Tesla: A $500B Gamble On Autonomy (NASDAQ:TSLA)

Introduction

Last week, I downgraded Tesla, Inc. (NASDAQ:TSLA) ahead of its Q2 2024 earnings report, citing significant deterioration in its expected 5-year CAGR return after TSLA stock had rallied by >50% within three months despite little to no improvement in its earnings revisions:

While Tesla’s stock has completely reversed a 40% YTD loss in a matter of weeks, the entire rally in TSLA has been driven by trading multiple expansion, with very little improvement in consensus earnings estimates over the past three months.

Given Tesla’s delivery numbers for Q2 beat consensus estimates, one would expect to see a rebound in Tesla’s EPS estimates. While Tesla hasn’t been cutting prices recently, the EV maker has been incentivizing consumers with discounted rates [e.g., 0.99% APR offer on Model-Y] to boost sales volumes. This is probably why Tesla’s EPS estimates have failed to move up by much in light of its Q2 delivery beat.

For Q2, Tesla is projected to generate $24.70B and $0.62 in revenue and normalized earnings per share, respectively.

On the back of its vertical run-up from the mid-$100s to mid-$200s, Tesla’s weekly RSI has raced up from ~30 [“oversold”] to ~70 [“overbought”]. Clearly, the sentiment around TSLA stock heading into the quarterly print is bullish. While a positive earnings surprise and/or (more) robotaxi hype can trigger an upside breakout, Tesla’s stock appears primed for another technical correction, with the Q2 report likely to be a “sell the news” event.

As we have discussed previously, Tesla is set to experience slower growth and continued margin pressures for the next couple of years:

Our company is currently between two major growth waves: the first one began with the global expansion of the Model 3/Y platform and the next one we believe will be initiated by the global expansion of the next-generation vehicle platform. In 2024, our vehicle volume growth rate may be notably lower than the growth rate achieved in 2023, as our teams work on the launch of the next-generation vehicle at Gigafactory Texas.

Source: Elon Musk, Tesla’s Q4 2023 Earnings Deck

Not much has changed on the fundamental/economic side, so I do not expect any explosive surprises in Tesla’s Q2 report. The hype around the Tesla robotaxi has boosted sentiment around TSLA stock; however, with the robotaxi launch event already confirmed to have been pushed out to later in the year, momentum can unwind rapidly if Q2 earnings fail to justify lofty expectations.

Based on our long-term growth [25% CAGR growth for the next 5 years] and steady-state FCF margin [20%] assumptions for Tesla, the rally from $160 to $250 per share has rendered TSLA stock a “Hold” due to a significant deterioration in its long-term risk/reward.

Here’s my updated valuation for Tesla:

At our previous assessment ($160 per share), Tesla’s stock was undervalued by ~5%; however, at current levels ($250 per share), TSLA stock is overvalued by ~30%, and this is despite an increase in our fair value estimate for Tesla, which is up from $170 to $179 per share.

Assuming a base case exit multiple of ~25x P/FCF, I now see Tesla stock going from ~$250 to ~$433 per share over the next five years at a ~11.6% CAGR. Since Tesla’s 5-year expected CAGR return has dropped from ~21% to ~11.6% [well under our investment hurdle rate of 15%], I am downgrading Tesla stock to a “Hold” rating.

Source: “Tesla: A Significant Shift In Risk/Reward Calls For A Pre-Earnings Downgrade.”

With Tesla stock suffering a double-digit post-ER plunge, my prediction that Tesla’s Q2 earnings would be a “sell the news” event proved to be prescient.

In today’s report, we will review Tesla’s latest quarterly result, which, in my view, had more positives than negatives. We will also re-evaluate Tesla’s long-term risk/reward and technical chart to formulate an informed investment decision in light of the new information received from the Q2 report and earnings conference call. Let’s dive right in!

How Did Tesla Fare In Q2, 2024?

In Q2 2024, Tesla generated $25.5B in revenues, a new quarterly record for the EV giant. While +2% y/y top-line growth is nothing to write home about, Tesla’s return to positive y/y growth is significant, given that automotive revenues were down -7% y/y in Q2.

