Tesla's 3 Biggest Challenges for 2020

Tesla's high valuation, its debt burden, and whether it can drive sustainable demand will likely fall under the microscope next year.

Tesla  (TSLA) - Get Report closed out the year on a high note -- but a new year brings fresh scrutiny for the polarizing stock. 

Since late October, when Tesla posted a surprise profit in its third-quarter earnings report, shares of the electric vehicle maker are up 64% to $418.33. In that time, investors were cheered by news of faster-than-expected progress in Tesla’s Shanghai gigafactory as well as reports that it’s looking to expand production in Germany. 

Still, there are several potential bumps in the road to look out for. Here are some of Tesla’s key challenges heading into 2020.

1. Profitability Questions

Tesla beat estimates by a wide margin for the third quarter, posting earnings of $1.86 per share versus an expected loss of 42 cents per share. But multiple repeat performances in 2020 are far from a sure bet.

The company's debt load is an ongoing worry, according to Wedbush analyst Dan Ives. "Strong cash flow and profitability will be needed for the coming years to help fund Musk's myriad of initiatives (robotaxis, Giga 3, European build out, insurance initiatives) and appease investors in the Tesla story,” Ives wrote in a recent note. Wedbush raised its price target to $370 and maintains a neutral rating.

As noted by RealMoney columnist Eric Jhonsa, Tesla had to implement heavy spending cuts to achieve what is expected to be a modest amount of free cash flow ($325 million, according to Wall Street’s consensus) for 2019. Additionally, Jhonsa pointed out, its automotive margins were down annually as of last quarter. And, with a debt burden of roughly $12 billion as of the third quarter, it all adds up to a “small margin of error” for Tesla next year, when it will be much more difficult to slash spending further with the ramp-up of multiple costly initiatives.

2. Demand Concerns

With demand in the U.S. maturing, Tesla anticipates a bump in demand from China and Europe. But how sustainable that demand will be is still an open question for many investors. In a Dec. 30 note, Cowen analyst Jeffrey Osborne raised its fourth-quarter delivery outlook, but reiterated the firm’s full year forecast of 356,000 vehicles for 2019, below Tesla’s target range of between 360,000 and 400,000 vehicles. According to Osborne, demand in China and the Netherlands could boost Tesla's fourth-quarter sales -- but it's not yet clear whether demand will hold steady. Excluding those two markets, Model 3 sales will decline 7% annually in the fourth quarter according to Osborne.  

Obsorne's estimate “highlights the demand saturation we are seeing across most mature markets as we shift from pent-up demand to steady flow demand,” he wrote. And with more EVs rolling out in 2020, investors will be keeping a close eye on how demand for Tesla vehicles hold up against a slate of competitors from Audi, Jaguar, BMW and others. Cowen maintains a $210 price target and underperform rating on Tesla shares. 

3. Justifying Tesla’s Valuation

Bullish analysts point to signs of healthy demand in China, a growing market for electric vehicles, and Tesla’s brand cachet as evidence that the stock is poised to skyrocket. In a recent note, however, Morgan Stanley analyst Adam Jonas cautioned that Tesla’s valuation may be unsustainable. 

“We are not bullish on Tesla longer-term, especially as, over time, we believe Tesla could be perceived by the market more and more like a traditional auto OEM,” Jonas wrote. “We are prepared for a potential surge in sentiment through 1H20 but question the sustainability.” Morgan Stanley maintains a $250 price target and equal weight ratings on Tesla shares. 

Tesla’s valuation of about $75 billion as of Dec. 31 places it well ahead of other, more established automakers, such as GM  (GM) - Get Report and Ford  (F) - Get Report. That may not be the case forever, and Tesla might have to work harder over time to convince investors that its expensive shares are worth shelling out for.