Shares of electric vehicle maker Tesla (NASDAQ:TSLA) have surged 65% higher quarter-to-date to new all time highs above $400. That’s an impressive rally. For comparison purposes, the S&P 500 — which itself has been red hot — is up less than 10% this quarter.
Indeed, Tesla stock is in the midst of its best quarter since 2013.
What has driven this record rally in Tesla stock in the final quarter of 2019? Put simply, it has become more and more clear over the past few months that Tesla is dominating the still rapidly expanding global EV market, and doing so with a healthy and improving margin profile. The implication here is that Tesla has a huge opportunity in front of it to become a very big global auto player at scale, one day delivering millions of vehicles per year with billions of dollars in annual profits.
As investors have adopted this reality as the consensus, Tesla stock has surged higher. It really is that simple. But, the more important question — can Tesla stock stay in rally mode in 2020?
Yes. But, there are two caveats here. First, shares may have to take a breather around $400 because this feels like a fundamental and psychological near-term top. Second, Tesla stock won’t have another 65% upside quarter in 2020. Instead, throughout the whole year, it looks like Tesla stock has about 10%-15% upside potential.
I remain long Tesla stock because shares are supported by a big time growth narrative that is only gaining momentum. But, I’m not chasing the rally, either, since a lot of that big time growth narrative is already priced in (though not all of it).
Tesla Will Be Very Big and Very Profitable
In 2019, it has become clear that Tesla is well positioned to one day turn into a very big and very profitable global auto giant, for three big reasons.
The first reason is that the global EV market is only gaining momentum. Consumers are on board with the EV trend, because they are increasingly aligning their purchases with ideas they believe in (and one of those ideas is carbon emission reduction). Governments are on board, too, as they are implementing legislation to further goose EV sales. Companies are, too. They are rolling out new EV after new EV.
All in all, then, everyone is on board with the EV trend, implying that EV sales will continue to surge higher over the next several years.
The second reason is that Tesla has certain enduring advantages in the global EV market which will keep it atop the market for a lot longer, despite rising competition. Those advantages include: 1) brand equity (Tesla is the only car brand young consumers care about), 2) battery tech (Tesla has better and more efficient batteries than competitors, enabling shorter re-charge times and longer ranges), and 3) optimized production (Tesla has bigger, better and more EV production capacity than anyone else, and it is still aggressively expanding production).
Among other things, these advantages will enable Tesla to remain the EV market leader for the next several years.
The third reason is that Tesla has a clear path toward big profits at scale. Tesla’s auto gross margins continue to improve as production capacity ramp slows. Operating expense rates continue to drop with improving scale. Both of these dynamics will persist. Gross margins will keep moving higher toward management’s target of 25%. Opex rates will keep moving lower toward auto industry average 10% levels.
That combines to a 15% operating margin, on what will be tens of billions in revenue — and that ultimately means billions of dollars in profits.
Tesla Stock Can Run Toward $450 in 2020
My math indicates that the fundamentals support a run in Tesla stock toward $450 in 2020.
You can take a deep look at the numbers and data sources here. But, to succinctly recap, the global passenger car (PC) market measures about 70 million vehicles sold per year. Global EV unit sales in 2019 will measure about 2.7 million, so about 4% of the total PC market. That’s up from less than 0.5% share in 2014. About 380,000 of those EVs will be Tesla vehicles, giving the company an impressive 14% market share, which is up from less than 10% EV share in 2016.
EV penetration rates will continue to march higher, behind consumer, government and corporate support. Given the current pace of share expansion, it is fairly likely that EV penetration rates hit 25% by 2030. At the same time, Tesla’s market share will get dented some by competition. But, not by much, given the company’s enduring advantages. At scale, then, Tesla should be able to grab 12% unit market share (up from my prior estimate of 10% given how successful the Cybertruck launch was), with average selling prices in the $40,000 to $50,000 range.
Gross margins will climb toward 25%. Opex rates will drop toward auto industry average levels around 10%. Thus, by 2030, Tesla has a visible opportunity to sell millions of EVs per year, report tens of billions of dollars in revenues and post billions of dollars in profits.
Given all this, my modeling indicates that Tesla will hit roughly $65 in earnings per share by 2030. Based on a market-average exit multiple of 16-times forward earnings and a 10% annual discount rate, that equates to a 2020 price target for Tesla stock of nearly $450.
Bottom Line on TSLA Stock
The market is finally starting to realize that Tesla is a winning company in a winning market. As the market has realized this, Tesla stock has climbed more than 60% in less than three months.
Tesla stock may take a breather here, since $400 feels like a fundamental and psychological near-term top to close 2019. But, the longer-term rally will remain in place, and Tesla stock should climb toward $450 in 2020, behind sustained big sales growth and significant margin improvements.
As of this writing, Luke Lango was long TSLA.