Over the past couple of quarters, I have been highlighting Tesla’s Energy Generation and Storage business as a potential source of strength, given the ongoing Megapack production ramp-up at Tesla’s Lathrop facility. Now, while management expects this segment to remain lumpy, Tesla’s energy business growing by 100% y/y in Q2 is mighty impressive. Furthermore, CEO Elon Musk believes this business could increase by 2-3x once the Megapack factory in China is completed:

For the energy business, this is growing faster than anything else. This is — we are really production constrained rather than demand constrained. So we are ramping up production in our U.S. factory as well as building the Megapack factory in China that should roughly double our output, maybe more than double — maybe triple potentially.

– CEO Elon Musk, Tesla Q2 2024 Earnings Call.

As I see it, Tesla Energy is going from strength to strength. Another bright light in Tesla’s report was its Services segment, which grew 21% y/y in Q2. As Tesla’s fleet grows, it is natural for the services business (revenues and profits) to expand. Hence, the service revenue strength isn’t surprising, despite ongoing revenue declines in Tesla’s auto sales.

Now, while Tesla’s automotive business is still in contraction on a y/y basis, the sequential uptick in automotive revenues and margins is being widely regarded as the start of a recovery for Tesla’s financial performance from the abyss of Q1 2024.

While Tesla’s delivery volumes fell ~5% y/y in Q2, the EV giant experienced a significant jump in deliveries on a sequential basis (+14.8% q/q). With deliveries outpacing production by ~33K, Tesla has successfully reversed a concerning inventory buildup and returned to positive free cash flow generation. As a TSLA investor, I am pleased with this inventory reduction!

Alright, so far, we have discussed all the positives from Tesla’s Q2 2024 financial numbers; now, let us discuss the negatives. As you might have observed, Tesla’s revenue beat [of ~3%] was accompanied by a -16% miss on consensus estimates for normalized EPS [$0.52, -43% y/y] in Q2.

Heading into the print, we had an inkling of this dynamic:

While Tesla hasn’t been cutting prices recently, the EV maker has been incentivizing consumers with discounted rates [e.g., 0.99% APR offer on Model-Y] to boost sales volumes.

Clearly, Tesla’s use of “attractive financing options” [indirect price cuts] boosted deliveries but hurt its unit economics [via reduction of ASPs].

Now, an even bigger impact on the bottom-line results came from a +39% y/y jump in operating expenses, spurred by increased spending on AI projects [FSD and Optimus] and Tesla’s workforce reduction from earlier this year.

Despite not being in an economic recession (yet), Tesla’s recessionary playbook [prioritizing unit sales at the cost of margins] is driving a drastic collapse in its earnings. And this dynamic could get worse in the event of a hard landing in the economy over the next 12-18 months.

Fortunately, Tesla has a solid financial foundation to navigate through a tougher macroeconomic environment, with $30.7B in cash and short-term investments sitting on its balance sheet.

As of now, Tesla is stuck between two major growth waves. However, cheaper models built on the Model 3/Y platform (with some aspects of Tesla’s next-gen vehicle platform) are on track to enter production early next year, and this means production volume growth could be just around the corner:

Yes, the robotaxi launch event getting postponed to October 2024 is a setback; however, Tesla looks primed for a growth and earnings recovery in upcoming quarters (barring a hard landing in the economy), a view supported by consensus estimates:

Overall, Tesla’s Q2 2024 report was quite mixed, but it could be the start of a turnaround for the EV giant.

Is TSLA Stock An Attractive Investment?

At ~$220 per share (~$700B in market cap), Tesla is currently trading at ~60x TTM P/E and ~90x forward P/E. Given Tesla’s single-digit revenue growth rate and collapsing earnings, such an elevated valuation multiple appears to be completely out of whack with the current financial realities of the business.

In recent quarters, Tesla has been losing market share across all three of its major geographies amid a drastic slowdown in EV adoption trends, and Tesla’s margin shrinkage has brought its operating margins to below auto industry average. While Tesla is much more than a car company, it’s financial profile surely resonates with one.

Interestingly, Tesla’s relative valuation premium over its auto industry peers has somehow lasted through this period of low growth and earnings contraction:

While Tesla investors could be looking towards cheaper models and the next-gen $25K vehicle (i.e., volume growth) to justify its premium valuation, I firmly believe that Mr. Market is pricing Tesla as an AI & robotics company (i.e., giving a lot of credit for futuristic projects like FSD, Dojo, and Optimus humanoid robot) and not an EV maker.

