Win McNamee
The Tesla (NASDAQ:TSLA) stock has lost some ground this week after Elon Musk disclosed another round of share-selling to “avoid an emergency sale of stock” in case the ongoing Twitter (TWTR) dispute concludes against his favour. Yet, the stock remains to be steadily positioned in the $900-range, a long way coming from its steep slump during the first two months of the second quarter when Tesla was caught in the depths of COVID mishaps in China and uncertainties over how Musk would finance the previously proposed Twitter acquisition.
We view the stock’s resilience to be a reflection of continued investors’ confidence in Tesla’s long-term growth prospects, especially after a solid post-COVID recovery in production volumes in Shanghai, as well as newly expanded capacity that has come online in the region to support a stronger second half of the year. As mentioned in our previous coverage on the stock, Tesla is also uniquely positioned for continued market share gains over the longer term, buoyed by its prescient procurement of key raw materials that are already showing signs of constraint as electric vehicle (“EV”) deployment accelerates worldwide.
In addition to robust fundamentals, Tesla’s high beta is also benefiting from what looks like a return of a bull market in favour of growth stocks. While market sentiment remains fragile over uncertainties of the Fed’s policy trajectory, recent economic data shows that the core driver of recent rate hikes – inflation – is cooling. This has heightened expectations that the central bank will revert its hawkish stance by 2023 – or at least slow the pace of rate hikes to assuage investors’ concerns of stifling growth. In the meantime, while consumer sentiment is waning, there has yet to be any material demand destruction observed in the auto sector, which makes a favourable tailwind for Tesla in both a fundamental and valuations perspective – in fact, EV take rates have remained strong, with the market remaining a function of supply availability. Tesla’s upcoming three-for-one stock split is also expected to draw additional interest and volumes from retail investors, further powering its momentum in the near term.
The fundamental and valuation foundation that Tesla has built in recent years have created a stock that is resilient in tough times and thrives in good times. This is further corroborated by the stock’s limited losses compared to its auto OEM peers in a market that just saw its worst first half performance in decades. In fact, Tesla’s ability to turn the years of first-mover advantage into an EV moat continues to be the core foundation fuelling the stock’s long-term upside potential.
High Growth
As discussed in our ongoing coverage on EV stocks, Tesla remains the best positioned EV maker to benefit from the robust demand environment ahead of electrification trends buoyed by favourable policy support, improving battery technologies, and increasing availability of public charging access. Let’s take a look at how Tesla has continued to take advantage of a favourable demand backdrop for EVs at its two core markets – China and the U.S.:
China
Despite the auto sales slump in April and May due to sprawling COVID lockdowns across the country to stem the virus spread, China’s June EV sales made a record comeback, topping 546,000 units (+130% y/y). The momentum continued through July, with EV sales exceeding 486,000 units (+110% y/y), and accounting for more than a quarter of total new car registrations in the country. The largest and fastest-growing EV market in the world now expects to “sell a new record of at least 6 million EVs by the end of the year”, which would be a record growth leap from the 3 million EVs sold last year.
The favourable recovery trends not only underscore a robust EV demand environment in China, but also point to favourable tailwinds for Tesla. As previously analyzed, the EV titan delivered more than 77,900 vehicles from its Shanghai facility alone in June. And despite a scheduled expansion of its Shanghai production line in July, Tesla still managed to crank out deliveries of more than 28,200 vehicles in the region last month.
Looking ahead, with the expansion of its Shanghai production line now complete, the facility is likely on track to ramping up production towards 22,000 vehicles per week through the end of the year:
While July volumes from Shanghai might be muted again ahead of scheduled expansion works that are expected to last until the first week of August, the efforts aim to expand the facility’s output to 22,000 vehicles per week once the upgrades are complete. This would mark a strategic catch-up on plans to produce “8,000 Model 3s and 14,000 Model Ys per week” in Shanghai, which were originally intended for mid-May if it were not for COVID-related disruptions. At this production run-rate through the end of the year, Tesla’s Shanghai manufacturing plant is also expected to contribute an additional 458,860 vehicles (i.e. approx. 22 weeks x 22,000 vehicles weekly production run-rate) towards the company-wide production target for the year. Paired with annual production capacity from Tesla’s existing Fremont facility (approx. 600,000 vehicles per year), as well as continued ramp up at its new Berlin and Austin facilities, the EV maker remains on a positive track towards its production goal of 1.5 million units by the end of the year.
Source: “EV Roundup: Everything from Tesla to NIO, U.S. to China“
The ramped up production volume at Giga Shanghai makes a favourable development for Tesla, especially as Chinese authorities continue to prioritize growth across the domestic EV market. Although China EV sales have already far exceeded the government’s earlier goals of achieving 20% penetration by mid-decade, the electric transportation sector remains a core contributor to the Asian nation’s decarbonization efforts.
