Rumors of Model 3 Production Constraints Should Unnerve Tesla Inc Shareholders

Markets need to price in a slow ramp-up of TSLA Model 3

By Chris Lau, InvestorPlace Contributor

Despite bad news churning out almost daily about Tesla Inc (NASDAQ:TSLA), stock markets are barely reacting. News that the company will miss Model 3 production by a wide margin and rumors of a mass layoff did nothing to move the stock by much. But shareholders ought to take the worsening developments at Tesla seriously.

Rumors of Model 3 Production Constraints Should Unnerve TSLA Shareholders
Source: Tesla

The media is interpreting that the tweets from Tesla’s CEO, Elon Musk, imply the company has supply constraints, due to production scaling problems for Model 3. If it is true, then the competitive moat Tesla has over its rivals may narrow. Tesla’s first-to-market advantage gave the company many years of lead time to take market share, but this could change overnight. If Tesla 3, which is more affordable than the other models, is in limited supply, Tesla’s market share growth will slow. The delay could also cannibalize Model S sales, as customers who waited for Model 3 in lieu of Model S may now cancel the order altogether.

Mercedes-Benz and BMW are wrestling with releasing a luxury-class electric vehicle (EV) that will compete effectively against Tesla’s line of automobiles. If the market share growth slows for Tesla due to production delays, then the fundamentals for Tesla stock become questionable. TSLA stock trades at around six times sales and has a debt/equity of 1.56 times. By comparison, Ford Motor Company (NYSE:F) trades at just 1.5 times book, though its debt/equity is 4.53 times. General Motors Company (NYSE:GM), which hovers at yearly highs, also trades at 1.5 times book like Ford’s stock but has a lower debt/equity ratio of 1.96 times.

Both Ford and GM could catch up with Tesla if Model 3 production does not pick up at a brisker pace. Ford’s CEO is keen to pivot the company’s cars away from fuel and toward EV. GM’s Volt is hardly a success, but its limited sales will give the company useful lessons. GM needs to get its styling, target market and pricing right if it wants to win over market share from Tesla. Given its lineup of gas cars are doing well, GM has a good chance of restructuring its EV strategy in such a way that sales for the latter will increase.

Volkswagen in the Running

Volkswagen AG (ADR) (OTCMKTS:VLKAY) is also chasing after Tesla. An executive said that Volkswagen must tackle Tesla’s innovation model in the EV market. Until Volkswagen has a compelling lineup of EV models, consumers will choose a Tesla vehicle first before even considering anything else. Volkswagen’s success will ultimately depend on the company catching up at a technical level to offer a product that’s comparable to that of a Tesla. It must have affordable  pricing compared to Tesla’s Model 3. At present, Tesla’s affordability hinges on the government continuing to subsidize consumers with a tax credit.

Firings at TSLA

Rumors over the weekend that Tesla fired hundreds of workers should concern TSLA stock holders. Already facing production delays, the employment problem at the company will only worsen the supply issues. Replacing the staff with equal or better-qualified expertise will take time. If done right, TSLA might have a chance to improve the company’s employee efficiency and morale. But chances are good that a layoff in the range of 400–700 staff will disrupt the company’s operations at least temporarily in the near term.

Takeaway for TSLA

Tesla is by far the most valuable EV maker in the world because it is ahead of the competition with its advanced technologies packed in cars. Its car designs are unique and recognizable, so much so that consumers are reserving Model 3 orders. Yet the slow initial production for the affordable Model 3 should unnerve investors. The stock is valued with the assumption that TSLA will keep growing its market share while keeping competitors out. This view is at risk until Tesla ramps up production. Until then, tread carefully when investing in TSLA stock.

Disclosure: Author does not own any of the stocks mentioned.


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