Tesla, Inc. investors cheered on as the company's recent Q3 earnings release led to a surge in the stock by over 20% on October 24, recovering most of the losses realized since its relatively underwhelming Robotaxi Day earlier in the month. The stock has been notably volatile throughout the year, with a 52-week high of $271 and a low of $139. Currently trading near its highs at around $269, it remains elevated at approximately 12x to 14x its pre-pandemic value. Considering the recent stock price recovery, I've reviewed Tesla's fundamentals to assess whether a buying opportunity has presented itself. But, with shares back near its highs, I believe Tesla remains overvalued at current levels.
While Tesla does have several growth catalysts, like it's expanding energy business and advancements in autonomous driving technology, which may help support the stock price, the increasing competition within the EV industry and escalating geopolitical challenges pose substantial risks to Tesla's business model. In this article, I'll explore why these growth catalysts fail to outweigh the current risks associated with Tesla, especially given the stock's premium valuation.
Automotive Business Remains the Core but Faces Growing Challenges
The automotive business remains Tesla's core, accounting for approximately 80% of its total revenue in Q3 FY24. Although the company's energy segment has grown to represent about 9% of total revenue, it's unlikely this area will significantly impact the company's finances until the late 2020s or early 2030s. Tesla's additional ventures—such as the robotaxi, Roadster, Cybertruck, and Semi—are also largely automotive-focused, a sector that is facing increasing challenges. According to S&P, market dynamics indicate that while the initial surge of battery electric vehicle (BEV) adoption attracted buyers interested in new tech, BEV growth has since slowed due to factors like high upfront costs, limited charging infrastructure, regulatory inconsistencies, and consumer preference for hybrid models. Consequently, Tesla has experienced a few quarters of stagnated sales, with minimal growth for nearly two years.
In Q3, Tesla posted a 7.8% YoY increase in revenue, consistent with the recovery trend observed in Q2. Tesla has used pricing adjustments to improve its competitiveness in the market, but intense EV market competition has largely constrained its revenue growth. High-interest rates have also impacted customer's affordability, although these pressures may have peaked. The company's recent revenue gains were primarily from the revenue growth in the Energy generation and storage business (+52% YoY) and the Services business (+20% YoY), while automotive revenue grew just 2% YoY amid the challenges facing the EV market and broader economic pressures. This shows that the automotive segment is not the growth driver for Tesla right now, with the revenue beat primarily driven by the energy business.
There's a lot of talk in the market about Tesla's broader tech focus moving forward, but in reality, Tesla still is an automotive business heavily reliant on government credits. Regulatory automotive credits reached $739 million in Q3 FY24, up from $554 million in Q3 FY23. However, these credits are not sustainable long-term, as they are temporary government incentives. While Tesla benefits from them for now, it's still extremely dependent on them. As these credits have a 100% profit margin, they significantly influence Tesla's financials. Excluding these credits, Tesla's diluted EPS would be just $0.41, compared to the current $0.62.
Alongside this, gross margins and EBITDA margins declined YoY in Q3 (as shown above), signaling deeper issues within the core auto business. Compounding these problems is the fact that Tesla's net income still remains quite weak, heavily dependent on regulatory credits (makes up ~39% of Tesla's net profit), indicating weak organic growth. The current price war in the EV sector is further intensifying Tesla's ability to expand margins and deliver strong bottom-line results. Unfortunately, the outlook does not show a turnaround happening anytime soon, as even Musk admitted in the earnings call that maintaining these levels of profitability would be challenging over the next few quarters. Investors should be aware that improving operating leverage is not Tesla's primary focus at this time; with a variety of ongoing projects requiring further investment, EPS growth could disappoint in the near term.
Growth Catalysts Are Promising but Long-Term and Uncertain
Tesla definitely holds growth potential, but the timelines for these opportunities are lengthy, with a significant amount of uncertainty involved. While Tesla aims to be starting volume production for the Cybercab by 2026, investors should be cautious about overestimating these prospects. Significant obstacles remain, including regulatory approval, technological advancements, and market acceptance. Although the long-term potential of autonomous driving is undeniable, I don't foresee meaningful market penetration until the mid-to-late 2030s. Even if advancements are achieved, they are likely to be gradual and costly. Consequently, the current excitement around Tesla seems to have inflated its valuation metrics beyond what may be justified at this point.
