Tesla: Fair Value Still Below Current Price (NASDAQ:TSLA)

Not long after my last article where I explained why Tesla (NASDAQ: TSLA) from around $220 was to be avoided at all costs, but the stock lost nearly 50% in such a short period of time. Everything is me I argued before, I still think so, but I realized that I was wrong: I was too positive in my assessment. Despite the 70% collapse overall, Tesla is still highly valued.

Herd mentality

The expansionary monetary policy of the past few years has literally given confidence to anyone who decides to invest in the stock market. No skill mattered, and sometimes it was enough to pick a random tech stock to make very good profits for a few months in 2020 and 2021. Companies that had been losing money for years suddenly became the opportunity of a lifetime, and companies from the “innovative” sector were so promising that people even invested in them with leverage. This general overconfidence was a driving factor in stock markets until the end of 2021, when the Fed decided to fight inflation with tight monetary policy.

From this point on, all companies with little or no value lost a lot of their value, but in my opinion, there is still a long way to the bottom. But where did all the hopes for the companies that will write our future go? Wasn’t Tesla supposed to grow indefinitely, led by a charismatic CEO?

I think the truth is that these companies have never been very promising, and Tesla is no exception. Herd mentality ruled the day, and so did FOMO. As of today, these companies face the harsh reality that expected future cash flows do not justify 2021 prices.

As far as I’m concerned, I think Tesla was the worst case because it became practically impossible to discuss it without insulting it, which was a very strong signal that a stock was under heavy speculation. In general, the average Tesla investor’s argument is that electric cars will be the future, and therefore Tesla will be the future, but without considering that Tesla is not the only company selling them, it’s just one of them. the first to do so. It’s the same rationale that drove the tech company bubble in the early 2000s: The Internet is the future, and all tech companies are the future. Basically, it’s true that the Internet is the future, but how many tech companies from the 2000s are still around today?

By this I’m not saying that Tesla is doomed, but investing in electric cars as the future is completely wrong, especially considering the industry in which it operates. Much of Tesla’s revenue comes from car sales, which has historically been a very competitive industry. That doesn’t mean never invest in a Tesla, but buy it when it’s undervalued and not at any price, “because it’s built for the future.”

It’s true that Tesla hasn’t felt the brunt of the competition in recent years, but how long can that last? Is it really possible for automakers with decades of experience to make electric cars that are less attractive than Tesla? In my opinion, this is impossible, and the sharply declining market share is proof of this. New affordable electric vehicles are becoming a reality and there are more and more options on the market. However, despite everything, Tesla remains the most important car company in the world, despite the sharp decline it is facing. At least in terms of market capitalization.

In any case, I don’t see how a car company selling cars for a minimum price of $43,990 can do well in a climate of rising interest rates, potentially accompanied by a recession. Plus, compared to other automakers, Tesla’s value is noticeably off the scale in my opinion, and it’s not reasonable to believe it’s sustainable. How can one car manufacturer be worth almost as much as every other car manufacturer? This is simply absurd.

The first slowdown in demand is already visible and is coming from the US and especially from China, the largest market for electric vehicles. Previously, there was a $7,500 discount and 10,000 free Supercharger miles for those who bought a Model X or Model S before the end of the year, while the Model 3 and Model Y were slashed in China. up to 9% in addition to subsidy for insurance costs. Chinese automakers are becoming more and more competitive, and if Tesla wants to compete, it will definitely have to lower prices and thus lower its profit margin per car sold. In my opinion, this is a sign that Tesla’s competitive advantage is slowly disappearing due to extreme competition in the industry.

Doubts about Elon Musk

One of the reasons why everyone began to believe in Tesla was the charisma of its leader, Elon Musk, one of the most famous controversial figures in the world. At the height of the speculative bubble, it literally only took one tweet to see Tesla’s share price skyrocket.

At first, I believed that Tesla’s CEO was its greatest asset. However, there are a few situations that have made me rebut my original opinion so far. There are mainly three reasons.

He is selling his stake in Tesla

Musk has been selling his stock for months now, and that’s certainly a factor to consider.

The confidence in the CEO is also reflected in the operations of the company he manages, and it is certainly not encouraging to see that there are only sales and no purchases. This is not to say that the CEO of a company cannot sell any shares, but selling so much in such a short period of time raises legitimate doubts among shareholders. His attitude was one of the reasons why Tesla lost almost 50% in just a few weeks. He recently announced that he will not sell any more shares until 2024. We’ll see if that’s the case. It has already said it will stop selling shares to finance a deal to acquire Twitter in April 2022.

