Tesla (NASDAQ:TSLA) stock might have slumped post second-quarter 2019 earnings as the numbers were not in sync with analyst estimates. However, I remain positive and bullish on TSLA and I believe that the current decline is another opportunity to accumulate.
This article will discuss the key triggers that can take Tesla stock higher in the coming quarters.
Positive Free Cash Flows
Given below is possibly the most important point from the company’s second quarter update letter:
“Additionally, we expect positive quarterly free cash flow, with possible temporary exceptions, particularly around the launch and ramp of new products. We believe our business has grown to the point of being self-funding.”
For Q2 2019, Tesla reported EBITDA of $370 million, net cash of $863 million and operating cash flow of $613 million.
Of course, this is not the first time that Tesla has reported positive EBITDA and operating cash flows. However, if the company’s statement holds true, positive cash flows will be more sustainable going forward.
Importantly, if the business is self-funding and free cash flow is generated on a sustained basis, Tesla has the opportunity to deleverage. In addition, existing shareholders will potentially be less worried about further equity dilution.
With nearly $5 billion in cash as of June 2019, and the prospect of continued healthy cash flows, I am bullish on TSLA.
Regional Diversification Will Help TSLA
The gigafactory in Shanghai is on track for completion and Tesla intends to commence production towards the end of 2019. The factory will have a capacity of 150,000 units per year.
Besides the fact that China is a big market, the factory will save logistics cost. Overall, as production scales-up, margins are likely to improve further.
In the Q2 2019 update letter, Tesla has also mentioned that the company is looking to accelerate efforts to set-up a gigafactory in Europe. The land acquisition is likely to be finalized in the coming quarters.
Therefore, in the next 2-3 years, Tesla will have production presence in the United States, China and Europe. In addition to growth in production volumes, the strategy to diversify production will translate into lower cost and acceleration in free cash flows.
Model Y Will Boost Revenue and Cash Flows
There is little doubt about the trend that car buyers in the United States increasingly prefer SUVs (crossover category) over sedans. Elon Musk expects that demand for Model Y could be double that of Model 3.
Even if the demand for Model Y is similar to that of Model 3, Tesla is positioned to witness sustained revenue growth in the coming years.
An important point to note is that there is overlap of components between Model 3 and Model Y. This is likely to translate into economies of scale once both models deliver robust production and sales on a consistent basis.
The following point from the company’s Q2 2019 letter is important to note –
Additionally, we are making progress managing Model Y cost with only a minimal cost premium expected over Model 3.
While the cost difference between Model 3 and Model Y might not be significant, the average selling price for Model Y will be higher. Therefore, Tesla does expect Model Y to garner higher margins than Model 3.
Overall, the success of Model Y is critical as it can help revenue growth sustain, boost margins and improve cash flows. It makes sense to remain invested in Tesla before Model Y is launched. A strong sales take-off can translate into the stock going ballistic.
Bottom Line on Tesla Stock
Tesla has maintained the guidance for 360,000 to 400,000 deliveries for 2019. This would imply strong volumes growth in 3Q and 4Q. With potentially strong deliveries, commencement of gigafactory in China, the launch of Model Y and the initiation of its gigafactory in Europe, the next 12-18 months will be exciting for Tesla stock holders.
Importantly, if Tesla can remain free cash flow positive on a sustained basis, TSLA is due for re-rating. I would therefore advise buying Tesla shares with the recent correction serving as a good entry point.
As of this writing, Faisal Humayun did not hold a position in any of the aforementioned securities.
