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Does Tesla's Model 3 'Production Hell' Make The Stock A Short?

By (Clement Thibault/ MarketsAug 02, 2017 03:57AM ET
Does Tesla's Model 3 'Production Hell' Make The Stock A Short?
By (Clement Thibault/   |  Aug 02, 2017 03:57AM ET
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by Clement Thibault

Tesla (NASDAQ:TSLA), the California-based electric car and energy storage manufacturer, is set to report Q2 2017 earnings on Wednesday, August 2, after the market closes. Consensus EPS is for -$1.94, on 2.5 billion of revenue.

Tesla Daily
Tesla Daily

In February, prior to Tesla's Q1 report, we said:

We expect little to change for Tesla [after the report]...and indeed most likely not until more information emerges about the true production time line of the Model 3, which probably won't be announced till sometime later this year.

At that time, the stock was trading a bit below $300 per share. As of last night it closed at $319.57, on the tailwind of the Model 3's 'arrival' last week. Does the physical availability of the car actually change things for Tesla?

Welcome to 'Production Hell'

Tesla's Model 3 has finally been delivered to customers. Well, at least the first 30 cars. And only the pricier, longer-range version.

Last Friday, Tesla sponsored an event celebrating the production and delivery of these first 30 cars. That's certainly a milestone of sorts for Tesla, though for most automobile manufacturers 30 cars off the production line would hardly be spectacular and surely nothing at all worth celebrating.

But then Tesla—at least to its investors and members of the cult of Tesla's charismatic founder Elon Musk—isn't a run-of-the-mill car manufacturer. For them, Friday's event was big. After all, production and delivery continue to be some of the thorniest question marks surrounding the company's long-range viability.

Though Tesla is already producing their higher-end Model X and S vehicles in limited scale, these 30 cars (50 if you include those Tesla kept for testing) are just the minutest tip of the iceberg. At Friday's event, Musk repeated that there are over 500,000 Model 3 orders awaiting production. He went on to say that ordering a Model 3 now would mean your car would be delivered late 2018 or early 2019, at best. That's quite a bit of time from now.

Before we continue, a little about the cars. There are two versions of the Model 3 being sold—a basic, $35,000 sedan and the $44,000 version which will have a longer driving range between re-charges. Autonomous driving capabilities, one of the most anticipated of Tesla automobile features, can be added as an option, for $8,000 extra.

The basic car will have a range of 220 miles (350km), while the long range model extends to 310 miles (500km) between charges. In comparison, the Chevy Bolt, General Motors' (NYSE:GM) electric car, provides an estimated 240 miles (380km) of range, for $37,500.That's pretty competitive, all things considered.

As well, the Bolt is already available to consumers. Yesterday, GM confirmed it had delivered close to 2,000 cars last month, bringing the total number of units delivered since last December's Bolt launch to over 10,000 cars.

For now, only Tesla's long-range Model 3 vehicles are in production. Production for the more basic, highly touted 'mass-market' car will only start in November, and that's a best case scenario. An even higher performance, all-wheel-drive Model 3 is expected to hit the market during spring 2018.

At last Friday's event, one thing Musk said during the launch event strongly resonates given the number of orders outstanding and production timeline detailed above. "Welcome to production hell," he laughingly commented to the gathered audience. "It's going to be where we are for at least six months, maybe longer." Media sources picked up the comment, which has gone viral.

And for good reason. Musk is surely aware that producing additional models on top of increasing orders equals added production problems. In the 22 weeks remaining until 2018, Tesla expects to ramp up production from 0 cars per week to 5,000 a week. Savvy investors have learned to almost never take Musk at face value, since the entrepreneur too often gets ahead of himself.

Musk is betting he and the company he founded can reinvent the way cars are manufactured, by completely automating the production line. He believes his company can ultimately be more efficient than such Japanese automotive powerhouses as Honda (NYSE:HMC) or Toyota (NYSE:TM). Evidently, there are enough customers and investors that believe him too, since currently the company is completely run on injections of cash via a variety of debt offerings and stock dilution. More on that below.

Tesla also believes in vertical integration. It wants to control everything: from manufacturing, to selling, to servicing, to charging, to customer support. That's a tall order, but it also reflects another aspect of Musk's belief that his way of doing things is the only way. Musk reckons he can manage and run the full vertical operation more efficiently via a centralized operation.

That's in direct opposition to the way conventional car companies have long done business. As a rule, all functions except manufacturing are outsourced. In the conventional automotive arena cars are sold via dealerships, often repaired in dealership or independently-owned garages, and fueled at gas stations owned by other companies.

Some problems have already started to crop up for Tesla, beyond the production line. Customer support issues, including problems with refunding the Model 3's $1000 pre-order deposit have been reported. The company promised it would refund deposits "up to three weeks" after an order cancellation. However, according to Wired, many customers have been left hanging for up to three months before they see their money back. This of course raises question about Tesla's broader ability to scale not just its manufacturing operation, but the entire supporting infrastructure, particularly since Tesla continues to insist it will run all its operations in-house.

Financials And Fundamentals

It's our view that nothing about Tesla's financials or fundamentals right now justifies a price tag of $320 per share. Not a single fundamental parameter.

The company may be selling a few cars, but mostly it's being powered by dreams. That's not to say we think Tesla is a Ponzi scheme or that it's headed toward bankruptcy. Rather, we're just pointing out the facts.

Though there are true believers who are certain Tesla will deliver on all its promises, will become a leading energy and car company, and that the share price has no ceiling, we see all this as simply romantic, at best. It's our view that a company should be judged as a business, not sized-up based on a chimerical vision.

The company is losing money, lots of it. It is mostly kept afloat by the above mentioned money injections. Last quarter, Tesla finished with a negative billion dollars in cash flow from operations and investment combined, offset by a $1 billion bond offering and $400 million raised in a secondary stock issuance.

The quarter beforehand looked almost the same, with a billion dollars in losses from operations and investment, offset by another billion dollars raised via a debt offering. During Q2 of last year, Tesla issued $1.7 billion in secondary stock issuance to finance the operation.

In three out of the past four quarters, Tesla needed outside money to survive—by the billions. Still, the company is worth about $55 billion today, a valuation that's higher than that of GM, Ford (NYSE:F), and Fiat Chrysler (NYSE:FCAU), all three of which are profitable companies and all already producing cars by the hundreds of thousands.

That makes Tesla sound like a shorting opportunity, but shorts have likely already learned their lesson. Tesla's share price is unpredictable and can go up on a market whim or a Muskian tweet.

Since there is no fundamental justification for the $320 share price, can lack of fundamental justification stop the stock from reaching $1000? It can’t.

Which is why right now, in our view, Tesla is neither a long nor a short. You either play along with the crowds and the excitement in order to ride the stock up while hoping to get out in time, or you wait for the financial reality to kick in before joining forces with the shorts.

We'd only take a true, long position after Tesla starts acting like a self-reliant, profitable business—no more casual issuance of billions of dollars in bonds to finance the operation, or dilution of its existing shareholder base. If or when that actually happens, we'll reconsider.

Does Tesla's Model 3 'Production Hell' Make The Stock A Short?

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Does Tesla's Model 3 'Production Hell' Make The Stock A Short?

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