Tesla Shares Rally Overdone Caution Most Analysts

The meteoric rise in Tesla (NASDAQ:TSLA) shares is encouraging for a long-time fan like me. But when the rally moves beyond logic, it’s time for a quick fact check.

So let’s start with what Elon Musk himself said about the way to win in the American auto space as it exists today:

“Incumbent car companies make most of their money from selling spare parts to their existing fleet at high margins, and they’ll sell the new cars at a de facto zero margin or even at a loss... If you are a new company, you do not have a fleet, so you have no fleet with which to subsidize the sale of your new cars. This is the primary reason there has not been a successful car company startup in the United States.”

So he identifies the lack of a fleet as the primary challenge for Tesla and the reason a Tesla needs to be compelling enough for people to be willing to pay a premium. If this strategy allows the company to reach critical mass, it’s only then that the car market dynamics will start to play out in Tesla’s favor. So how does he propose to get this done?

In Musk’s words, “In order for a car company to be successful, it has to succeed on two fundamental technology discontinuities: one being electrification, the other being autonomy,” because electrification alone is not enough. “The combination of those two is the only opening for a new car company to make it.”

So what he’s really saying is that while this EV craze/government support/etc is good, and a chance in a lifetime for a new car company to leverage, he wants us to take a long-term view of Tesla’s success. Because it’s only when the automation part is added will this be a viable business.

In the meantime, things like hitting quarterly targets, cash flow generation, new battery-making facilities coming online, the democrat initiative/plan to build a cross-country EV-charging network will lend some buoyancy to shares. On the other hand, unforeseen setbacks like the coronavirus, as well as the end of government subsidies in some regions, the Chinese government’s decision to phase out subsidies, protests in Germany against the location of the new Gigafactory in that country will remain pressures.

Almost all sell-side analysts believe in the company now although some think there’s reason for short-term concern. And irrespective of their rating on the shares, all analysts are advising caution given the strong rally (and relatively small correction) in the shares.

Morgan Stanley (NYSE:MS) analyst Adam Jonas said that “many investors are struggling to identify a strong fundamental underpinning for the move” and “folks are asking a lot of questions.”

Cannacord Genuity analyst Jed Dorsheimer, who downgraded Tesla stock from Buy to Hold expressed fear about the coronavirus: "Just as we observed a clear buy signal coming into 2020, we see the risk of China's coronavirus as a clear headwind to the Shanghai facility, suggesting a more pragmatic position," he said, observing that the valuation doesn’t include a production reset from the targeted 3,000 Model 3s per week as a result of the compulsory shut down of facilities until Feb 9. "Following an electrifying run in 2020, we are downgrading shares of Tesla to hold as we see a balanced risk reward for investors to lock in profits," he said.

Wedbush analyst Daniel Ives believes the Shanghai shutdown will have a limited impact on the 150,000 Telsa units likely to be sold in the region over the next year considering how aggressively the company started production at its China plant and the strong demand in the Shanghai area.

Needham analyst Rajvindra Gill called the rally “irrational exuberance” and said, “While we acknowledge the fundamentals have improved, we remind investors the following: 1) TSLA has never posted a full annual profit since going public; 2) its growth rate decelerated in '19 and 3) GAAP gross profit increased only $27MM despite revenue increasing $3.1BN in '19. Needham has an Underperform rating on Tesla.

Gene Munster of Loup Ventures, a former Wall Street analyst turned venture capitalist points to unrealistic expectations for first-quarter profit and sales when he expects a quarter-on-quarter sales decline, negative cash flow, and margin pressure from production ramps and fewer sales. The holiday quarter was “golden” according to him, but some buyers were simply getting in before tax incentives in the U.S. and in the Netherlands started phasing out.

He thinks that standard language changes about quarter-to-quarter sales increases “likely indicates Q1 deliveries will decline significantly from 112k vehicles in Q4.” Moreover, “Vehicle production will likely outpace deliveries significantly in Q1, which may lead to negative FCF for the quarter.” But to a certain extent, the run-up in share prices is “justified” because it has rightfully reclassified Tesla as a tech company. The only concern is that “the Street is overlooking short-term headwinds.”

Barclays (LON:BARC) analyst Brian Johnson remains "underweight" on Tesla while raising his price target from $200 to $300. "We continue to believe TSLA is fundamentally overvalued – but nevertheless concede that the recent price action opens up the possibility of raising capital cheaply, and hence reduces that chance of a stalled business."

Cascend Securities' Chief Investment Strategist Eric Ross agrees. He says that "renewed access to equity capital could reduce their debt load significantly." Raising equity at this valuation would be a smart move according to him and it could be used to pay off debt thus improving earnings by $1 and also the balance sheet. Additionally, the debt-free balance sheet would help Tesla acquire future debt financing.

While some have compared Tesla’s volatility to Bitcoin, Cramer who thinks it’s a “technology company on wheels,” strongly disagreed. He thinks, which likely was the case, that some people who recently sold off the shares were letting "some air out of the balloon," although all signs say that there’s "plenty of helium left," meaning that investors were merely taking some profits. As regards its trajectory back to the $968 level he said, "Maybe it will take a while, but when it gets back there, I bet it keeps climbing."

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