to Elon Musk, Tesla is now boosting production at a dedicated Megapack factory to help meet the increased demand.

What also has improved my optimism in recent developments is the release regarding the new Twitter CEO. It means that Elon Musk will step down as Twitter’s boss and will now have more capacity to involve himself in Tesla’s business. For me, as an investor, it is a positive sign.

Yesterday, on May 16, Tesla conducted its annual general meeting with shareholders, where Elon Musk shared the future prospects of the company. For me, the most important was the piece of information regarding the Full-Self Driving [FSD] developments. According to the CEO, the software is “getting close to where it’s safer than human driving” and reiterated his expectations that the system should be ready during 2023.

Overall, I am quite positive about recent developments for Tesla, especially the way the company addresses current headwinds without sacrificing long-term goals and strategy

Valuation update

A lot has happened since my previous valuation analysis was conducted. Therefore I need to update it with more reasonable assumptions. First, for WACC, this time, I use 11%, which is the highest point of the range provided by valueinvesting.io. Second, given the challenging environment and Tesla’s discounts to address slowing demand, I revise free cash flow (“FCF”) estimates to be more conservative. For FCF margin, I use 3.25%, which is FY 2022 levered FCF less stock-based compensation (“SBC”). And I also use revised consensus revenue estimates which project a 21% CAGR over the next decade, one percentage point lower than earlier. I expect the FCF margin to expand one percentage point per year between 2023 and 2025 and to accelerate to 150 basis points for the years beyond as the tough macro environment will ease.

As we can see, after incorporating all assumptions into the model, TSLA stock is massively undervalued, with tremendous upside potential. But I would like to simulate an additional scenario with a less favorable revenue growth rate and other assumptions remaining unchanged. There are different forecasts on the overall EV market growth rate till 2030, but I prefer to use a more conservative 17.3% CAGR provided by vantagemarketresearch.com and round it down to 16% to be on the safer side.

As you can see, even under a much more pessimistic revenue growth trajectory, the stock has substantial upside potential. If you would like to know the “break-even” growth rate where NPV becomes close to zero, it would be 13.1% CAGR, according to my valuation model.

I am highly convinced that 13.1% CAGR is doable for Tesla, given the secular global shift to EV, where the company is a leader with a strong brand and customer loyalty. Thus, I believe that the margin of safety is vast here.

Also, if we look from a valuation ratios standpoint, we can see that current multiples are much lower than 5-year averages, which for me, also suggests undervaluation.

Risks update

As we have seen, Tesla has vast pricing power to address weakening demand due to challenges in the macroenvironment, including probable recession for most of the developed economies, which are the most aggressive EV adopters. But there is rather high uncertainty in terms of the extent and severity of the recession. I am confident that Tesla will weather the storm, but broader conditions will affect its revenue growth and margins expansion pace. These metrics, in turn, will directly affect valuations, meaning that the tougher the recession will be, the longer it will take Tesla to achieve its long-term goals.

The possible global credit crunch also poses additional risks for Tesla. With fewer credits and loans available for vehicle buyers demand will continue to soften. A vehicle is a durable good that is usually financed by either loan or lease. With higher base rates from central banks, all financial services become much more expensive for consumers, including loans/leases and insurance as well. The chronological length of the credit crunch together with the probable recession should significantly affect Tesla’s growth prospects.

Bottom line

Overall, I reiterate my strong buy thesis for Tesla, Inc. stock. The company apparently faces multiple headwinds in the current broad reality, but Tesla has everything to weather the storm, including unmatched pricing power together with the solid balance sheet. My valuation analysis suggests TSLA stock has massive upside potential and it is the reason I am adding Tesla to my portfolio at current levels. Risks are in place, but I believe that the potential Tesla, Inc. upside outweighs them by far.

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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.

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