Two weeks after JPM predicted that the Tesla “going private” transaction was bunk and slashed its price target on the electric car maker by $113 to $195, overnight it was Goldman’s turn, and now that the bank is once again unrestricted from advising Musk on the imaginary deal, Goldman analyst David Tamberrino is out with a scathing reinstatement of coverage, which carries a Sell rating and a $195 price target.
Goldman’s investment thesis, or lack thereof, is familiar to those who have read the company’s report on Tesla in the past. And while the core issue remains Tesla’s cash burn and the “exhaustion of higher price point buyers “, what is notable is that Goldman now focuses on growing competition – the same risk we highlighted several months ago – as the biggest challenge facing Elon Musk:
We have removed the NR designation from TSLA shares. We add TSLA to the Sell List with a 6-month price target of $210. While we see the potential for a better near-term backdrop with growth in Model 3 production/deliveries driving positive FCF in 2H18, we believe this will likely not be sustained as working capital tailwinds abate and as spending ramps back up after a period of cash conservation. Further, we see the medium-to-longer term industry backdrop as challenging for Tesla’s products; this follows from an increasing number of EV launches from both traditional OEMs and other start-up competitors – at a time when the company’s product cadence hits a gap. Ultimately, we believe the intensifying industry dynamics combined with the phase out of the US Federal EV Tax Credit for Tesla customers – driving an exhaustion of higher price point buyers – could weigh on company gross margins and profitability. Altogether, we remain bearish on the company’s ability to execute, achieve its targeted production ramp/margins, and sustain FCF generation.
Goldman then focuses on the following 5 key points behind its bearish outlook:
- Electric vehicle competition on the come up … as Tesla product cycle takes a pause. With regional mandates and tightening CO2 standards, both traditional and new entrants are expected to launch several EVs in the coming years (Exhibit 2) – with a large crescendo in the early-to-mid 2020s. With Tesla not expecting to launch the Model Y until 2020 (and likely not ramp volume until 2021), we believe the company will see pressure to its lead in EVs as competition catches up.
- Demand / margins further tested as tax credit phases out. In addition to growing competition, TSLA will face the phase-out of the $7,500 US Federal EV Tax Credit beginning in 1Q19 – which has been a key point by sales associates when up-selling customers on the current offering of higher trim packaged Model 3s; as the incentive declines and base Model 3s are offered, we expect a downward trajectory to mix. Further, the loss of EV tax incentives has typically corresponded with declines in demand for EVs. We expect both to present challenges to TSLA hitting its gross margin targets.
- Balance sheet a concern. The company has seen net-debt balances increase each quarter – partly due to its on-balance sheet lease activities, but also as cash has declined. Customer deposits have helped keep the company above our estimate for minimum cash balance (i.e., a $2bn level given historical quarterly FCF burn of $1bn), but recently saw a sequential decline. With looming maturities on convertible debt (Exhibit 10), we believe the company would likely need to come back to the capital markets in 1H19.
- Estimates still well below the Street: Our 2018 through 2020 adjusted EBITDA estimates remain an average 19% below FactSet consensus expectations, largely from a slower demand cadence and lower forecast gross margin trajectory.
As a result of the above, Goldman sees downside to TSLA shares:
Our 6-month $210 price target (based on Automotive, Energy, and SolarCity segment valuations) implies 30% downside risk vs. 6% upside potential on average for our Americas Autos coverage. We believe investors that are looking to be long TSLA are essentially under-writing growth to approximately 3.5mn annual units by 2025 – which we believe will likely be challenging to achieve given incremental competition coming, current capacity levels, capex requirements, and historical operational execution.
As noted above, what is most notable in the latest report is Goldman’s focus on the changing competitive landscape as more and more EVs – many at lower price points – come on line. Here is the key excerpt:
While TSLA has developed a lead relative to OEM peers with respect to electric vehicle technology, we see increasing competition from new EV models launching from both traditional OEMs and new entrants leveling the playing field. This is coming as OEMs bring technologies to scale, battery pack costs decline, and the consumer payback period reduces. And while we still expect overall EV penetration to remain relatively low near-term, there is a multitude of new electric vehicles due to come to market on the back of increased spending (Exhibit 1-2). We believe this could lead to a more challenging demand environment and ultimately profitability trajectory for TSLA especially as the new models are launching across vehicle segments and price points – while TSLA has a slower launch cadence planned (historically a new vehicle every three years), and we believe the higher price point buyers for the Model 3 could be exhausted for TSLA by year-end. However, we recognize that timelines for some of these vehicle launches could be aspirational and execution issues could arise (from project funding, manufacturing issues, and/or market acceptance) from potential new-comers —driving less intense competition in the market.
Looking specifically at the products launching, Goldman points out that “we are seeing model variants across regions, product segments, and price points. This has come as battery electric vehicle (BEV) plans and launches have moved from being more niche at specific EV companies to increased investments from traditional OEMs focusing on launching EV models for mass production.”
Further, traditional OEMs are also launching a cadence pick up with multiple models and variants launching in succession, versus the slower launches typically seen from EV specific companies and startups.
And while the lower price point of the Model 3 should allow TSLA to be more competitive, it is still priced at a higher ASP than what is planned to be launched by many of the mass market models traditional OEMs and we believe this may come at a time where there is an exhaustion of higher price point buyers for EVs.
