Tesla Share Prices Decouple from the Fundamentals [1/2]

Recently the Tesla (NASDAQ: TSLA) share price broke above the $1,500 threshold, bringing its market cap to ~ $270 billion and making Tesla the largest car manufacturer in the world. In the past 52 weeks, Tesla share price has moved up by more than 500% despite a still negative return on equity. It is currently trading at a 730x P/E multiple vs a 10-20x in the industry, 40x multiple of luxury car maker Ferrari. Having 1% of the total car manufacturing revenue and 30% of global OEM market cap, investors are clearly valuing Tesla for far more than its sales. Although Tesla has a first mover advantage in the expanding Electric Vehicle market, we think the growth expectation baked in for Tesla’s current share price could be unrealistic.

Technical Perspective – The end of the short squeeze

A Short Squeeze happens when a stock rises higher sharply, forcing investors who bet on the stock price falling to purchase the stock at the market price to recover their positions, and as consequence, pushing the price even higher.

We think short squeeze played a role in pushing up TSLA’s share price over a reasonable range, but now, with short bets on TSLA decrease, TSLA’s share momentum is likely going to face headwinds. According to data, TSLA shares shorted by investors were 23% of total shares one year ago, and this number decreased to ~ 8% recently.

Along with short positions falling lower, the TSLA share price is also moving proportionally upward. Now, data shows it will take less than 1/3 of trading volume compared to last year to clear all TSLA’s short positions, meaning that a temporary sharp price increase will have less additional upward effects on TSLA’s share price because there will be less short sellers buying.

Brand image and margin trade-off

The success of Tesla in the EV market can be attributed to the brand image it has built with its technology and futuristic design. Tesla has traditionally been able to apply a premium value to its vehicles and shift consumer preferences. However, in Europe we see two headwinds regarding Tesla’s premium in brand image. 1. The high problem rate and low accessibility of relevant services are destroying Tesla’s credibility. 2. As Europe is the home court to many established auto brands such as BMW, Daimler, Volkswagen, Renault, and etc, Tesla is likely to face some headwinds as it expands.

In addition, Tesla’s strategic shift, from high end S and X model sales to a focus on lower end Model 3 and Model Y sales, is further lowering margins and bringing both short term and long term bottom line concerns. Compared to the 24% gross margin of Model X and S, Model 3 and Model Y are currently running on 17% margins. With decreasing Model X and S deliveries and increasing Model 3 and Model Y deliveries, Tesla is further pressing its margins. While the increasing EV presence is a consensus, the pace of inflection is subject to debate. Given the volatility of taxes and various policy benefits in the past, Tesla might need to further lower its margin if existing tax and policy benefits are limited in any way. In the long run, as existing ICE (internal combustion engine) manufacturers launch more EV models at all price levels, Tesla might capture a smaller market share, resulting in weaker bottom-line growth.

Europe – A big upside and big volatility

In our view, Tesla sales in Europe have proven the high correlation of environmental law and Tesla sales. Currently, the two largest Tesla consumers in Europe are the Netherlands and Norway, accounting for 40% of total Tesla sales in the continent. Both countries are also pioneering in BEV adoption – while they account for 3.8% of total passenger vehicle sales in Europe, they accounted for 35% of the BEV market in Europe in 2018.

Policy in Norway required all new light vehicles sales by 2025 to be ZEV (Zero Emission Vehicles) and 75% new heavy commercial van sales to be ZEV by 2030. In the Netherlands, the government also required an all ZEV sales target by 2030. Both countries also provided tax incentives for ZEV buyers. As a result, Tesla was able to quickly gain tractions and saw a jump in sales. With the EU's goal being to aggressively reduce carbon dioxide emissions by 2025, we might see Tesla’s adoption rate rise in other countries as purchasing and maintenance incentives come to light, especially in Germany and the UK.

Policy is crucial, and growth is mixed

To comply with the tough emission rules in Europe, EV penetration will rise by approximately 5.5x from 2018 to 2021, and Norway and Netherlands’ share will drop from 38% to 10%  by BNP Paribas’ estimate. Germany and the UK are likely to be the drivers for this EV growth.

If sales in Norway and the Netherlands are any leading indicator for Tesla’s sales in Germany and the UK, Tesla could be capturing hyper growth in Europe and fully support a $400/share valuation given by BNP Paribas. However, we think the driver for Tesla’s growth in these two countries could be very volatile.

The growth story in Germany and the UK was constructed upon the large corporate fleet demand in either country, accounting for 53% and 56% of total vehicle demand respectively. According to BNP Paribas, this could create a TAM of 3.2 million units.

With multiple growth catalysts, it’s important to analyze how sales of each model for Tesla will perform under the current situation. For Model X and Model S, future sales are not looking very optimistic – 1. These two models might not be able to fully enjoy the tax benefits in Europe due to their high price, and 2. Model S and Model X are subject to quality concerns and can incur high maintenance costs.

This article is part I of our analysis on Tesla. Please continue to part II.