Tesla (NASDAQ:TSLA) stock is up 26% from its June 2019 lows of $178.97 and is showing signs that it might become profitable sooner than expected.
TSLA reported on July 24 that it delivered 95,356 electric cars in the second quarter, including 77,634 deliveries of Model 3. Its previous quarterly record was 91,000 total units delivered in Q4 2018.
Management is now expecting to produce 10,000 cars per week by the end of the year, up from 7,000 now. TSLA says it should deliver 360,000 to 400,000 cars by the end of 2019.
TSLA said its Model 3 average selling price stayed above $50,000, including all features, during the quarter. However, analysts noted that it has now lowered its stated price by $1,000, to $38,990, while raising the price of its full self-driving capabilities by $1,000 on Aug. 16.
But TSLA’s outlook was extremely positive about its ability to generate a profit.
TSLA’s Financial Outlook
Tesla made some very interesting statements in its quarterly letter about its financial viability. First, it said that, it believes its business is now self-funding. That means it won’t need to raise additional equity capital. It now has $5 billion in cash and equivalents.
Second, TSLA said that it expects to reach positive free cash flow “with possible temporary exceptions.” In Q2, Tesla reported operating cash flow of $614 million, including capital expenditures. According to Tesla, its new product launches should facilitate that goal.
Some might doubt Tesla’s free cash flow projections, though, given that it expects to start producing Model 3s in China by the end of the year. This will ramp quickly to 500,000 units by mid-2020. That ramp-up will likely use a large amount of capital and hinder free cash flow.
It might be difficult to see how TSLA stays cash flow positive while it ramps up in China. In addition, Tesla plans to start making mini-SUV Model Ys in the fall of 2020. This could also eat up capital.
In its quarterly letter to TSLA shareholders, the company states that its main focus is on “volume growth, capacity and cash generation.” about its focus on cash generation.
On the quarterly conference call, Elon Musk said he expects Tesla to be “around” breakeven in Q3 and positive profits in the fourth quarter of 2019.
Skeptics Abound
Vince Martin, a contributor to InvestorPlace, is a skeptic. His article on July 29, “Earnings Raise More Questions about the Viability of Tesla Stock,” argued that the price decreases and product ramps will largely eat up TSLA’s long-term profitability. I am not so sure.
I think average selling prices across Tesla’s full range of deliveries will trend upward. Also, TSLA has developed cost reduction know-how in launch ramp-ups. It has mastered the key elements economies of scale production. It can leverage this learning with the Chinese Model 3 and the Model Y launches late this year and next year.
For example, total labor hours have been cut in half since the third quarter of 2018, with higher production. Its Q2 report showed gross margin improvement in nearly all its lines of business.
Outlook for the Tesla Stock Price
It’s hard to put together a cogent free cash flow model for Tesla, given the huge amount of variables involved. At this point, we have to rely on the company’s statements to a large degree.
But If Elon Musk’s prediction on the conference call holds true, demand for Model Y will reach 2 million cars a year in couple of years. At that point, there is no question that Tesla will be GAAP net income profitable. It will also generate lots of free cash flow.
Its stock price will likely be higher than it is today.
Here is a simplified example. Let’s say that TSLA produces 2 million Model Ys per year in three years. Each would be priced at a much lower average selling price of just $40,000 due to economies of scale. Let’s also assume each Model Y yields a profit to TSLA of 5 percent, or $2,000 per car.
That works out to profits to TSLA of $4 billion per year, just from the Model Y. Today TSLA’s market value is $40.6 billion. This means TSLA stock is selling just a little over 10x expected earnings in a few years. And this is just from Model Y deliveries.
At that point, the market would be looking forward another several years, including other profitable product lines. TSLA stock would likely be even higher.
The bottom line is that TSLA stock is likely to deliver to patient investors who can withstand the quarterly ups and downs.
As of this writing, Mark Hake, CFA does not hold a position in any of the aforementioned securities.