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In addition to the competition, Goldman also highlights the gradual phase out of of tax incentives in the future, which the bank says is somewhat exacerbating the competitive environment, to wit:
TSLA is losing the US tax credit ahead of competition, posing further challenges to affordability at a time when competition is intensifying. This comes as we still believe the higher up-front costs of EVs require an equalizer to match internal combustion engine (ICE) as the current price differentials (approximately $8k on a like-for-like basis comparing just propulsion costs) to ICE vehicles still put EVs out of the mainstream. Even with cost savings versus ICE powertrains, we estimate that the payback period today is approximately 10 years. We believe that the payback period needs to decrease to around 2-3 years for mass-market consumer adoption (similar to the payback period that drove rapid hybrid adoption in the mid-2000s).
However, we do not see that occurring until 2025-2030. Looking at cases where EV incentives were cut or reduced in the past, EV sales saw significant reductions. Notably, we saw this occur in both Denmark and Hong Kong where TSLA previously had high market penetration (Exhibits 5-6). Ultimately, we see similar risk as the US Federal EV incentives will begin to phase out at the end of 2Q18 for TSLA and will completely end by the end of 2019, as other OEMs and competitors launch models (Exhibit 7).
It is worth noting that while the phase out of US tax credits would drive an increased price point to potential Tesla customers, even with the Federal Credit, TSLA pricing remains above comparable ICE models. Given this, Goldman believes the phase out will particularly impact demand for TSLA’s higher priced models (Model X and S, and higher trim Model 3 offerings), while TSLA will begin offering a lower priced variant of the Model 3. This could further weigh on the company’s ability to hit its gross margins and profitability targets.
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Going back to the traditional complaints about Tesla, Goldman then focuses on the company’s balance sheet, and specifically its growing debt load. As a reminder, the company ended 2Q18 with a net-debt position of $9.2bn, up from $8bn at 1Q18 and $4.8bn at 2Q17, and gross debt of $11.6bn. This implies a net-debt leverage ratio of approximately 88x TTM adjusted EBITDA, increasing from 14x at the end of 2017. On our 2018E EBITDA this is a much lower 6.4x, however, it is still a relatively high level of leverage for an automotive company (most are net-cash, excluding pension obligations).
Further, the company has looming maturities of convertible debt – with a conversion price that is currently higher than the company’s current share price. When combined with the company noting that it does not want to raise additional equity capital to fund growth – and there is likely incremental capital needed to enter China, net-debt levels could likely increase going forward (dependent upon cash flow generation). This could add incremental interest expense that weighs on cash generation and adds more risk in our view.
Here, Goldman also notes that Tesla’s cash balance has been helped by its customer deposits –taking reservations for future product offerings in advance to gauge interest (i.e., the Roadster 2.0 and the Semi-truck) as well as for the currently offered Model S, X, and 3. However, the company’s cash balance less that deposit line item is now down to approximately $1.4bn – and has been declining sequentially each quarter from $3bn in 3Q17.
In light of the above, Goldman now expects that Tesla’s next capital raise will take place in the first half of 2019. It explains the math below:
That said, with the expectation for positive FCF in 2H18 (resulting from a large working capital benefit as the Model 3 production ramps), we do see the company ending the year with approximately $3bn in cash. However, as we expect growth capex to resume in 2019, in combination with incremental spending on new product development, and potential cash needs for debt-maturities (given conversion prices and the prevailing share price), we believe TSLA would likely need to come back to the capital markets in 1H19.
Finally, on the operational front, Goldman sees Tesla continuing to miss its production targets:
We increase our estimates minimally (2018-2020 Adj. EBITDA moves to $1,372mn/$2,821mn/$3,572mn from $1,367mn/$2,814mn/$3,572mn, and our EPS estimates become a loss of $7.12, a loss of $0.34, and +$1.86 respectively) as we update the model for incremental 10-Q details. However, we continue to forecast approximately 48k Model 3 deliveries in 3Q18 (vs. consensus of 55k) and for the company’s Model S/X 2H18 deliveries to achieve 45,500 units (vs. consensus of 54,800 and implied guidance of 56,000). When combined with our expectation for slower growth to the demand curve and some pressure to gross margins relative to the company’s targets, our 2018 through 2020 adjusted EBITDA estimates remain approximately 19% below the Street.
Which brings us to Goldman’s conclusion and why the company remains a sell:
We add TSLA to the Sell list with a 6-month price target of $210. Our price target is derived from our probability-weighted valuations for the Automotive segment ($185), Tesla Energy segment ($20), and the SolarCity segment ($5). For the Automotive segment valuation, we model our base case, a downside case, and three “disruptive” upside cases based on the potential upside to the EV market – similar to historical precedents. We then run P/E valuations off the five separate P&Ls, taking the average stock valuation from years 2019 through 2025 and discounting back to present at a 25% discount rate. For Tesla Energy, we value the potential ramp of the business through 2020E based on our forecast for the company’s gigafactory output, apply P/E multiples based off of earnings growth and a 1.2 PEG ratio, and discount back to the present. For the SolarCity segment, we model the business (PPAs and cash/loan sales) out to 2025E, apply peer average EV/EBITDA multiple to the business, and discount back to the present.
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