British investment bank Barclays PLC (LSE:BARC, Financial) has downgraded Tesla Inc.'s (TSLA, Financial) stock ahead of the automaker's July earnings date.
In a note released to the public, Barclays' equity research team said its "experience covering TSLA has made us well aware of the potential for TSLA's stock movements to be driven by more than fundamentals... In fact, we have at times been willing to be more generous with our target multiple given the belief that TSLA is far more likely to get the more than a carmaker treatment by the market, with support from different pockets of the investment community, including retail and momentum investors."
Although Barclays' team raises numerous valid points, a counter argument reveals a few fault lines.
Operational review
Tesla's business model continues to provide resilient results despite an economic wobble, as illustrated by the 24.38% year-over-year revenue growth realized in its latest operating quarter.
Many analysts seem worried that Tesla will need to slash its product prices to continue receiving government subsidies. Moreover, many investors are concerned about the economic environment and how that could play out in the durable goods space. However, Tesla has proven it is a secular company that grows no matter the challenge, which, coupled with its continuous innovation, invites an argument that it can augment further progress.
Further, a widely ignored topic among analysts and investors alike is the softening input cost environment. Among the electric vehicle makers, Tesla is set to benefit the most from receding commodity prices and lower wage demands given its asset-heavy business model, which includes numerous Gigafactories.
Expanding on the argument above, prices of aluminum, plastic and titanium have all settled lower in recent quarters. They will likely continue to trend lower as post-pandemic supply and demand factors resume their leveling-out process. Moreover, freight costs are more compelling than in recent years, allowing Tesla and its suppliers to deliver more affordable products.
In essence, the question now becomes: Will Tesla's recent price cuts diminish its profitability? The most likely answer is no because other factors will offset such headwinds.
New market and potential synergies
Tesla's expansion into energy generation and storage is an aspect that investors should keep close tabs on. The segment delivered $1.53 billion in quarterly revenue during Tesla's previous reporting period, which adds up to a 148% year-over-year increase, illustrating the potential of the business.
The allure of Tesla's energy business is not confined to its financial benefits. Instead, prospects for synergies exist. For instance, a customer purchasing Tesla's solar systems might later opt to extend their budget and acquire a Tesla vehicle.
In addition, the segment lends Tesla an opportunity to develop a profitable unit that enables technology sharing with its EV segment, allowing for more succinct research and development processes throughout the value chain.
Tesla's energy generation and storage business will play a critical part in ensuring it sustains its growth amid more burdensome government subsidy vetting processes and industry fragmentation within the electric vehicle space.
Valuation
Tesla will naturally trade with elevated price multiples during its tenure as a growth stock. Therefore, a relative comparison to its industry peers and its past valuation is probably the best way to value the stock.
According to GuruFocus, Tesla's price-earnings ratio of 77.24 is below its cyclical midpoint of 233.3, suggesting an earnings-based valuation implies Tesla is undervalued. On top of that, the forward price-earnings ratio of 76.77 shows the company's future earnings will most likely settle higher than its trailing earnings.
Tesla's price-sales ratio of 10.06 should ideally be lower. Although it is a growth company, the price-sales ratio is a metric that should align with companies at any stage of the business cycle as it is a top-line earnings measure that phases out cost-cutting practices. Nevertheless, one could argue the benefit of the doubt can be granted to Tesla as its revenue is projected to scale at 25.43% annually within the next five years.
Risks to consider
Tesla is a growth stock with extreme sensitivity to the broader stock market. Thus, any technical corrections in the market might cause the stock to shed a significant amount of weight. Therefore, it is needless to say Tesla adds tremendous risk to any investment portfolio.
Another aspect worth considering is Tesla's technical features. The stock's relative strength index numbers are above 70, indicating it is theoretically overbought. As such, an isolated study of the stock's price level conveys that it does not provide an ideal entry point for the time being.
Final word
Qualitative and qualitative factors suggest Tesla's stock is undervalued and primed for growth.
Aspects such as expansion into new business markets and cooling commodity prices phase out risks of economic weakness. Moreover, newly established synergies and a forecasted compound annual growth rate of 25.43% provide a parsimonious indication of Tesla's best-in-class business model.
The stock possesses a few valuation concerns, with fundamental and technical features revealing fault lines. However, Tesla's pros by far outweigh its cons.
