How To Work Out Whether Tesla's Valuation Is Justified

about 1 year ago15 mins

How To Work Out Whether Tesla's Valuation Is Justified

Introduction

In the eighteen years since it was founded in 2003 by a small group of engineers, America’s Tesla has gone from underdog champion of niche electric vehicle (EV) design to market leader in one of tomorrow’s most exciting technologies.

The company released its first EV, the Tesla Roadster, in 2008. The car’s launch attracted considerable fanfare: its range, acceleration, and top speed were all unprecedented for a mass-produced EV at the time.

Fast forward to 2021 and Tesla, now offering four different models and counting, is the world’s biggest-selling EV brand. The company delivered around half a million EVs last year: six times more than in 2016, with revenue rising more than 300% across that four-year period.

Leveraging its expertise in producing the batteries that power its EVs, Tesla today also has a growing energy storage business. These battery systems – essentially shipping containers full of power cells – are increasingly being used to help electricity grids cope with wind and solar power’s naturally fluctuating supply.

Tesla’s energy storage deployments were up more than 80% last year, while 2021 should see the company complete construction of the world’s largest battery facility. Nevertheless, Tesla’s EV arm remains – for now – the firm’s most important driver of revenue and profit, which is why investors remain obsessed with metrics like quarterly vehicle deliveries.

In fact, Tesla’s strategy and its share price – particularly after the latter’s 700% rise in 2020 – are controversial topics in the investor community. On top of CEO (sorry, “Technoking”) Elon Musk’s often erratic behavior, the company’s $1.5 billion investment in bitcoin earlier this year raised a fair few eyebrows.

But with a stock market value more than 100 times higher than 2021’s projected profit, the most important questions arguably relate to the appropriateness of Tesla’s valuation. The purpose of this Pack is therefore to present you with a professional-style framework you can use to value Tesla’s stock for yourself – allowing you to get properly informed before (or even after) you consider investing.

Finding a framework

Tesla is currently in the high-growth phase of its development as a company. That means profit and profitability are generally growing, albeit erratically. Tesla’s cash flow is also all over the place as it spends heavily on building new factories and increasing production – and shortfalls often have to be plugged by fresh sales of shares or debt, both of which impact the company’s per-share valuation.

Taken together, all this means that it’s hard to value Tesla today by simply applying a multiple to its current earnings, or else trying to forecast its medium-term cash flows and then discounting them to the present. All those variables are arguably just too volatile right now. A better approach may be to ask the following question: what will Tesla’s stabilized earnings look like after its growth phase – in, say, 2030?

That’s the path we’re going to take in this Pack. Based on various well-educated assumptions, we’ll attempt to forecast Tesla’s financial position in 2030 in terms of both revenue and profit and use this to value Tesla’s future stock. We can then discount this valuation back to the present to see what the company’s shares should be worth today.

We can also calculate the average annualized return investors can expect given the difference between Tesla’s actual stock price at present and the theoretical “fair value” per share in 2030. But before we get to that, let’s kick things into gear by investigating what Tesla’s future revenue might look like.

Forecasting revenue

Tesla generated $31.5 billion of revenue in 2020. The bulk of that – $25.7 billion, to be precise – came from selling cars and related services such as internet connectivity, over-the-air software updates, and access to the company’s EV charging network.

The remainder came from regulatory credit sales, repair and maintenance services, and the company’s energy storage business. We’ll touch on these in a bit – but for now, let’s focus on forecasting the biggest driver of Tesla’s revenue: auto sales.

This involves estimating two key figures: the number of cars sold (or, given Tesla’s previously notorious production backlog, delivered), and the average selling price (ASP) per car. You can see the relevant data for the last five years shown below.

Tesla vehicle deliveries

Tesla delivered half a million cars in 2020, representing an impressive compound annual growth rate (CAGR) of 60% since 2016. And the company’s ambition is to maintain a similarly strong average growth rate of 50% over the medium term, according to its latest shareholder deck. Tesla should be able to keep expanding production capacity thanks to a recently opened Shanghai plant as well as forthcoming factories in both Berlin and Texas.

Tesla’s installed and upcoming production capacity (Source: Tesla)
Tesla’s installed and upcoming production capacity (Source: Tesla)

In terms of forecasting Tesla’s vehicle sales in 2030, a top-down approach is probably our best bet: first looking at total projected global EV sales for 2030, and then multiplying that by Tesla’s estimated future market share.

According to research provider Bloomberg New Energy Finance (BNEF), 1.7 million EVs were sold worldwide in 2020. (Note that this only includes the battery electric vehicles Tesla sells and not plug-in hybrids.) Tesla’s 500,000 vehicle deliveries therefore accounted for around 30% of the global EV market last year.

