Tesla (TSLA) again, with fewer numbers plucked out of the air

I got a comment from Russ about my recent TSLA post, in which I concluded that a ton of future growth is already priced into the stock. The gist of his comment is that earnings could be a lot higher than I’ve been assuming. What powers a conventional car is an internal combustion engine–an expensive machine spewed out of large-scale factories that need to operate at close to capacity just to break even. The technology is also mature. In contrast, TSLA uses gigantic batteries, a technology in its infancy, i.e., one where costs are falling.

So I decided to abandon my back-of-the-envelope approach and take a look at TSLA’s 2019 financials. Call this my front-of-the-envelope analysis.

2019 sales and direct expenses

TSLA sold 367,500 cars in 2019, at an average price of $54,341 each. It made a gross profit from auto sales (I’ve ignored leases) of $4.0 billion, or $10,900 per car. Gross profit means after all direct cost of manufacture, including materials, labor and the cost of running the plant (including depreciation).

general expenses

The company spent about $4 billion on R&D + sales, general and administrative expenses (SG&A). This offset basically all the manufacturing profit. TSLA had interest expense + taxes, so it made a loss for the year.

where the operating leverage is

The essential point, which somehow eluded me last week, is that the general expenses laid out in the preceding paragraph have been steady for the past several years. Typically, an analyst would have them accelerate at some (low) trend rate of increase. Still, any increase in this expense number will be dwarfed in short order by the rise in gross income if TSLA continues to grow at the current high rate.

If we thought that TSLA could expand sales at 30%/year for the next half-decade, while retaining the same gross profit, then it would have gross profit in 2025 of about $15 billion. If general expenses increase at 5% yearly, they would be around $5 billion then. Net income would likely be about $7.5 billion, or close to $40/share.

new battery?

What about the battery? Let’s assume–I’m just making numbers up here–that the cost of parts is a third of total gross costs (three kinds of costs: materials, labor, factory) and that the battery is half of the cost of all parts. That would make the cost of today’s battery about $7000 per car. Say new technology cuts that figure in half. That would add $3500 to the gross profit per car for TSLA, assuming (unlikely, I think) it could retain the whole amount. TSLA’s unit sales in 2025 would be about 1.4 million at a 30% cagr, meaning $14/ share more in eps, if so.

As I’m writing this, the TSLA price is about $1700, implying a pe of just over 40x, assuming no changes in unit profits and 30+, on the same assumptions, if all the profits of new battery technology accrue to TSLA.

what a good analysis of Tesla (TSLA) would contain

A basic report on TSLA by a competent securities analyst would contain the following:

–an idea of how the market for electric cars will develop and the most important factors that could make progress faster or slower.  My guess is that batteries–costs, power/density increases, driving range, charging speed–would end up being key.  Conclusions would likely not be as firm as one might like.

–TSLA’s position in this market, including competitive strengths/weaknesses.  I suspect one main conclusion will be that combustion engine competitors will be hurt by the internal politics of defending their legacy business vs. advancing their electric car position.  The ways in which things might go wrong for TSLA will be relatively easy to come up with; things that could go right will likely be harder to imagine.

–a detailed income statement projection.  The easy part would be to project (i.e., more or less make up) future unit volume and selling price.  The harder part would be the detail work of breaking down unit costs into variable (meaning costs specific to that unit, like labor and materials, with a breakout of the most important materials (i.e., batteries)) and fixed (meaning each unit’s share of the cost of operating the factory).  An important conclusion will be the extent of operating leverage, that is, the degree to which fixed costs influence that total today + the possibility of very rapid profit growth once the company exceeds breakeven.

There are also the costs of corporate overhead, marketing and interest expense.  But these are relatively straightforward.

The income statement projection is almost always a tedious, trial-and-error endeavor.  Companies almost never reveal enough information, so the analyst has to make initial assumptions about costs and revise them with each quarterly report until the model begins to work.

–a projection of future sources and uses of cash.  Here the two keys will be capital spending requirements and debt service (meaning interest payments + any required repayments of principal).  Of particular interest in the TSLA case will be if/when the company will need to raise new capital.