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Correction or Crash? Our Verdict on Tesla

It might be a new year… but some high-profile companies are still battling the same old problems they were at the end of 2014.

Take automaker Tesla (TSLA), for example.

On the one hand, Tesla, the car company, is still humming along nicely, delivering new vehicles, rolling out upgrades to its older models, and moving forward with its new battery “gigafactory” in Nevada.

But then there’s Tesla, the stock. Shares have suffered in recent months, tumbling from an all-time high of $291.42 on September 4 to $196 as I write this.

What gives? Is Tesla crashing or just hitting the brakes? Let’s take a look…

Tesla Speed Bump #1: Who Needs an Electric Car When Gas Is This Cheap?

As gasoline prices have seen a huge drop in recent months, so have Tesla shares.

After all, when gas is so cheap, who needs an electric car?

Moreover, what if gas prices stay cheap for the foreseeable future? Saudi Prince Al-Waleed bin Talal is on record as saying that oil will “never” see $100 per barrel again.

Gas prices are a legitimate concern for Tesla, in addition to building out the electric car infrastructure.

But there’s a bigger point here…

Regardless of gas prices, with the average price for a Tesla car over $100,000, they’re hardly geared towards budget-minded buyers. The cars sell because they’re ridiculously cool.

Current Tesla buyers aren’t seeking refuge from gas prices. But the common consensus is that to really grow its business, Tesla needs to develop more affordable cars for the mass market.

It seems Tesla investors are judging the company’s future on what may or may not be a short-term decline in gas prices without remembering that gas prices can move up, too.

Tesla Speed Bump #2: General Motors Is Making an Electric Car

Another seemingly negative piece of news for Tesla shares is General Motors’ (GM) announcement that it will produce an all-electric car with a competitive mileage range.

At the Detroit Auto Show, Chevrolet introduced a concept of the Chevy Bolt – which it claims will travel 200 miles on a single charge and will be priced under $30,000 (after accounting for a $7,500 credit, of course). The car is aimed squarely at Tesla’s planned Model 3, which is touted as the vehicle that will take Tesla from the realm of “supercar” into the mainstream market.

However, why GM’s announcement should put such pressure on Tesla shares is mystifying. It’s no surprise to see larger automakers dip into the electric car business, as technology improves and makes the cars accessible to more consumers.

Competition in any industry has always existed – and is to be expected. Only a fool would have bought Tesla stock thinking they’d have the electric car market to themselves.

In fact, at the very same auto show where Chevy unveiled the Bolt, Tesla CEO Elon Musk cajoled the big automakers into boosting their investment in electric vehicles. And long before that, he made his company’s technology free to all comers, in hopes of jump-starting development.

He didn’t do this out of pure philanthropy.

He knows that getting bigger players into the market will accelerate R&D spending. In turn, this will lower the cost of electric vehicles, increase battery-charging facilities, and enhance overall acceptance of electric vehicles for the masses. So Chevy’s move is actually good for Tesla.

And it’s far too early to say whether the Bolt will be successful. After all, GM has overpromised and underdelivered before.

Tesla has another advantage here, too.

The crux of electric car adoption hinges largely on reducing the cost of batteries and their power capabilities. Tesla is at the forefront of this movement. While electric cars have been around for years, good electric cars are very recent. And Tesla is learning how to extend battery ranges and bring down costs – not just from current manufacturing technologies, but from data the company gets from its existing fleet.

In fact, Tesla just announced that owners of its older model can upgrade and extend the battery range by 40% or more. This comes from a combination of better battery technology, better understanding of aerodynamics, and better tire design. We can expect to see other improvements in the future.

Tesla Speed Bump #3: Tesla Doesn’t Make Any Money… And Doesn’t Plan to Soon

The real threat to Tesla’s stock price (although not to the company itself) came in part of Musk’s speech at the Detroit Auto Show.

He said he doesn’t see Tesla being profitable until 2020 when Tesla hits its capacity of 500,000 vehicles at its current plant, in addition to assembly plants in Europe and Asia.

It finally seems to be dawning on investors that it’s going to take a lot of time and new capital to get Tesla near the level of production necessary to justify the current share price.

But how much capital will the business need? And what return will new investors demand to supply it? The irony here is that the higher the share price is, the higher it can go. Why?

Because a high share price means the cost of capital will be lower. For example, raising $1 billion on the current equity capital base of $25 billion is much less dilutive to existing shareholders than raising that amount on half the equity base or less. In addition, debt financing becomes cheaper.

So the higher Tesla trades, the more likely it will be to stay high. By contrast, if it continues to decline significantly, the downdraft could compound itself, as the additional necessary capital becomes more expensive.

The Verdict on Tesla

Tesla has a bright future, but the stock is currently too pricey, given how much it still has to accomplish.

To put the situation into perspective, Tesla shipped 1.5% as many cars as Ford (F) last year… but has almost half of Ford’s stock market value. Next year, if Ford stays flat, Tesla’s percentage will rise to 4% of Ford’s total. Impressive, but still not a level that justifies a market value that’s half of Ford’s.

Bottom line: Tesla isn’t going to fail. But even with its share price decline, now isn’t the opportunity to buy its shares at an attractive price. Look for the company to either accomplish more, or for its share price to retreat further before considering an investment.

To living and investing in the future,

Greg Miller

Greg Miller

, Senior Analyst

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