Summary
Strong demand means the only constraint is the pace of capex deployment.
Tesla’s Operating Cash Flow is throwing off enough cash to fully finance capex costs.
Tesla plans to maintain capex at a constant level, limiting growth potential.
Justin Sullivan/Getty Images News
Thesis
What brought Tesla, Inc. (NASDAQ:TSLA) to my attention was a common characteristic that it shares with the midstream sector in the oil and gas industry, the midstream sector being the pipeline companies that transport hydrocarbons from the wellhead to downstream users. It's an area about which I have written a lot and currently favor. And similar to midstream operators, Tesla faces an extremely strong demand environment whereby everything it produces it can sell. There's currently no demand constraint to the company's growth, meaning that the company's primary obstacle is not demand creation but rather the speed at which it can add supply capacity to meet that demand.
In analyzing Tesla's stock and growth prospects, that means the emphasis needs to be on Operating Cash Flow ("OCF"), not Free Cash Flow ("FCF"), and management's ability to deploy internally generated funds in a manner that will maximize the rate of return on those funds. Tesla has wisely chosen to strike a balance between using part of its OCF on growth capex and part on debt repayment. Unfortunately for investors though, the market seems to be well-aware of this and is the reason why Tesla trades at such a lofty valuation relative to its peers. That means that the stock is neither a buy nor a sell at current levels as it appears to be well-priced.
Strong Demand
There's no question that demand for Tesla's automotive products is extremely strong. The company manages to sell every vehicle it produces and year-end vehicle inventories have fallen every year since at least 2017. Going from 28 days of sales in 2017 to 6 days at the end of last year and that's in spite of the company's production increasing over nine-fold during that time.
Investor Presentation
An added benefit of these high levels of demand is that Tesla also has no need to advertise. Advertising is a cash cost that subtracts directly from the bottom line as every dollar spent on an ad campaign is one dollar less in net income. It's an expense for which the effectiveness is very difficult to measure and marketing budgets in many companies are often wastefully spent. That's not to mention the internal allocation of resources as marketing departments must be maintained to coordinate media buys and work with advertising agencies.
Tesla is able to sell everything it produces and still have an order backlog, without having to purchase a single television commercial. And advertising is not a trivial cost as Ford Motor Company's (F)2021 10-K filing shows that it spent $3.1 billion, $2.8 billion, and $3.6 billion, in 2021, 2020, and 2019. General Motors Company's (GM)2021 10-K shows that company to have spent $3.3 billion, $2.7 billion, and $3.7 billion, in those respective years. Ford's net income last year of $18 billion would have been 17% higher had it not advertised while GM's 2021 net income of $10 billion would have been 33% higher. However, the question then becomes, would their sales have reached the same levels if they had not advertised?
The ability to drive demand so effectively using a mix of free media and publicity from news outlets is itself worth a certain premium on Tesla's stock. Given this demand picture, the question then becomes how fast can Tesla add productive capacity, how will it be financed, and what will be the rate of return on that financing?
Financing
The answer to the second part of that question, concerning the source of financing became much clearer in 2021. That's because last year, Tesla's Operating Cash Flow finally began throwing off enough cash to cover the costs of building new factories. In 2021 OCF increased to a level of $11.5 billion from just under $6 billion in 2020 and $2.4 billion in 2019.
Twenty-twenty's $6 billion of OCF had forced the company to do a $12.3 billion cap raise during that year as it was building 2 facilities at the time, in Austin and Berlin. That's not to mention the maintenance capex required by existing locations. However, the firm's ability to now generate $11.5 billion per year in OCF, a figure that will grow over time, means that Tesla can cover the costs of building at least one factory per year, if not more.
Capex
There are numerous media reports discussing the cost of Tesla's factories such asthis one that gives the cost of the Austin facility at $1 billion andthis one that lists the cost of the German build-out at $7 billion. However, using the number provided in the statement of cash flows will allow us to capture any ancillary costs these reports may have missed as well as the cost of maintenance capex, a relatively small expense given how new Tesla's facilities are but something sure to grow over time and as the number of factories grows.
Looking at cash spent on property and equipment over the last 2 years we see outflows of about $6.5 billion and $3.2 billion in 2021 and 2020, respectively. It should be noted that facilities in both Austin and Berlin were not completed at the end of 2021 and some costs will spill over into 2022 but the $11.5 billion in OCF was able to easily cover ongoing construction at two new facilities. The company even had enough cash left over to repay $5.3 billion in debt, leaving it with a debt balance of $11.7 billion on which it paid $357 million in interest, or about 3%. It's clear that Tesla is now able to self-finance these projects.
The Machine that Builds the Machine
The gross margin on each additional car produced by Tesla has been increasing over recent years. After falling to 21.2% in 2019 from the previous year's 23.4%, automotive gross margin has seen substantial improvement in each of the last two years to reach a level of 29.3% in 2021. This permitted the company to achieve a gross profit of $13.839 billion after delivering 936,222 vehicles last year, or just under $14,800/vehicle.
Investor Presentation
The companyhas guided production growth to a 50% yearly increase this year, something that seems readily achievable given the Berlin factory'sestimated capacity of about 500,000 vehicles per year and the Austin plant'spotential production capacity of 600,000 per year. Granted, it will take time for these facilities to reach full production but they should be able to make meaningful production contributions this year and allow the company to reach its production targets.
If that occurs while Tesla simultaneously manages to maintain its gross margin at the same level as last year, the company should be able to hit a gross profit of $20-21 billion this year. A number that could wind up being higher if we see an overshoot on production or an increase in gross margins.
However, it doesn't appear that the company intends to grow capex at the same pace. In its most recent 10-K filing Tesla indicated that it expects capital expenditures to be "between $5.00 to $7.00 billion in 2022 and each of the next two fiscal years". This means that capacity will continue to grow, along with production and the absolute dollar levels of gross and net margins. But maintaining capex at a constant level means that growth rates of both gross and net margins will eventually decline.
Conclusion
In and of itself that's not a huge problem given that all companies eventually face declining growth rates at some point. But Tesla's stock already trades at a very healthy valuation of 156x TTM PE and 75x FWD PE based on an anticipated doubling of EPS over the next year. So, while it's highly likely that the company's PE will decline as a result of earnings growth over time, the leveling-off of capex also points to an eventual fall-off of the growth rate. That means that any new investors looking to initiate a position with expectations of significant price appreciation from these levels may wind up being disappointed.$Tesla Motors(TSLA)$
Comments
Good work