Elon Musk recently admitted that Tesla’s stock value is out of control. “I do believe this market cap is higher than we have any right to deserve,” he said in an interview for the Guardian newspaper in the UK about Tesla (NASDAQ:TSLA) shares.
A lot of people have been thinking the same for a long time, but the share price seems to defy gravity. Even Musk’s own admission did nothing to halt the rise of the stock, which values the company at about $51 billion, equal to the much larger and much more profitable General Motors (NYSE:GM).
In this article, I make my own evaluation, based on what I consider to be reasonable assumptions, using projections of cash flow from 2017 to 2037. I have only attempted to value the automotive part of the business. The battery and the solar panel business no doubt have value, but I believe that Tesla is primarily a car company, and that’s where most of the value lies in the minds of investors.
BEV Sales forecast
The first part of my analysis takes a look at projected sales for battery electric vehicles (“BEV”). The information comes from this site, where you will find graphs like the one below:
On the referenced website, forecasts are provided for three scenarios, from Bloomberg, Goldman Sachs and the International Energy Agency. I have extracted the information and presented the three forecasts together in the graph below:
The average of the three forecasts has global BEV sales rising steadily to around 48,000,000 vehicles by the year 2037.
The next step in the analysis is to forecast Tesla’s market share. In 2016, Tesla had just under 11% of global BEV market (in terms of number of vehicles). So far, Tesla has been competing only in the luxury vehicle market, going up against ICE vehicles such as the BMW 5 series, GM’s Cadillac line and the Mercedes E-class. At the end of this year, Tesla will introduce its Model 3 car which will be in the same price range as the BMW 3 series, the Lexus ES and the Mercedes C-class. There is pent-up demand for the Model 3, pre-orders are in the region of 400,000 units, though no one really knows how many of those orders will translate into actual sales. The introduction of Model 3 will very likely lead to an increase in market share, at least temporarily. For the purpose of this analysis, I have pushed the market share up to 22% (of global BEV sales) for 2018, and 18% for 2019.
The automotive business is highly competitive. In the long term, Tesla will have to compete for sales against all of the big automotive companies, and market share will very likely fall as the competitors make more serious inroads into the BEV market. Achieving a market share higher than 10% is extremely difficult. Toyota (NYSE:TM), General Motors and Volkswagon (OTCPK:VLKAY) have all at one time or another been global leader in sales of cars and light trucks, but no company has consistently achieved higher than 10% market share. For this analysis, I have assumed that Tesla will be as successful in the BEV space as Toyota is in the ICE space, and will over the long term achieve a 10% market share.
Also, to maintain that market share, Tesla will need to have products in the full range of prices including compact cars, mid size, full size and luxury. Based on those assumptions, I have derived the graph below which forecasts Tesla sales for the next 20 years.
The next step is to calculate revenue from the forecast of sales. In the model I am using, I have Model S and X sales increasing at 3% per year, Model 3 sales climb to about 400,000 by 2020 and then increase at 7% per year. In 2020, a new lower priced car comes on line to compete in the mid-sized sector at the $35,000 price point, and a compact is added at the $25,000 price in 2023. Revenue per car falls steadily as the company introduces lower priced models to retain market share. By 2035, revenue per car is around $35,000, which is still quite a bit higher than the big auto companies.
Cost of sales
Tesla’s cost of sales in 2016 were 77% of revenue. This will probably increase as lower priced models are introduced. Among larger companies, the lowest ratio in the business belongs to Toyota which has a cost of sales of about 80% of revenue. I have assumed that Tesla’s cost of sales will rise to 80% of revenue to match the best in the business.
Tesla’s Selling, General and Administration expense, plus R&D expense in 2016 were $2.27 billion. That is a very high percentage of revenue when compared to the larger auto companies, and is obviously a result of the small scale of the operations. General Motors has SG&A expense of 8% of revenue versus Tesla’s 33%.
In the long term, Tesla’s SG&A and R&D expenditures expressed as a percentage of revenue should decrease significantly. My economic model assumes that 8% of revenue is the variable component which will increase with revenue, and the remainder is a fixed component.
Cash will be needed to support increases in inventory, which will come with increased sales. I have assumed that for every dollar of revenue, inventory will increase by 6 cents. The logic for this is GM’s inventory to revenue ratio which is about 6%.
Finally, I look at capital expenditures. There is capital investment required to achieve growth, and there is sustaining capital which is required to maintain production with no sales growth. For the first component, I looked at Tesla’s expenditures to date to get to the first stage of 500,000 cars per year. Tesla has spent $8 billion, and will likely have spent as much as $10 to $11 billion by the time the Fremont Factory, the Nevada battery factory and the Model 3 reaches its design production level. That equates to $20,000-plus per annual unit of production. For my analysis, I have been generous and assumed it takes $12,000 per unit to increase production levels. For 2017 and 2018, I assumed $2 billion and $1 billion respectively, with capex increasing after 2018 to accommodate growth from 2020 onwards.
I assumed $900/car in sustaining capital, which is similar to what GM has been spending for the last 3 years, with no significant growth.
What will Tesla be worth 20 years from now?
The assumptions I have made result in a company which is producing 5 million cars per year by 2038. It is the “Toyota of the electric car business” with multiple car assembly and battery plants spread amongst all major regions of the world. By 2038, growth in electric vehicle sales will have reached the top of the S-curve, and Tesla’s valuation, based on several years of financial data will be in-line with that of other typical major car manufacturers. Let’s assume that it has the same valuation, on a per car sales basis as Toyota. It will be worth about $82 billion.
Discounted cash flow (DCF) analysis – discount rate
Tesla’s weighted average cost of capital is used as the discount rate for the DCF analysis. The value used is 8.8% which comes from this website.
Based on the assumptions I have made, which I consider on the optimistic side of reasonable, I end up with a valuation of $177/share for the automotive component of the business.
I will add 10% for the battery business, which produces about 10% of Tesla’s revenue.
I will value SolarCity at the same market cap that it traded at last November when it was acquired by Tesla – that is $2 billion or $15/share.
Adding the three components of the corporation, I reach a valuation of $210/share.
Elon Musk is correct when he says that Tesla is overvalued at its current price of $315/share.
No doubt there will be readers who disagree with this analysis, I invite comments and suggestions for improvement. I am happy to evaluate other scenarios based on your comments.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.