Here’s why:

• If Tesla were priced like an auto company at say ~10-20x P/E, assuming NTM EPS of $3, TSLA stock would be trading at $30-60 per share or $105-210B in market cap.

Looking at it from a different angle, without a high-margin AI/software business [FSD + Optimus], Tesla is probably worth less than $200B. Since Tesla’s current market cap is $700B, the market is essentially ascribing a value of $500B to autonomy!

As I see it, Tesla is a binary bet on autonomy, and Elon Musk seems to agree:

The value of Tesla overwhelmingly is autonomy. These other things are in the noise relative to autonomy. So I recommend anyone who doesn’t believe that Tesla will solve vehicle autonomy should not hold Tesla stock. They should sell their Tesla stock. If you believe Tesla will solve autonomy, you should buy Tesla stock.

Although the numbers sound crazy, I think Tesla producing at volume with unsupervised FSD essentially enabling the fleet to operate like a giant autonomous fleet. And it takes the valuation, I think, to some pretty crazy number. ARK Invest thinks, on the order of $5 trillion, I think they are probably not wrong. And long-term Optimus, I think, it achieves a valuation several times that number.

Source: Tesla Q2 2024 Earnings Transcript.

Solving autonomy is hard, but in my view, Tesla is heading in the right direction and getting closer in its endeavor, with miles per intervention apparently climbing higher and FSD 12.5 getting rave reviews from users!

According to Elon Musk, he has been too optimistic about the timeline for achieving autonomy, but as of now, he expects Tesla FSD to reach full autonomy by the end of next year:

When I laid out my bullish investment thesis for TSLA stock at ~$180 per share earlier this year, I wrote the following:

In 2023, Tesla produced 1.8M vehicles and exited the year with an annualized production run rate of 2M vehicles! And, unlike most of its EV competitors (legacy auto and pure EV startups), Tesla is making billions of dollars in free cash flow making electric vehicles.

Like Tesla’s management, I don’t know how much of its serviceable-addressable-market Tesla has already captured in its automotive business. However, I the growth runway for Tesla is very, very long. The world’s transition to renewable energy is inevitable, and so is electrification of the auto market. As of 2023, EVs make up 9% of total auto sales globally, and this number will continue to rise for several years to come.

Hence, Tesla may not grow rapidly over the next couple of years, but this incredible growth story has many more chapters to come.

Furthermore, Tesla’s Energy Storage business has incredible momentum and an even longer growth runway ahead of itself. As I shared earlier in this note, Tesla’s services (& other) revenue is becoming a meaningful piece of the business, and this segment should continue to record strong growth as Tesla’s fleet size increases and in general growth of the EV market [remember all major auto manufacturers are adopting Tesla’s charging standard, with Tesla opening up its supercharging network to other auto OEMs].

In addition to these tangible businesses, Tesla is also developing ambitious futuristic projects like FSD (full self-driving), Optimus (humanoid robot), Dojo (AI chips), etc. While the outcome of these ambitious projects is uncertain and success is far from guaranteed, Tesla could potentially generate hundreds of billions of dollars per year if all or some of these projects were to work out.

Let me share some napkin math on the potential of FSD as a recurring revenue business for Tesla:

• As of Q4 2023, Tesla has ~400K FSD users in North America (with a total fleet of 5.7M vehicles, i.e., an attach rate of ~7%.
• While I do not have data on the split between upfront ($12K) and FSD subscriptions (Basic autopilot: $199 per month, Enhanced autopilot: $99 per month); let’s assume this ratio is 50:50 for the purpose of this exercise.
• Over the next five years, I see Tesla’s vehicle fleet growing to ~20-22M vehicles (considering the next-gen vehicle’s launch in 2026). If FSD reaches full ‘L5’ autonomy by then, I think attach rate could easily rise from 7% today to ~25% in the long run [and this could prove to be conservative].
• Furthermore, Musk has repeatedly claimed that FSD reaching full autonomy will boost the price of each Tesla to ~$100-200K, which basically means the value of FSD would likely ~10-15x from current price of $12K. Let’s assume it only goes up by ~5x. In this scenario, Tesla could potentially extract ~$1K per month from each FSD subscription (depending on use for ride hailing in idle time).
• Considering the 50:50 split between upfront and FSD subscriptions, a 25% attach rate (5M FSD users -> 2.5M FSD subscriptions) would result in FSD generating ~$30B in annual recurring revenue just via subscriptions! I am not even considering the upfront FSD sales numbers, and I think my assumptions are conservative. Imagine Tesla’s fleet growing to 100-200M vehicles over the long run and attach rates rising to 50-90%!
• More importantly, FSD is likely to command software-like margins. Hence, FSD could very well become Tesla’s primary profit center if full autonomy can be achieved.