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Tesla's energy business, though exciting and showing rapid growth, is another long-term play that is unlikely to significantly impact the company's overall performance in the near term. The energy segment's revenue doubled over the past year, contributing to Tesla's gross margin improvement, as it has higher margins than the automotive business (mid-20s vs. high teens). However, this business remains a small part of Tesla's overall revenue mix and won't overshadow the automotive business for several years. I expect that the earliest significant impact from the energy storage business will occur in the late 2020s (around 2028 or 2029).
Cash Flow Concerns Amidst a Challenging Environment
Tesla's cash flow composition is increasingly worrying. In Q3 FY24, cash from operations (CFO) rose to $6.3 billion, up from $3.3 billion in Q3 FY23—its highest ever for a third quarter. However, if you break down the CFO, excluding contributions from accounts payable ($2.6 billion), stock-based compensation ($457 million), and regulatory credits ($739 million), the core cash flow would only be $2.47 billion, not $6.3 billion. For a company aiming for a trillion-dollar valuation, such heavy reliance on these non-sustainable sources is concerning. Additionally, Tesla could face significant cash burn in the future, possibly in the billions annually. This risk will likely grow as Tesla invests heavily in AI hardware and network infrastructure for its energy business and autonomous driving technologies. These financial pressures could reduce Tesla's cash reserves, raising doubts about its ability to sustain growth and profitability amid such challenges.
Valuation Concerns and Downside Risk Remain Significant
Given the ongoing challenges in Tesla's core automotive business and the increasing uncertainty surrounding its autonomous driving technology, I maintain that the stock is at risk of a substantial re-rating. If Tesla shares were trading at a more attractive valuation, I might be more optimistic about the company's prospects. However, as shown in the chart from Gurufocus, Tesla's stock is currently trading at an almost 71x forward price-to-earnings (P/E) multiple. This is extraordinary, especially when compared to the rest of the Magnificent 7, which trade at significantly lower multiples, ranging from 15x to 35x forward P/E. Moreover, Tesla's current forward P/E multiple is significantly higher than its 1.5-year average of 55x. This relative valuation does not paint a favorable picture for Tesla. Although the company has historically traded at a premium to its peers, I expect Tesla's valuation to compress below its 1.5-year average of 55x, likely approaching the 50x mark as the company's operational struggles continue as a result of the broader industry and macro challenges. Based on this expectation, my target price for Tesla is $159 per share, representing a downside risk of about 30% as the multiple compresses from the current 71x level to 50x.
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To corroborate the high valuation indicated by the relative analysis, I also applied a discounted cash flow (DCF) model. This model, which assumes a base case of 14% CAGR in revenue over the forecast period in line with Wall Street expectations (though I believe this to be somewhat optimistic), still supports my reasoning for Tesla's overextended valuation. It's important to note that Tesla has recently faced multiple downward revisions in revenue forecasts, reflecting the market's expectations for weaker growth due to the challenges discussed earlier in the article. The DCF model also factors in margin compression through the first three years of the forecast, aligning with consensus estimates, followed by a margin improvement later in the forecast period as the energy business begins to contribute more significantly. For this DCF analysis, I used an 8% discount rate, which corresponds to Tesla's WACC, and a 3% terminal growth rate to account for the company's gradual transformation away from heavy reliance on the automotive sector, driven by growth in its energy business. Despite these assumptions, the DCF model yields a fair value of $200.15 per share, implying a downside risk of over 25%.
Final Thoughts
In light of Tesla's ongoing challenges within its core automotive business, combined with the uncertainties surrounding its growth catalysts and premium valuation, I remain cautious about the stock's near-term prospects. While Tesla may eventually recover, the timeline for meaningful progress is still quite unclear, and the current valuation leaves little margin for error. As such, I recommend a sell on Tesla, with a close watch on any signs of an operational turnaround.
