So far in 2019, Tesla (TSLA) stock has been extremely volatile, trading in a wide rage and making very little progress overall. Amid more of TSLA stock’s trademark trading action, the company itself is in the midst of a critical transformation that will completely redirect investors’ bull thesis this year.
Tesla may have made it through the growing pains of Model 3 “production hell” in 2018. But now that it has somewhat hit its stride in ramping up production, the electric carmaker will need to prove to investors that there’s a big enough market for the Model 3 to justify TSLA stock’s sky-high valuation.
Next Frontier For Tesla Stock
Wedbush Securities analyst Daniel Ives says the 50% cut in U.S. electric vehicle tax credits in 2019 will likely weigh on Model 3 demand. In January, Tesla cut prices on all models by $2,000 to partially offset the reduced tax credit. The company subsequently cut prices for the Model 3 by another $1,100 following the end of its customer referral program.
It remains to be seen how big of an impact the tax credit will have on Tesla’s U.S. demand. In the meantime, Ives says Europe is a major test for Tesla.
“With the U.S. EV tax credit getting cut by 50% to $3,750 and then again to $1,875 on July 1, the Tesla demand story in 1H19 has clearly shifted from the U.S. to Europe as pent-up Model 3 demand in the region will be the major swing factor for the stock in the near-term,” Ives recently advised clients.
Ives says China and Europe will be proving grounds for Tesla. The company has famously had a number of logistical and production stumbles in the U.S. He says Tesla stock will be “show me” shares as its U.S. narrative shifts from production to demand and margins in the near-term.
The Good News …
The most bullish news for Tesla investors from the fourth-quarter report is that Tesla is not strapped for cash, for now. Tesla reported $910 million in free cash flow in Q4 and ended the period with a cash balance of $3.7 billion. In addition, Tesla said it is paying for its Shanghai Gigafactory using low-cost debt from local Chinese banks. That’s good news for investors concerned about headline risk related to a potential U.S. equity offering in the near-term.
Investors are certainly paying attention to the carmaker’s financial health. Tesla stock tanked to as low as $279 in January after the company missed Q4 delivery expectations and announced it was laying off 7% of its workforce. TSLA stock subsequently bounced back as high as $324 in the weeks that followed. The bullish move came after Q4 earnings showed the company is not in a near-term cash crunch. The cash situation is especially reassuring for investors after CEO Elon Musk admitted in a recent interview that Tesla was within weeks of bankruptcy last year.
… and the Bad News
The bad news for investors is that Tesla is entering uncharted territory when it comes to mass market demand. The company has had tremendous success with its luxury vehicles and has established a loyal base of satisfied customers. However, it has yet to come anywhere close to its low-end Model 3 target price of $35,000. The recent $1,100 price cut dropped the base cost of the Model 3 to $42,900. The average sales price for new U.S. vehicles is currently around $37,500, but that number is heavily influenced by pricey truck and SUV sales.
Bulls say the Model 3’s mass appeal will drive Tesla’s long-term growth story. But as the Model 3’s prices drop, Tesla’s margins will fall as well. At the same time, legacy automakers are investing heavily in EV technology and startups like Rivian and Electrameccanica Vehicles (NASDAQ:SOLO) are gunning for Tesla’s market share.
Tesla Has a Lot to Prove
The first thing Tesla will need to prove is that there is mass market demand for the Model 3. Europe and China should play a large role in that thesis in 2019. The second thing Tesla will need to prove is that it can meet that demand at a reasonable margin. If not, Tesla’s business will ultimately look a lot like low-margin operations of Ford (NYSE:F) and General Motors (NYSE:GM). The only difference among the three stocks would be that TSLA stock trades at 2.4 times sales. Ford and GM shares both trade below 0.4 times sales.
There’s no question 2018 was a volatile and unpredictable year full of challenges for Tesla and its investors. Tesla stock bulls think the most difficult part of Tesla’s maturation process is behind them. They may be in for a rude awakening in the next several months.
As of this writing, Wayne Duggan held no positions in the aforementioned securities.