Tesla is scheduled to report their Q4 2016 and FY2016 operating results Wednesday, February 22nd after the close. (view the earnings Webcast here at 5:30 ET/2:30 PT) Tesla is the most well-known designer, manufacturer, and retailer of electric cars and powertrain components. Unlike the major auto manufacturers, Tesla owns its sales and service network. The company, led by Elon Musk, completely transformed the image of the electric car with Tesla’s second offering, the Model S. No longer are electric cars exclusively thought of as modest, range-limited, glorified golf carts. The Model S is a sleek luxury car you can buy online, will show up a Mercedes S-class of BMW 7 series in the parking lot, dust a Porsche 911 at a stoplight, carry seven passengers (using the rear-facing jump seats), has available all-wheel drive, can be “refueled” in your garage and drives itself. In 2015 Consumer Reports had to change their scoring methodology because their point system awarded a Tesla Model S P85D a total of 103 points in their testing on a scale of 100. Once adjusted they awarded the Model S a “100”, the first, and still the only, car to ever achieve a perfect score. It would be hard to overstate the significance of this engineering and operational accomplishment from a major manufacturer, but this was Tesla’s first exclusively engineered car. (An earlier model was essentially a modified and electrically repowered Lotus). More recently the company offered pre-orders for their upcoming lower-cost alternative, the Model 3. They received 400,000 orders in the first month despite the fact the car would not be available for a year at least, and possibly much longer. If that statistic doesn’t impress you, it should. That is 10% more orders in 2016 than for the Toyota Camry, the best-selling sedan in the United States last year. The Camry is readily available on dealer lots everywhere, costs half as much, and is marketed aggressively, yet Tesla managed more orders for a car almost no one had ever seen in person, let alone driven.
Of course, true believers consider Tesla, much more than an automobile manufacturer. The company leverages their electrical battery storage expertise into energy storage systems and solutions for homes and business. Electric power can flow either way. Using a “Powerwall” a Tesla owner can charge their car in the garage, but in the event, the power goes out theoretically one could use the battery in the car to provide backup electric power to the house. With the merger with Musk’s other company SolarCity the solution comes full circle. Solar panels on the roof charge the batteries when solar energy is high, and batteries supplement home power needs when it is low. Although solar cell efficiency is not at a level to support this yet, one can imagine the end-goal is complete energy independence for both home and car; and according to Tesla, the car will ultimately be completely self-driving too. The company announced that as of October 2016 all Tesla cars are built with the necessary hardware to permit fully autonomous driving (SAE Level 5 in industry-speak).
With a vision this transformative, one better understands how some very prominent and thoughtful investors have made substantial investments in the company, and believe the upside potential is enormous. Ron Baron, Chairman and CEO of Baron Capital, has called Tesla “maybe the most interesting” company he has ever invested in (source CNBC) and, although risky and still in the “show me” stage, suggested it could ultimately be worth a trillion dollars. A long-time friend of mine and multi-decade fund manager at Fidelity Investments, Tesla’s second largest shareholder, once told me that he believed Tesla would completely change the world with respect to energy and transportation. Both Ron Baron and Fidelity saw this opportunity early, both having bought the stock when it was well below $50/share.
If I stopped here, your next step might be to buy the stock, but there are some other important considerations. To begin with, neither Tesla (founded 2003) nor SolarCity (founded 2006) have ever been profitable for a full fiscal year. This is despite billions in government assistance in the form of tax dollars for grants and factory construction, discounted loans, tax credits and rebates for the buyers of both solar panels and electric cars. So while Tesla may have made a car that got a perfect score from Consumer Reports in 2015, they lost almost $900 million despite government assistance. Meanwhile, Ford Motor Company, which has a comparable market capitalization, made money; a lot of it, almost $7.8 billion.
The auto industry is an exceptionally capital intensive business. In round numbers, Ford averages ~$7 billion a year in CapEx/Research and Development, more than Tesla’s total FY2016 revenue estimates. The R&D budgets of GM, Volkswagen, Toyota, and Daimler are substantially larger than Ford’s. With product cycles of 6 to 8 years, Tesla not only needs to continue to develop and build new cars, they will need to raise money, which will dilute shareholders. Meanwhile, the major global auto manufacturers are making billions of profits and have well over $100 billion in cash on their balance sheets and huge R&D budgets. They may not have created the “buzz” that Tesla did, but now that consumers are showing interest, they are far better armed financially than Tesla is, and government assistance isn’t going to last forever.
