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I Can’t Justify Tesla Motors Inc (TSLA)’s Valuation

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Tesla Motors Inc (NASDAQ:TSLA) CEO Elon Musk thinks the company can produce 21,000 cars this year. Though this is certainly an impressive achievement, it pales in comparison with the 500,000-vehicle production rate Musk recently told Bloomberg he thinks Tesla Motors Inc (NASDAQ:TSLA) can achieve at some unidentified point of time. Easier said than done. The scenario is definitely probable if Tesla really can introduce an electric vehicle in the $30,000 range, as Musk has suggested the company can do in as little as three to four years. Though it’s a big what-if, it’s fun to speculate exactly what kind of money the company could be earning if this scenario came to pass.

Tesla Motors Inc (NASDAQ:TSLA)

Fudging the numbers
Producing 500,000 cars per year, Tesla Motors Inc (NASDAQ:TSLA) could earn about $880 million in operating income annually. That means at today’s price, Tesla could be trading at just 15.7 times the company’s earnings potential at a 500,000-car production rate. Comparatively, Ford Motor Company (NYSE:F) trades at 10.6 times operating income.

I arrived at 880 million in operating income by making several assumptions:

  • Tesla sells 500,000 cars per year.
  • Tesla will eventually sustain a gross margin of at least 25%.
  • Zero-emission-vehicle credits will cease to benefit Tesla’s top line.
  • Average selling price will decline to about $40,000.
  • Revenue from development services will grow in proportion to automotive sales.
  • Operating expenses will decline to 30% of revenue (still about three times higher than Ford’s) as the company scales its operation.

Obviously, this model has been drastically simplified, and estimating something this far out into the future has very poor chances of being even close to correct. Even worse, I have no timetable for when Tesla Motors Inc (NASDAQ:TSLA) could reach 500,000 cars annually. But the exercise does add some perspective.

Is it realistic?

Though Tesla may be able to attain a 25% gross profit martin by the end of 2013 on sales of the Model S, is it likely the company can sustain such an impressive gross profit margin when it starts selling a car in the $30,000 range? That’s tough to say — $30,000-$40,000 is a huge drop from the Model S prices ranging from about $70,000 to $80,000 and about $95,000 for the Model S performance

So taking things down a notch and estimating a 17% gross profit margin, close to Ford Motor Company (NYSE:F)’s first-quarter outcome, Tesla Motors Inc (NASDAQ:TSLA) trades at just 25 times estimated 500,000-car production rate operating income.

Twenty-five times future operating income doesn’t sound too bad for a growth stock, but there are just too many uncertainties involved in this math. When you find yourself fudging the numbers to estimate an outcome, projecting turns into pure speculation.

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