BNEF predicts annual global EV sales will hit 26 million by 2030. But it’s unrealistic to expect Tesla to maintain a 30% market share in the face of rising competition from traditional automakers like Volkswagen, Hyundai, BMW, and the Renault–Nissan–Mitsubishi Alliance, as well as Chinese upstarts such as NIO, Xpeng, and Li Auto. If we assume that Tesla’s market share accordingly drops to 20%, then that would represent 20% x 26 million = 5.2 million vehicle sales in 2030. Feel free to make your own educated assumptions here, of course – this is all a matter of conjecture.

Time for a sense check: 5.2 million Tesla vehicle sales in 2030 would represent a 26% CAGR over the next decade. That matches up pretty well with the company’s ambitions to grow vehicle deliveries at a 50% CAGR over the next few years. You’d then naturally expect that rate to drop off in the second half of this decade: it’s much harder to maintain a high growth rate as the numbers get bigger.

By way of comparison, investment bank Morgan Stanley expects Tesla’s 2030 deliveries to sit at 5.4 million, while investment firm Wedbush Securities predicts Tesla will approach 5 million annual deliveries by the end of the decade. Some analysts are even more optimistic: ARK Investment Management expects Tesla’s vehicle deliveries in 2025 to hit 5 million at worst, and a whopping 10 million in the best-case scenario.

So what about the average selling price for the company’s EVs? This has been decreasing lately due to what’s known as the “mix effect”: as shown below, an increasing proportion of Tesla’s sales are of cheaper vehicles such as the Model 3 and Model Y (prices starting at $37,000 and $49,000 respectively). In 2020, the company’s ASP was $51,400.

An increasing proportion of Tesla’s vehicle sales are of cheaper models
An increasing proportion of Tesla’s vehicle sales are of cheaper models

As shown below, however, research from consultancy Oliver Wyman suggests EV costs will fall by around a fifth over the next decade. If we assume that the competitive EV market reflects this in vehicle prices, and that the mix effect at Tesla continues on its present course, then the company’s ASP could well fall 25% to reach $38,500 in 2030.

Once again, feel free to use your own assumptions. Intuitively, however, Tesla’s ASP will have to decline in order for it to access greater levels of EV demand. If Tesla is going to sell 5.2 million vehicles annually by 2030, the average car will probably have to have a more affordable price tag attached.

EV costs are projected to fall by around a fifth over the next decade
EV costs are projected to fall by around a fifth over the next decade

5.2 million vehicles at an ASP of $38,500 would give Tesla $200.3 billion of auto revenue in 2030. We can safely assume revenue from selling regulatory credits will be zero: these are due to be phased out. The company’s revenue from repair and maintenance services, meanwhile, averaged 10% of auto revenue over the past four years. Keeping that percentage flat, 10% x $200 billion = $20 billion of additional revenue from selling services in 2030.

Finally, and significantly, Tesla generated almost $2 billion of revenue from selling battery energy storage systems in 2020. This business is expected to be a big part of Tesla’s future: in fact, CEO Musk thinks it could eventually contribute at least as much revenue as EV sales. As wind and solar power come to represent a greater portion of more countries’ generation capacities, efficient battery storage will become critical to the effective management of electricity grids.

The chart below shows consultancy Wood Mackenzie’s predictions for global energy storage capacity increases over the next decade: it expects a 31% compound annual growth rate. For Tesla, let’s assume that 2020’s $2 billion energy storage revenue will rise at a 20% CAGR to hit $12.3 billion in 2030. This involves partially offsetting Wood Mackenzie’s capacity forecasts against expectations for falling battery storage prices, which will likely reduce Tesla’s revenue per unit of battery storage sold. As ever, you may want to use your own assumptions.

Energy storage forecasts

Putting all the above together gives us a total Tesla 2030 revenue forecast of $232.7 billion, summarized in the table below. Note that the cells in yellow represent where we’ve inserted assumptions that you can play around with further.

Tesla revenue forecast

Forecasting profit

More specifically, we’re forecasting EBITDA: earnings before interest, taxes, and non-cash expenses such as depreciation and amortization. EBITDA essentially calculates a company’s operating profit before factoring in the impacts of various financing and accounting decisions. It’s very common to value companies based on some multiple of EBITDA – so this is the metric we’re going to focus on in this Pack.

The simplest way to calculate Tesla’s future EBITDA would be to multiply our revenue forecast by some assumed margin percentage indicating how many cents of EBITDA the firm makes for each dollar of sales. Tesla’s EBITDA margin in 2020 was 18.4% – but that overstates how much profit the company is generating from its core businesses. That’s because Tesla’s 2020 EBITDA includes $1.6 billion of revenue from selling regulatory credits, a source of cash that will likely soon disappear. Stripping this out gives us a purer EBITDA margin of 13.4% in 2020.

