Tesla: A Significant Shift In Risk/Reward Calls For A Pre-Earnings Downgrade (NASDAQ:TSLA)

Introduction

In light of its Q1 2024 report, I reiterated Tesla Inc. (NASDAQ:TSLA) as a “Buy” at $160 per share, citing its future growth prospects and compelling long-term risk/reward [5-year expected CAGR return of 15%+]:

Based on fundamentals and technicals, I view Tesla’s near-term risk/reward as skewed to the downside. 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: I rate Tesla a modest “Buy” at ~$160 per share, with a strong preference for slow, staggered buying over the next 12-24 months.

Source: Tesla: Weak Q1 Report, But Cheaper Models Give Hope

Since then, Tesla’s stock has rallied up by ~55% in just about three months!

Two big catalysts that have powered this move in TSLA are –

1) Elon Musk winning the shareholder vote on his $56B compensation package, i.e., removal of risk associated with Musk moving AI/robotics away from Tesla; and

2) Tesla recording better-than-feared delivery numbers for Q2 2024 [plus announcing a record high quarterly deployment of energy storage products: 9.4GWh]

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 seems to have reversed some of the recent inventory buildup, as projected by Tesla’s leadership last quarter. As I see it, the inventory reduction will help propel Tesla’s FCF generation back into positive territory.

Now, Tesla is all set to report its Q2 numbers in after-hours on July 23; however, after going up from $160 to $250 per share in a flash, is TSLA stock still a “Buy”? Let’s find out!

Tesla’s Updated Risk/Reward

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.

In light of its recent run-up, Tesla’s long-term risk/reward has deteriorated significantly. Considering its recent financial performance and uncertain business outlook, I view Tesla’s near-term risk/reward as skewed to the downside. At TQI, we have paused the accumulation of Tesla shares ahead of its Q2 report, and I have no plans to get off the sidelines until TSLA’s 5-year expected CAGR rises above 15%.

Key Takeaway: I rate Tesla a “Hold” at ~$250 per share.

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