The other parts of the power grid story where Tesla currently has a jump start will likely have some competition too. Utilities in several places have aggressively and pro-actively begun to install charging stations for electric vehicles, and are unlikely to simply cede the power markets to SolarCity. In round numbers, the total generation in the United States from all sources averages about 350,000,000 megawatt hours per month. The largest percentage of that is from coal. The wind represents the largest renewable source at about 5% while utility-scale solar represents about 1%. Again these are approximations because power demand is quite volatile and weather dependent, as generated from renewables. So while renewables have enormous room for growth, it isn’t clear that Tesla and SolarCity will be the winners. Even if SolarCity creates a business that competes with conventional generation, it’s worth noting that the largest generation company in the country by Megawatts is Duke Energy which currently has a market capitalization of $51 billion and profits of ~ $3 billion. In other words, Tesla’s valuation has already priced in either the generation business of Duke Energy or the Auto business of Ford or some split between the two. Could there be much more upside from here?
While the size of the auto industry is likely to grow with the population of car drivers and riders, it is fair to say that electricity generation will need to expand substantially. In the United States, we consume about 9.2 million barrels of gasoline per day. Using the gasoline gallon equivalent (GGE aka GEG) of ~33.7 kWh/gal we get 396,076,100 mWh/month of incremental power demand if gasoline cars went electric. In other words we need to essentially double generation. Note that this ignores diesel cars and trucks, doesn’t entirely reconcile with Tesla’s estimated range/charge figures, but is really just to get us thinking about the scale. At the very least power generators need to contend with underutilization when demand is low, such as it is at night when these cars would typically be charging away in the garage.
One takeaway is that the future of Tesla offers enormous potential, but enormous risks as well, and the ride is likely to be a very bumpy one. For these reasons, on Options Action Friday, my friend and co-contributor Dan Nathan advocated a zero-cost collar ahead of earnings as a means to provide some protection against a sharp downside move while still providing some upside in the event TSLA, currently trading tantalizingly close to the mid-2015 all-time closing high of $280, rallies out of earnings. The street is expecting net losses of ~ ($140 million) on revenues of approximately 2.155 billion, and EBITDA (earnings before interest, taxes, depreciation and amortization) of just over $200 million. On average, since TSLA first reported earnings as a publicly traded company, it has moved slightly over 10% the day following earnings, although the four most recent quarters have been substantially more subdued with moves no larger than 5%. The options market is implying a one-day move of roughly 6%.
In most instances, stocks will respond favorably or unfavorably to their operating performance. Did the company grow revenues, earn profits, generate free cash flow? Did the company have positive trends including growth in the aforementioned financial metrics and others that might apply to their business? Are management comments positive or negative? How are they guiding for the future; assuming they provide guidance. Naturally, this data is also taken within the context of the street’s expectations and estimates for all of these. Deliver solid results while beating The Street expectations and offer some upbeat guidance and the stock will show relative strength. Disappoint on all of those and the stock will show relative weakness.
In Tesla’s case, investors are probably not concerned with the Q4 2016 results as much as they are the forward-looking statements. The narrative is one of a transformative renewable energy, infrastructure and transportation company and investors need color on the prospects for profitability, not details on past financial performance. How might emissions credits phasing out affect the ultimate the Model 3? How many of those who ordered expecting to receive a $7500 tax credit might elect not to actually purchase if they don’t receive one? Is the company on pace to meet their goals and projections regarding Model 3 deliveries? Can the company provide evidence that they can achieve profitability in line with other auto companies (at least!) without the assistance of government incentives? Watch GAAP earnings carefully. Tesla may be an industrial company, but employees receive significant stock-based compensation which is more common for tech companies. Looking at the single quarter where the company did report profits of .71/share on a non-GAAP basis, that drops to only .14 on a GAAP basis net of the dilutive impact of those stock grants.