The market capitalization goal doesn’t convince me

When I read the transcript of the Q3 2022 earnings call, I was very surprised by Musk’s words about his market cap targets. In my opinion, they are not only highly unrealistic, but also out of context:

And a few years ago, I said that I thought it was possible that Tesla was worth more than Apple ( AAPL ) , which was the highest-cap company in the market at the time, on our earnings call. At that time I think it was around $700 billion. I said it would take incredible execution, at least a bit of luck, and we just didn’t get it.

Tesla, in fact, went or passed the market price of Apple at the time. And now we think we can greatly exceed Apple’s current market value. In fact, I see Tesla potentially way more valuable than Apple and Saudi Aramco. Now, that doesn’t mean it’s going to happen or it’s going to be easy.

In fact, I think it will be very difficult. It’s going to take a lot of work, some very creative new products, managing expansion, and always a bit of luck. But this is the first time I see — I see a way for Tesla to — let’s say, almost double the value of Saudi Aramco (ARMCO). I don’t think I’ve seen it yet.

In my opinion, market capitalization targets are not very meaningful because they are not relevant in the long term, since the latter mainly depends on how much the company can earn. Profit and free cash flow are the only things that matter, market capitalization is the result. Moreover, comparing Tesla to Apple and Saudi Aramco based on market capitalization is completely out of context because the comparison doesn’t hold up at all. Let me give you a chart so you understand what I mean.

Click to enlarge

Based on this data, do you see a potential scenario where Tesla could be worth as much as Apple and Saudi Aramco combined? What I see is that Tesla is still overvalued at a market cap/FCF of 43.16 and even being worth $1 trillion in 10 years would be a huge feat given the industry it operates in. This is what matters in the long run. free cash flow generated, so I don’t understand the purpose of the market cap other than to hype up Tesla fans.

Twitter acquisition creates disruption for Tesla

Tesla shareholders were unhappy with the Twitter acquisition because it adds additional responsibilities to their CEO, who must run Space Xi in addition to those two companies. Moreover, it is necessary to take into account that the purchase of Twitter was financed by the sale of Tesla shares by Musk. negative signal to shareholders. I have no doubt that Musk can handle this as best he can, but the concerns are valid. Compared to last year, his attitude toward Tesla is changing, and shareholders are feeling it.

How much is Tesla worth?

In my previous article, I already calculated my fair value for Tesla, but I think I need an update after about three months. I previously calculated a fair value of about $110 in the most likely scenario. I believe I am very positive so far. True, I had reached my price target a few days ago, but I did not expect such a sudden change in sentiment. My impression is that the perception of the Tesla brand is changing, and certainly not helped by strong competition.

The new fair value will still be calculated using discounted cash flows, but obviously the inputs will change.

• Because Tesla has negative net debt, the WACC will equal the cost of capital. The latter will be calculated with a beta of 1.91, a Country Market Risk Premium of 4.20%, a Risk Free Rate of 4% and additional risks due to competition of 1%. The result is 13%, quite high, but justified in my opinion. Investing in Tesla is risky and it is reasonable to demand a return above the market average.
• Free cash flow for 2022 reflects the estimate of TIKR Terminal analysts. From 2022 to 2025, I’m looking at only 5% growth because I expect an economic slowdown where companies like Tesla, which are very sensitive to the business cycle, will be the main losers. How many people can afford expensive cars during a recession?
• From 2025 to 2031, the growth rate of free cash flow will be 15% according to my calculations. This is a very positive assessment in my opinion and I am open to a downward revision in the future.
• Net debt and outstanding shares were acquired through the TIKR Terminal.

In light of all these considerations, Tesla’s fair value is only $49.21 per share. It was a very high but in my opinion inevitable discount rate based on valuation. Certainly, the growth rates included are not consistent with those of the past, but it is also important to note that this model assumes stable and increasing free cash flow, which is virtually impossible in the auto industry. In short, the actual growth may be higher than the input, but I doubt that Tesla can have such stability in making money by operating in the auto sector.

In general, I see Tesla as the epitome of a speculative bubble after a massive stimulus to the economy. Like all bubbles, they burst sooner or later, and that’s what’s happening now with Tesla. Although I think $50 is a fair price, I personally would not invest at that price because I believe there are better opportunities on the market right now. Tesla mania is over, and there’s hardly a tweet to save the day.