That’s still an impressive number. Japanese automaker Toyota has some of the highest profit margins in the old-school industry, and its 2020 EBITDA margin stood at 13.2%. Tesla is fortunate in that it generates some sales from extremely high-margin services such as software upgrades: in the screenshot below, for example, you can see Tesla’s online store offers the option of a $10,000 self-driving top-up at checkout.

Source: Tesla
Source: Tesla

Play around with your own precognitions here, but we’ll assume Tesla’s EBITDA margin will expand by ten percentage points to hit 23.4% in 2030, driven by two main factors. First, Tesla should benefit from an increased manufacturing scale lowering the cost of its EV production. Second, technological developments mean the company may well sell more high-margin software products to its customers. As a sense check, we can draw an analogy with Apple, which first sells iPhones and then sells software and services to iPhone users. Apple’s EBITDA margin is around 30%.

Multiplying our 2030 revenue forecast of $232.7 billion by our 23.4% EBITDA margin gives us a 2030 Tesla EBITDA estimate of $54.5 billion.

Valuation

Now we’ve forecasted Tesla’s 2030 EBITDA, we can value the entire company by applying a commonly used valuation multiple called EV/EBITDA – or enterprise-value-to-EBITDA. Enterprise value (not to be confused with electric vehicles) is the value of a company’s outstanding shares plus its “net debt” – total debt minus cash holdings. Enterprise value is essentially what someone would have to pay to buy the entire company.

So what EV/EBITDA multiple should we use when valuing Tesla? A common approach to making that decision involves seeing what multiples similar companies are trading at. Tesla in 2030 will probably be a hybrid between an automaker and a tech company with a powerful premium brand – and as alluded to previously, Tesla’s mixture of hardware and software specialties means it may find a close analogue in tech giant Apple.

As the table below shows, the average EV/EBITDA of the world’s 10 largest automakers stood at 11.7x at the time of writing. Apple’s multiple meanwhile stood at 23.5x. Averaging the two gives us 17.6x – and applying that to our 2030 EBITDA estimate of $54.5 billion yields a forecasted 2030 enterprise value for Tesla of $960 billion.

Data source: Koyfin
Data source: Koyfin

Because enterprise value is the value of a company’s outstanding shares plus its net debt, we need to subtract Tesla’s forecasted net debt in 2030 to arrive at a pure stock valuation. As of the time of writing, Tesla’s net debt is actually negative: it’s got more cash on its balance sheet than borrowings. For simplicity’s sake, we’ll assume net debt is zero in 2030 as Tesla spends some of its current cash and/or issues more debt to fund its expansion over the next decade.

If Tesla’s forecasted 2030 enterprise value of $960 billion is also its total stock value, then we can divide that by the number of shares outstanding (960 million at the time of writing) to arrive at a nice, round valuation of $1,000 per share in 2030.

Yellow = assumption (including outstanding shares in 2030)
Yellow = assumption (including outstanding shares in 2030)

Conclusion

You can interpret the present-day significance of this in two different ways. One involves discounting the valuation and comparing the result to Tesla’s stock price today. Discounting $1,000 in nine years’ time at 10% per year, for example, gives you a $424 per share value today – whereas Tesla is actually trading for around $675. Alternatively, you can calculate how much you’d make investing in Tesla shares at today’s prices and watching them rise to that $1,000 level in 2030: a 4.5% compounded annual return.

Whether you think these assumptions are fair and accurate – or whether you think Tesla has more upside to gain from, say, launching a fully autonomous taxi network – is outside the scope of this Pack. The main point is that you’ve now got a framework that you can use and play around with to arrive at your very own valuation for Tesla.

You can download our model’s Excel file here in order to explore things further. Adjusting its variables based on different assumptions will help you think more deeply about Tesla’s future – allowing you to weigh in on the company’s great valuation debate and invest (or not, as the case may be) with greater confidence. Arise, Technoking…

In this Pack, you’ve learned:

🔹 Tesla designs, manufactures, and sells electric vehicles – but it’s also increasingly getting into battery energy storage systems.

🔹 Since Tesla is currently in a high-growth phase with erratic profitability, valuation attempts should first begin by forecasting its future, stabilized financials.

🔹 To forecast the company's 2030 revenue, we're assuming that it makes 20% of the 26 million projected global EV sales that year and that their ASP is 25% lower than in 2020.

🔹 We’re assuming Tesla’s EBITDA margin will meanwhile expand to 23.4% as it benefits from increased manufacturing scale and more higher-margin software sales.

🔹 Applying a 17.6x EV/EBITDA multiple (arrived at by averaging large automakers' and Apple's current multiples) gives Tesla a valuation of $1,000 per share in 2030.

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