Tesla: Too Many Headwinds To Deal With (NASDAQ:TSLA)
Tesla, Inc. (NASDAQ:TSLA) faces a difficult operating environment with intense price competition and slowing demand going into 2024. The company’s financial performance continued to weaken throughout 2023 with falling margins and free cash flow, and it will be difficult for the company to rebound given the Cybertruck’s ramp-up and potentially another round of auto price cuts. The contribution of Cybertruck to profits will most likely not become very meaningful, while the payoff from rising investments in Artificial Intelligence technology may show only years from now. The management refrained from giving any forward guidance on profitability in the recent earnings call, and I believe the company’s earnings will likely be more volatile in 2024. The valuation remains elevated as investors expect Tesla’s other bets like Tesla Bot and autonomous robotaxis to pay off in the long-term. However, I believe the elevated multiple cannot be justified based on the company’s slowing growth prospects and dwindling market share in the global light vehicle market. I assign a sell rating to the stock.
2023 was rough, but the pain is not over
Tesla has reported remarkably dismal performance over the past year, with a sharp decline in the company’s profit margins and free cash flow. To make matters worse, the management has given a dim outlook going into 2024 as well, reflecting the challenging operating environment it faces. The management refrained from providing any guidance regarding profitability and expects the car delivery growth to be slower going forward in 2024.
The volume growth for electric cars remained robust; however, overall demand for electrified cars rose not as strongly as in 2022, and demand could stay weaker somewhat longer, even as the structural outlook remains promising. The company’s growth is now being affected by several trends, including high inflation, elevated interest levels and reduced incentives in some countries – that have recently weakened affordability and reduced the willingness to buy an electric car.
It is now clear that the key issue relating to the weak demand for EVs has been affordability for end consumers. This is consistent with the survey of EV owners and intenders worldwide, that found out that almost half of the respondents consider EV prices to be too high at current levels. Bloomberg estimates global unit growth to slow down to 22% in 2024, a distance from Tesla’s 50% growth goal for annual production.
Price cuts remain a double-edged sword
As the growth rates for sales continue to decline, the EV industry has recognized that the prices need to be affordable for mass adoption. In order to rekindle demand, Tesla embarked on a price war last year, and many competitors also soon started cutting prices. Although the lower prices helped the company in meeting its full-year target to deliver 1.8 million cars in the year, a solid growth of 37%, the price war has also had some negative consequences, including a decline in the residual value of a car. Recently, rental car company Hertz cited this trend and higher than-expected repair costs as the reason to slow its pace of electrification. It will sell 20,000 electric vehicles and replace these by combustion engine cars.
Elon Musk acknowledged the high level of competition that the company faces, and perhaps this is why TSLA proceeded to provide more details about its plan to add a more affordable car, expected to be priced around $25k. However, that is something that is still far ahead in the pipeline, and the company stated that the design process of this car will only start in the second half of 2025. I believe that the demand for such an affordable car would be very strong, especially if the car is differentiated, perhaps as a result of new manufacturing methods, improved battery technology and/or self-driving capabilities. However, at the moment, it is hard to say that it will be a guaranteed success for the company since at the moment it is evident that other firms are already having success with their affordable models, and that potentially gives them better opportunities to tap the potential around affordable electric cars than Tesla. I expect Tesla’s market share to dwindle as competition increases in the coming few years, with rivals like Acura and Volvo expecting to launch a wave of new EV products by 2025.
Cybertruck faces tough timing
A near-term rebound for TSLA largely depends on the company expanding Cybertruck output and maintaining pricing while keeping car production utilization at its maximum. The Cybertruck is Tesla’s first addition to their vehicle lineup since the launch of the Model Y in 2020. Tesla’s CEO has faced scrutiny from the US SEC for communication issues in the past, and is cautious about setting high expectations for the Cybertruck. Although there is significant interest in the new model, with over 1 million reservations so far, Musk has suggested that production may not exceed 250,000 units in the coming years and might not reach this level until 2025, despite deliveries starting in late November.
