Tesla's Q3 Earnings: The Bull-Bear Debate

Tesla Inc TSLA surged Wednesday after posting a major bottom-line beat and its first profitable quarter in two years.

“Tesla flexed is model leverage muscles in [Q3], exhibiting a dramatic swing from negative to positive on a number of key metrics,” according to Nomura. 

The automaker surpassed its production target of 5,000 Model 3s and exceeded Street estimates for auto deliveries, free cash flow, capex and accrued liabilities. Model 3 gross margins of 20 percent exceeded expectations, as did lower research and development and selling, general and administrative expenses.

Bears Question Sustainability

But some on the Street were unimpressed.

“Many of these elements, particularly mix, are peaky in nature, and will likely fade in the future, so the burden of proof remains on TSLA to generate core underlying earnings and cash flow absent peak factors,” according to Bank of America Merrill Lynch. 

The sell-side firm said it's seen similar results before, comparing the Q3 print to Tesla's Q3 of 2016. In that report, "transitory factors" such as ZEV credit revenue, stock-based compensation, "thrifting" on R&D and capex and working capital benefit drove positive earnings and cash flow.

" ... Although these were not sustainable, and [it's] likely the same case now." 

BofA predicted a peak in Model 3 profitability with upcoming margin pressure from mix and price degradation, and UBS forecast pressure from declines in average selling prices.

Morgan Stanley concurred.

“We continue to question sustainability and leave our target unchanged at $291,” Morgan Stanley said, reiterating an Equal Weight rating. “... While we acknowledge the significance of Tesla’s very strong Q3 result, we do not believe investors will assume the company is fully self-sufficient without a more sustained period of execution.”

The analyst firm expects economic, political, regulatory, technological and competitive forces to challenge Tesla’s standalone status. BofA foresees similar struggles.

“Ultimately, TSLA is caught between a rock and a hard place, in which further unit growth at higher-ASP/margin is likely limited, while expansion of volumes into lower-ASP/margin will likely be materially dilutive to margins,” the sell-side firm said. “If TSLA is successful in pushing volume, it would likely evolve into none other than a lower-margin automaker.”

Evercore ISI was slightly more optimistic, although similarly cautious. It anticipates upcoming volatility in Model 3 margins; no “major revenue uplift” until the Model Y release in 2022; no repeated improvements in working capital, operating expenses and capex; and no ongoing ZEV-credit tailwinds.

Bulls Target Model 3, Profit Growth

The Q3 metrics were more warmly received by others on the Street. 

“The combination of improved corp governance and meeting operational milestones allow us to become more optimistic on TSLA shares,” according to Canaccord Genuity. 

Nomura internalized Tesla’s guidance for continued profitability and FCF positivity.

“In other words, Q3 may mark the quarter in which Tesla became a sustainably self-funded entity,” the firm said. 

Meanwhile, Loup Ventures forecast growth in Model 3 demand in 2019 and noted room for gross margins expansion as deliveries begin in Europe and Asia and the firm cuts the costs of goods sold. The targets appear particularly feasible given recent success among consumers who were previously outside the market for premium vehicles, Loup said. 

China Expansion

Another source of optimism for Loup Ventures: Tesla's new Shanghai site, which will help the automaker circumvent costly tariffs.

“The China market represents the largest EV opportunity globally,” the tech venture capital firm said. “Currently, Teslas face a 40-percent import duty in China, creating artificially low demand. Producing cars in that region will significantly lower the cost of the vehicles (lower tariffs, labor and delivery costs).”

BofA countered that the gains could take a while to manifest.

“Tesla has yet to break ground on a factory in China, so we view a 2019 production target as overly ambitious." 

Capital Raise And Debt Position

Despite Tesla’s claims to the contrary, Morgan Stanley continues to expect a $2.5-billion raise in the fourth quarter, and UBS concurs that additional cash is required to expand Fremont production, ramp the Model Y and construct the Shanghai factory.

Oppenheimer noted that 2019 debt maturities may drive expectations for a capital raise, but the payments could be made through working capital acceleration.

“With $890 million in convertible notes due March 2019 with a strike price of $359.87 and $525 million due November 2019 at $759.36, we expect TSLA to hope shares trade above the March 2019 conversion price and pursue a new fixed-income instrument to address capex and the November 2019 converts,” the sell-side firm said. 

Loup Ventures considers Tesla to be on pace to fulfill its debt obligations with the cash it generates. 

Side Opportunities

Morgan Stanley cut its mobility valuation from $95 to $71 per share on a ramp deceleration and rising competition. Meanwhile, Loup Ventures noted that ride-sharing operations are more than six years into the future.

Ratings Changes

Here are some of the other ratings:

• Bank of America Merrill Lynch maintained an Underperform rating on Tesla and raised its price target from $200 to $220;
• Evercore ISI maintained an In Line rating and raised its target from $299 to $309;
• Oppenheimer maintained an Outperform rating and raised its target from $385 to $418.
• Nomura maintained a Neutral rating with a $300 target; and
• UBS maintained a Sell rating with a $190 target.

Related Links:

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Citron Turns Bullish On Tesla For The First Time

Photo by Windell Oskay/Wikimedia.