Again, this is just some napkin math, but it shows how FSD could be an absolute game changer for Tesla.

Source: “Tesla: Learn From The Past, Think Of The Future (Rating Upgrade).”

Now, I understand that FSD could need a few more years to reach full autonomy, and it may fail to do so due to technology and/or regulatory hurdles. However, Tesla FSD moving from Supervised to Unsupervised will be the equivalent of Apple’s iPhone or Nvidia’s GenAI moment!

As an investor, ignoring Tesla FSD would be a grave mistake. While I don’t factor in any revenues from FSD into my valuation model to instill a margin of safety there, our steady-state free cash flow (“FCF”) margin assumption is based on Tesla building a sizeable AI/software business. For now, I am not considering Optimus and other projects like Dojo into my modeling. If those moonshot projects pay off, I will be happy to have received them as free embedded options for buying/owning Tesla stock!

Tesla Fair Value And Expected Returns

While Tesla is set to experience slower growth and continued margin pressures for the next couple of years, we must continue to take a long-term view of the business to determine its fair value. As such, I am sticking with our long-term growth and steady-state margins assumptions.

On the back of a double-digit post-ER decline, Tesla has lost a bit of its froth and moved somewhat closer to our fair value estimate of ~$180 per share.

Assuming a base case exit multiple of ~25x P/FCF, I see Tesla stock going from ~$220 to ~$436 per share over the next five years at ~14.7% CAGR.

Considering Tesla’s recent financial performance and uncertain business outlook, I view Tesla’s near-term risk/reward as skewed to the downside. However, Tesla’s 5-year expected CAGR return has moved up from ~11.6% to ~14.7% after last week’s stock price decline, which is roughly in line with my investment hurdle rate of 15%. Hence, Tesla is a modest “buy” under our valuation process.

TSLA Stock Technical Setup

From a technical standpoint, Tesla’s bullish momentum is still intact despite its post-ER pullback, as TSLA stock is still trading above a confluence of key moving averages, i.e., 10-week, 20-week, 40-week, and 100-week. In my view, the $185-210 range should serve as a strong support for the stock, with the rising trend line connecting bottoms from 2020, 2022, and 2023 (marked in yellow dotted line) providing secondary support at ~$165. This seems like a decent buying area for long-term investors.

Now, if TSLA stock starts breaking down below $160-165 again, then we could see another leg down into the low-$100s. Such a decline would likely materialize in the event of a hard landing in the economy. Tesla is currently investing billions of dollars into its ambitious AI projects. However, if its core businesses were to become unprofitable during a recession, the company could have to pull back on its autonomy investments due to lack of capital. A failure or perception of failure on autonomy can relegate TSLA stock to an auto industry P/E multiple, i.e., $30-60 per share.

Concluding Thoughts

Barring a recession, Tesla’s financial performance should continue to improve in upcoming quarters. However, as we have seen in this article, Tesla’s near-term financials have little to do with its valuation. Tesla is a binary bet on autonomy, and only investors with a long-term horizon and a stomach for volatility should consider allocating capital to Tesla at current levels.

In my view, investors with a 1-2 year investment horizon should continue to avoid Tesla. On the other hand, I like the idea of restarting accumulation for investors willing to look beyond a couple of years due to Tesla’s favorable long-term risk/reward. At my investing group, we like to operate with a 5+ year time horizon, which is why we will restart slow, staggered accumulation in TSLA stock at our next bi-weekly deployment. To be clear, we understand that Tesla could drop more than 50% from current levels in the event of a hard landing. The plan is to dollar-cost average for the next couple of years even if Tesla keeps spiraling lower during this low-growth period for the EV giant.

Key Takeaway: In light of its Q2 2024 report, I rate Tesla a modest “Buy” in the low-$200s, with a strong preference for slow, staggered buying over the next 12-24 months.

Thanks for reading, and happy investing. Please share your thoughts, concerns, and/or questions in the comments section below.