In the US, where full-size pickups are most popular, the Cybertruck will face fierce competition. Its market potential outside of North America is expected to be limited. Convincing buyers to switch from well-established pickups like the Ford F-150, Chevrolet Silverado, and Dodge Ram to the Cybertruck will take time. Additionally, the Cybertruck’s size and curb weight of 7,000 to 8,000 pounds, up to twice that of the Ford F-150, could classify it as a commercial vehicle in Europe and China, potentially reducing consumer demand. The Ford F-150 typically sells for about $61,000, while its electric version, the Lightning, is priced at $77,000. The Cybertruck’s price range falls between $50,000 and $80,000. Cybertruck’s ramp-up will likely have a drag on margin for most of the year, based on Elon Musk’s comment earlier last year that the Cybertruck won’t generate substantial positive cash flow in the next 18 months.
Financial outlook & valuation
Tesla’s margins remain competitive versus Mercedes (OTCPK:MBGAF), Audi and BMW, in part due to its highly automated, non-unionized manufacturing that enables Tesla to accelerate two of Elon Musk’s original goals from his Master Plan from 2006: to build an affordable car and use that money to build an even more affordable car. However, Tesla’s gross margin shrank more than 600 bps from Q4 2022 to Q4 2023 as price cuts by the company overwhelmed incremental margins from higher volume. I believe Tesla may find it difficult to reverse the declining margin trajectory in 2024 as the company will be under pressure to cut prices amidst high competitions. The company has recently cut prices in China and also reduced prices across Model Y trims in a number of major European countries. In the United States, Tesla has not initiated any price cuts this year, even though most Model 3 models no longer qualify for the IRA EV tax credit. However, I believe it is likely that Tesla might eventually lower its prices to counterbalance the loss of the tax credit. Moreover, with Cybertruck likely being a niche product that will be negative to margins and a dearth of new products in its near-term pipeline, price may be the key catalyst for volume that could further damage profit and cash flow.
Currently, there is intensifying international competition, concerns about the sustainability of government subsidies, and a flood of new electric models entering the market. I expect fierce competition among EVs to constrain pricing in the overall industry. TSLA’s stock is currently trading at a forward P/E of 60x, which is almost 3x higher than the multiple the company was trading at one year ago. In my view, TSLA’s elevated multiple is unreasonable now and cannot be justified based upon the company’s slowing growth prospects and dwindling market share in the global light vehicle market. I believe the high multiple is due to the investors having high expectations from the company’s other bets such as the Tesla Bot and autonomous robotaxis, etc. However, at the moment, it is difficult to assess potential in AI and robotics at the moment in my view. I believe that given the slowing revenue growth, eroding revenue margins and the number of execution risks that the company is currently facing, the multiple is very high and poses a negative risk/reward scenario. Hence, I assign a sell rating to the stock.
Tesla may be able to post a trough in margins during 2024 and can reverse the sliding margin trajectory beyond 2024 driven by price stability alongside Cybertruck improvement. Although the company did not show much progress on full self-driving during the past year, if there is any progress in the near-term and the company is able to achieve full self-driving, that would be further beneficial for the margins and would drive optimism around the company leading to a multiple expansion. The recent launch of FSD V12 beta is an important step in the company’s FSD narrative, and I will be observing the progress closely. Moreover, longer-term the launch of the next-gen platform targeted for 2025, and Model 2 (lower cost variant) might keep investors optimistic on the company’s prospects which may provide support to the company’s high valuation going forward.
Tesla is facing a challenged fundamental environment into 2024, which I believe will lead to negative EPS revisions ahead. I expect the profit margins to continue to decline due to significant price reductions initiated by Tesla and Cybertruck’s drag on margins that will most likely continue throughout the year. The stock is trading at a significant premium, and I believe the risk/reward is skewed to the downside at current levels, which is why I assign a sell rating to the stock.
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