Tesla Still Has Further to Fall

Tesla's bouncing up and down day to day, but the fundamental truth is that it's likely just too expensive after its rapid run-up and needs to correct.
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The market, as Elon Musk cannily observed on Monday, had been a “bit high” going into the recent Covid-19 turmoil. And though Musk didn't say it about his own company, that’s still the case with Tesla  (TSLA) - Get Report, which still needs to correct a fair bit more since its surge of 50% since the beginning of this year wasn’t really tied to any fundamental change in the business. That's something to keep in mind as the shares climbed another 3.9% Tuesday with the market’s broad rebound.

After the recent turmoil, the shares are still up 50% in just two months. And Tesla looks way too pricey compared to peers.

Tesla’s current valuation as a multiple of profit it is expected to make this year is 29 times forward earnings. That’s quite a bit higher higher than the average of 18 times earnings for the largest tech stocks -- Apple  (AAPL) - Get Report, Alphabet  (GOOGL) - Get Report, Amazon  (AMZN) - Get Report, Facebook  (FB) - Get Report, Microsoft  (MSFT) - Get Report, and Netflix  (NFLX) - Get Report. Netflix, in fact, is the only company of comparable scale that’s more expensive than Tesla, trading at a whopping 39 times forward earnings. The average of the other five is just 14 times, which means Tesla is nearly double the price of the average of most of its peers.

A lot is going right for Tesla: it said it is moving to almost-normal production of its cars in China, and on Tuesday, it announced it built its millionth vehicle in February. So things are on track. But it’s all in the stock, and then some.

Here’s the simple Tesla math. The stock, at a recent price of $633.91, has a market capitalization of $115 billion. For a company like Tesla with a lot of debt, the first place to start with valuation is to calculate the “enterprise value,” the market cap plus any debt, less cash on hand. The company has about $6 billion in cash against $11.6 billion in long-term debt and finance lease obligations. That’s a net debt position of $5.6 billion. Add that to the market cap and you have an enterprise value of about $120.6 billion.

Divide into that $120.6 billion the total amount of pre-tax profit the company is expected to make this year, which analysts estimate at $4.5 billion. That $4.5 billion is what’s known as “earnings before interest, taxes, and depreciation and amortization,” or Ebitda. It’s an appropriate measure for an asset-heavy company such as a car manufacturer, which has to depreciate factory equipment and such. The division of $120.6 billion by $4.5 billion is known as the “enterprise value-to-Ebitda ratio,” a fundamental valuation metric.

(Keep in mind that Ebitda is on a non-GAAP basis, calculated in a way that excludes more items than traditional accounting would exclude.)

The result is a valuation of 26.8 times this year’s projected Ebitda. If one goes out a year, to 2021, the multiple is more rational, at 20.1 times. That’s still way above the peer-group average, excluding Netflix, but a bit of a premium might make sense for Tesla, given that its Ebitda is projected to rise about 39% from this year to next, which is a high rate of growth.

The only thing is that Tesla has had a spotty history of meeting profitability targets in the past. And it’s always possible the company will take on more debt in order to fund its expansion plans, which would make the stock more expensive than it now appears.

Re-setting that valuation of 26.8 times this year’s expected Ebitda to something more reasonable such as 20 times forward earnings, assuming that debt stays as it is, would require rolling back the stock price to $466. That’s a roughly 26% drop from here.

That may sound like a big drop, but that’s where the stock was in early January. The shares ran up so fast this year, investors have forgotten how much lower Tesla was not very long ago.

The latest good news could stem the declines. Reuter’s reported Tuesday that Chinese government documents show Tesla has applied to expand production dramatically in Shanghai -- an upbeat stance in the face of that country's struggles with the virus.

And Musk on Monday evening tweeted “Congratulations Tesla team on making our 1,000,000 car!!” According to NewStreet analyst Pierre Ferragu, who's generally highly bullish on Tesla, that milestone implies that Tesla made about 81,000 cars since the beginning of the year. That would put the company on track to meet his target for production of 108,000 cars this quarter, or 8,300 per week. That’s one small sign that business is holding up at Tesla.

Which is nice, but the same furious trading that drove up the stock 50% so far this year really shows little conviction. On Tuesday, the stock is up almost 4%, having pared gains of 7% earlier in the session. Last Monday, the stock gained 9%. But yesterday, it lost almost 13%. Tesla, like much of the market, is a football that is getting tossed about without any sign of a goal from day to day.

These ups and downs can continue for some time. But the fundamental fact is that the stock appears overpriced and needs to reset lower. How much lower is anyone’s guess, but there's a strong chance it will happen.