Tesla Motors Inc (TSLA) recently unveiled the Model 3 to much celebration, much success and a quick pop in Tesla stock. Within the first couple of weeks, preorders hovered near an outstanding 400,000 Model 3 units, astonishing industry experts.
Even at the 325,000 mark, one analyst wrote that the “325,000 deposits on an as-yet-constructed automobile is unprecedented in the auto industry. It might be unprecedented in any industry.”
The excitement surrounding the Model 3 unveiling and dizzying preorder figure is easy to get caught up in. TSLA claimed the 325,000-unit preorder figure represented an aggregate value $14 billion in future sales, meaning at nearly 400k units, we’re looking at more than $17 billion in future sales. (This figure comes from not the $35,000 base price for the Model 3, but from an average selling price of $42,000 after upgrades are added to the vehicle.)
From March 31 (the Model 3 unveiling date) through April 6, Tesla stock jumped nearly 14%. However, shares have pulled back and leveled out since then.
And Tesla stock owners should rightfully be nervous.
Too Much Demand CAN Be a Problem
Tesla’s potential problem comes down to production.
Let’s start with last quarter. TSLA had a goal of delivering 16,000 cars during the quarter, but only delivered 14,820. The weak delivery figure came after Tesla hit 17,400 units in Q4 2015 and a total of 50,580 vehicles in 2015.
Despite Q1 2016’s miss, Tesla still expects to deliver 80,000 to 90,000 cars during 2016, which translates into at least 65,000 in just three quarters. Tesla noted “unusual circumstances” for the first quarter, and blamed the delivery miss on parts shortages in a press release:
“Tesla’s hubris in adding far too much new technology to the Model X in version 1, insufficient supplier capability validation, and Tesla not having broad enough internal capacity to manufacture the parts in-house.”
Tesla went on saying it is learning from its lesson to ensure it does not repeat the same mistake with the Model 3.
However, a week later, Tesla voluntarily recalled roughly 2,700 Model X units, saying the third-row seat in the car could fail in a crash. The maker of the third-row seat, Futuris, is paying for the recall, and marks the first recall of the Model X. (The Model S has had a pair of recalls.)
The issue has been referred to as a manufacturing flaw by Tesla representatives, and the company claims repairs will not affect production.
Both the missed production figures and the recall are being blamed on outside suppliers, which would sound like it’s not a Tesla problem. But it is. Parts suppliers might not be as quick to change their technologies or put as much time into perfecting the parts they are making for the innovative and detail-driven Tesla, which ultimately hurts TSLA stock and its shareholders.
To combat these outsiders’ mistakes and flaws, Tesla is making more of its own parts. For instance, in its Q3 2015 shareholder letter, the company said it would bring the manufacturing of the Model X’s second-row monopost seats in-house. That issue forced Tesla to pare back its 2015 delivery forecast, sparking a drop in Tesla stock.
Taking “in-house” production one step further, back in 2014, Tesla announced plans for (then shortly began building) the Gigafactory — a plant where TSLA would produce the lithium-ion battery cells for all of its cars. While the building still is under construction, it does manufacture battery packs — though not cells yet — for Tesla Energy products.
Management stated during a conference call a few months ago that it wasn’t concerned about battery cell production, which is scheduled to begin at the Gigafactory later this year. More recently, however, the Gigafactory hit the news when the Reno Gazette-Journal ran a piece implying construction on the factory was weak and possible delays could be expected. These reports were denied by Tesla CEO Elon Musk on Twitter, and a pair of union job boards deleted references to construction delays or cutbacks.
But whether the Gigafactory is on time right this second isn’t even the point.
This is all an illustration of how many variables must line up correctly for Tesla to hit its projected delivery figures and to scale its production to keep customers satisfied and heavily interested in its products. Plus, it illustrates how much has already gone wrong.
As a Tesla stock holder (or a prospective buyer), you’ve long had to ask yourself, “With so many what-ifs, is Tesla promising too much, too quickly?”
And now, you have to wonder just how problematic that eye-popping 400,000 preorders number really is.
Let’s say TSLA allowed only 100,000 preorders of the Model 3 and delayed the first delivery date, but met (or even beat) all production figures, you could rightly expect Wall Street to react bullishly. That’s much more favorable than what we’ve seen whenever Tesla hits a production snag.
Tesla regularly overpromises and underdelivers, and for shareholders’ sake, it should be doing the opposite.
Bottom Line for Tesla Stock
Comparing Tesla unit production figures to make an overvaluation case versus Ford Motor Company (NYSE:F) and General Motors Company (NYSE:GM) is pointless. They all make cars, but otherwise, they’re vastly different companies.
But just on its own, TSLA is trading at 75 times future earnings estimates at a price/earnings-to-growth ratio of close to 6, and a price-to-sales ratio of more than 8. This is the effect of a fantastic 75%-plus bounce off the February bottom that has brought shares to $250 for new year-to-date highs.
Tesla stock is simply priced for perfection. And while Elon Musk & Co. doles out innovation, sharp design and high-quality vehicles … Tesla doesn’t produce perfection.
In full disclosure, I am a Tesla stock owner and plan to continue to hold my shares. But that is because I bought in years ago and am a long-term buy-and-hold investor who doesn’t try to time the market.
With that being said, I am confident Tesla stock will be cheaper in the future, when it misses a deadline or production figure. I am also confident TSLA will be higher in the future.
But I don’t know when either will happen. So my recommendation? Hold what you have, and if you want to buy, wait for big dips — which will come — to do so.
As of this writing, Matt Thalman was long TSLA. Follow him on Twitter at @mthalman5513.
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