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Saturday, February 25, 2017

Peak Auto (II): Tesla Valuations

Mike Smitka

My previous post looked at frivolous investments by assemblers as evidence that's we're at the peak of the automotive cycle. Of course that doesn't mean that we're heading into a trough, just that there's not much upside. Investors in Tesla ought to take that to heart. The company sold about 80,000 vehicles last year in a 90 million unit global market (order of magnitude) that's growing by over 3% (again, a round number). That translations into 2.7 million incremental units a year, the equivalent of 11 new standard 240,000 unit annual capacity assembly plants. From a global perspective, Tesla isn't even a rounding error. In the $100,000+ performance car market they're more of a player, but Tesla's rivals are all launching their own battery-beefed-up or full-battery performance vehicles. Those rivals have global distribution and service networks in place, too. So if Tesla is to expand it must be in the volume segment end of the business.

...investors [are] reading more profits into the industry than it can feasibly generate...

So what will Tesla need to accomplish, besides not running out of cash? Their financial statements show that for all the talk of solar cells and batteries, they remain an automotive company in revenue and operating costs. So on that basis, their long-run P/E should reflect that reality. Here is what the industry looks like:

FirmSymbolP/E ratioMarket ValueRevenue (quarterly)
GMGM65744
FF115039
FCAFCAU91730
ToyotaTM1116883
HondaHMC155643
NissanNSANY93827
PSAPUGOY111714
RenaultRNLSY82713
BMWBMWYY85923
DaimlerDDAIY97841
VWVLKAY[+140!]7758
TeslaTSLA[negative]422.3 (2.0 automotive)
Average 10  

Source: Yahoo! Finance; financial statements for Nissan. I did not include VW's P/E in calculating the industry average.

Some of these companies have recent negatives, others recent positives. So the average of about 10 should be a good indicator. On that basis Tesla needs to generate $4 billion in profits. If we assume, very [very!] generously, that they can manage a 10% profit margin on sales then they need revenue of $40 billion [Ford earned 3.3% globally in 2016Q3, down from 7.7% in 2015Q3]. What will Model 3 give them? US sales of 250,000 units a year are highly optimistic, given sales of other vehicles in that segment, and Tesla has little infrastructure in other big markets. Exporting 250,000 a year isn't going to happen. Expanding their domestic US sales and service network will eat into margins, too. But let's buy into the bullish story, and assume they can actually sell 300,000 units in 2018 at $40,000 per car. That's still only $12 billion. Add in other models and there's maybe another $8 billion, assuming gratuitously that sales of those aging models don't sag despite new entrants. [In point of fact, sales of existing models are flat.]

So they're a growth story – but they won't start producing the Model 3 in volume until 2018. [Tesla has yet to host journalist test drive shindigs yet – with the automotive journalist motto "drink free or die" those are rightly called drive-and-drink weeks. Anyway, those are 6 months before production, and with a new model and a new plant ramp-up then can't be earlier than 2018.] If they have a followup model that will add volume, then it can't be any time before 2021, as they've yet to raise money for a new assembly plant, much less break ground. But by then they'll be needing to launch Model 3a, because staying competitive in the volume segment requires periodic updates.

In short, any additional growth for the Model 3 won't be until sometime in the 2020s. After all, in visiting suppliers as a judge for the latest round of the Automotive News PACE competition, MY2019 was mainly a done deal, with firms working on their order books for 2020 and beyond. Tesla has said nothing about commencing development work on a Model 5, or whatever they hope next to do.

...autos aren't rocket science, they're much more challenging...

Now there are lots of downsides. No other car company has seen fit to get into the battery business, and lock themselves into a particular technology. The flip side is that other auto companies don't believe that economies of scale will prove the key to lowering costs. More important is for suppliers such as LG Chemical to utilize capacity. In that case, Tesla has no particular advantage in selling battery packs for home users and utilities. Tesla's solar panels are again a strictly US play, don't have a monopoly and face regulatory hurdles in sunshine states such as Nevada. And then there's the Tesla's historic inability to launch their automotive products on time and on cost. Finally, Tesla can't count on ZEV credits adding $3,000 a vehicle as total output rises, because the size of that pot will shrink over time as other companies launch compliance cars in California. Elon Musk has yet to demonstrate a golden touch when it comes to designing, developing, making and selling physical products. That's not his forte: autos aren't rocket science, they're much more challenging.

Meanwhile Faraday Motors seems to have bitten the dust; de novo entrants to the auto industry have not fared well this past half-century. I do expect a couple to survive in China, perhaps Great Wall, but dealership challenges plague many players, including Audi and BMW. (For more on that see my book! The room for error in the car industry is narrow, the potential to make big mistakes is wide.

So we're seeing peak auto not just in car companies having more cash than they know what to do with. We're also seeing investors reading more profits into the industry than it can feasibly generate.