In an environment of volatility, it is usually the high beta stocks (a stock rating that determines the price movement of a stock against a benchmark index, like the S&P 500) that decline the most in valuation.
In the trading session at the end of May, Tesla Motors Inc (NASDAQ:TSLA) got pummeled and declined by 6.85%. The stock currently trades at around an $11.6 billion market capitalization. The company’s valuation is starting to be tested by the broader market.
Defining the value of Tesla’s business
Elon Musk believes that the company will report a 20% gross margin even without fuel credits. It excludes subsidies but relies partially on tax credits provided to consumers. That being the case, the company will be selling 21,000 units of the Tesla Model S, which is currently sold at $77,400. Therefore the company will generate $1.625 billion in revenue by the end of the year.
Ford Motor Company (NYSE:F), General Motors Company (NYSE:GM), and Honda Motor Co Ltd (ADR) (NYSE:HMC) all operate within the 3.2% to 5% net profit margin range. But because Tesla Motors Inc (NASDAQ:TSLA) business model is aimed at a more affluent customer base, the company could eventually generate higher net profit margins as a result of the higher average selling price.
Analysts on a consensus basis anticipate that the company will generate a net profit margin of 5.16% by 2014. However, these net profit margins could improve as the company ramps up the production of its vehicles. The company plans to increase the size of its manufacturing facilities by expending an additional $200 million on its manufacturing capabilities.
Sustainable business strategy
In its latest quarterly earnings announcement, the company was able to reduce the build times on its cars by 40%, thus reducing labor costs by 40%. Labor costs are a large component in the cost of manufacturing. It is highly likely that the company will continue to improve the efficiency of its manufacturing process, which will in turn increase the amount of profit generated.
The company also plans to expand the size of its manufacturing and store footprint. This business strategy is likely to be hugely successful. The reasoning is that Tesla Motors Inc (NASDAQ:TSLA) is selling its cars in showrooms around the country in prestigious mall locations, making them easily accessible; I actually went to one of Tesla Motors showrooms at the Scottsdale Fashion Square Mall. The retail strategy is proving effective as malls are known to attract wealthy consumers with deeper pockets. According toMacerich Co (NYSE:MAC), the average mall customer has an average household income of $73,000. So it is highly likely that the showroom concept Tesla Motors is currently pursuing is going to be effective at generating sales.
Tesla Motors product strategy
Currently Tesla Motors is pulling ahead of the competition, which includes Ford and GM. The Tesla Model S is a far superior product, offering 208 miles in range per charge. The Ford Focus Electric, by comparison, only has a 76-mile range, though it is also priced at approximately $38,000, which implies that it could potentially attract lower-end electric vehicle customers.
Ford is planning on increasing its commitment to electric vehicles by making sure all of the technicians at its dealerships are certified to work with electric vehicles. Currently, Ford dealerships are starting to install electric charging stations to help make long distance travel much more feasible. The company plans to increase the range and efficiency of its cars, but it seems that Tesla Motors is well ahead of the curve. That’s not to mention that the Tesla Model S is a much more attractive vehicle than the Ford Focus Electric.
The GM Volt, on the other hand, doesn’t even bother with being a full electric vehicle; it’s more of a gas-and-electric hybrid. This makes the company’s product pretty uncompetitive in comparison to Hyundai Sonata Hybrid and Ford’s Fusion Hybrid. The two car companies are doing a better job of selling cars in the niche then GM is with its Volt.
General motors is going with the ultra-cheap plan. It has recently introduced the Chevrolet Spark Electric 2014 model to the world. The car is cheap, at a surprising $20,000, and offers an 82-mile per charge range. Currently, the Spark is available for order in limited quantities across participating dealers in California and Oregon. The Chevrolet Spark is ridiculously small, and it looks similar to the Smart for Two. The car looks hideous, but it wins the cheapest electric car of the year award by a long shot. I am not sure how the American market will respond to this car, but it seems Tesla is also pursuing lower-end cars too.
Elon Musk plans on capturing an even larger percentage of the electric vehicle market with a third-generation car at $30,000 in three to five years. With a 208-mile range if not more and a host of fuel charging stations, the company could effectively shut larger competitors out of a lucrative market for high-end and perhaps even lower-end electric vehicles. If that is the case, we have to come up with an even broader assumption as to Tesla Motors Inc (NASDAQ:TSLA)’s future revenues.
Let’s not forget that Tesla Motors Inc (NASDAQ:TSLA) has a better distribution strategy than the dealership model imposed by ToyotaToyota Motor Corporation (ADR) (NYSE:TM), Ford, GM, and Honda. The fact is dealerships are expensive to operate and cannot be opened and closed as rapidly as showrooms in malls. Also, selling a Tesla car in a show room and shipping it directly to the customer is pretty practical in light of the capital constraints Tesla Motors currently faces.
Future valuation
The total number of cars that Tesla is projected to sell will be approximately 65 million according to Scotiabank. Because Tesla Motors is planning on becoming a global player over the next five years, it is highly likely that the total number of vehicles Tesla will sell will capture at least 1% of the global market for vehicles by 2018. This means that TeslaTesla Motors Inc (NASDAQ:TSLA)motors will sell at least 650,000 vehicles. Assuming that 10% of those sales are Tesla Model S and the remaining are the $30,000 model, the company will generate $234 million net income from the model S, and the $30,000 model will bring in about $877.5 million. Combined, Tesla Motors can generate $1 billion in net income by capturing 1% of the total market for vehicles.
Capturing 1% of global market share can be accomplished by targeting markets that are dense with high income. This includes the South Asia Pacific, certain regions of the United States, certain regions of Europe, and some of South America. If the company were to represent 2% of global vehicle sales, the company’s net income would double to $2 billion. Therefore, the $11.6 billion valuation is reasonable.
Companies always trade at a premium over earnings growth. So when Tesla Motors is making $1 billion it is highly probable that the stock will still be trading at an above-average price-to-earnings multiple. My guess is the P/E multiple will be in a range of 20 to 30 times. This implies that the stock could be trading at around a $20 billion to $30 billion market capitalization over the next five years.
Conclusion
I believe that Tesla Motors Inc (NASDAQ:TSLA) should be bought during this dip. Assuming a $20 billion to $30 billion market capitalization in the future, the stock could be considered cheap in light of the future growth potential of electric vehicles. That being the case, over the short term this stock’s beta is extremely high. So if the stock market were to decline by 5% to 10%, the value of the stock could decline by 15% to 30% in a matter of weeks.
The short-term correction should be seen as a potential buying opportunity in the hopes that the company grows into becoming a five- or ten-bagger over the next ten years.
I anticipate that there will be a lot of negativity surrounding the company in the next few weeks while the stock is declining. It would be better to focus on the long-term and to ignore the short-term chatter.
Alexander Cho has no position in any stocks mentioned. The Motley Fool recommends Ford, General Motors, and Tesla Motors . The Motley Fool owns shares of Ford and Tesla Motors.
The article Buy Tesla Motors on the Dip originally appeared on Fool.com.
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