In addition to a range of newly announced accommodative policies that include purchase tax breaks by local governments in Shanghai and Beijing to support post-pandemic auto sales recovery, and an official statement from the Chinese State Council Information Office outlining its support for “promoting sales of new energy vehicles and ensuring the supply of auto chips and related raw materials with a relatively stable price”, Chinese Premier Li Keqiang has also recently highlighted the importance of “spurring production and purchase of electric cars [and] vowed to maintain preferential policies that are designed to boost sales and stimulate demand of cleaner cars”. As the third largest EV seller in China, commanding close to 10% of market share in the region, Tesla continues to benefit from a sustained demand environment – especially over the longer term as it continues to penetrate growing mass market opportunities in the region with the highly-anticipated roll-out of a lower-priced offering capable of higher margins through scale, similar to its current best-sellers, the Model 3 and Model Y.
U.S.
U.S. EV demand has also demonstrated resilience this year, despite a surging average price tag due to the lack of supply, and a slowing economy that has caused consumers to tighten their belts on big-ticket item purchases. Again, by commanding the largest EV market share in the region, Tesla continues to benefit from pent-up demand in the U.S.
Specifically, the Inflation Reduction Act (“IRA”) that has been signed into law by President Biden earlier this week is slated to replicate the achievements that China’s EV subsidies did over the past decade in encouraging EV demand. Under the IRA, passenger EV purchases priced under $55,000 and electric SUVs/pick-up trucks priced under $80,000 would be eligible for a $7,500 tax credit. This effectively puts Tesla’s best-selling Model 3, with prices starting at $40,390, within the eligible list.
The new tax credit also has no cap, differing from a previous subsidy program that limits incentives to the first 200,000 vehicles sold by an EV maker, which Tesla has long exhausted. The new incentive, paired with the generally improved sentiment for EVs in the U.S. is expected to further Tesla’s top-line growth in the region – more than a quarter of the American population has indicated an interest in making their next vehicle purchase an electric one, citing improved battery technologies, increased availability of charging infrastructure, and wide-ranging price segments as key drivers for their change of preference. Tesla’s edge over the increasingly competitive EV landscape in the U.S. is also further reinforced by the recent EV tax incentive under the IRA, which requires eligible vehicles to be assembled in the U.S., a requirement that the EV titan satisfies – this effectively eliminates more than 70% of currently available EV models from the eligibility list, including highly-demanded mass market options offered by Hyundai (OTCPK:HYMLF / OTCPK:HYMTF / OTCPK:HYMPY) and Toyota (TM / OTCPK:TOYOF).
In addition to the $7,500 tax credit on eligible passenger EV purchases, Tesla is also poised to benefit from increased fleet demand given the newly announced tax credit of up to $40,000 on eligible electric commercial vehicle purchases under the IRA. The long-anticipated roll-out of the Tesla Semi electric truck, which boasts 500 miles of range on a single charge, has been touted to make its first customer delivery before the end of the year upon confirmation of the latest incentives under the IRA.
If materialized (we all know how flaky Musk’s promises are), the Semi’s debut would have come at an opportune time to capitalize on increasing commercial fleet demand as emissions standards becoming increasingly stringent on urgent climate change pledges. Specifically, the commercial EV market is expected to expand at a CAGR of 22.1% through 2030, which makes strong tailwinds for Tesla’s emerging foray in heavy-duty fleet operations. And the EV maker has already demonstrated proven demand for the Semi’s upcoming debut, given the heavy-duty electric truck’s “significant backlog” accumulated over the years, including an order of 100 units from PepsiCo (PEP).
High Beta
In addition to solid fundamentals, the Tesla stock is also uniquely positioned to benefit from further upsides in a bull market given its five-year beta of more than 2. This essentially means that the Tesla stock is slated to “swing higher than the market during prosperous times”, something that markets are now preparing for after a tumultuous first half of the year.
Traders are now paring bets on another 75-bps rate hike in favour of a 50-bps increase instead next month after the July inflation print came in lower than expected at 8.5%, compared to consensus calls for 8.7% and a 40-year record high of 9.1% in June, which indicates that price pressures may have peaked. With both demand- and supply-driven price increases now cooling off as consumer spending slows and supply chain constraints start to ease, the Fed is making positive progress on taming runaway inflation – the core driver of the current rate hike cycle. This has accordingly improved market sentiment in recent weeks, as expectations for the return of a more accommodative policy backdrop increase. This is further corroborated by the Fed’s consideration to “slow the pace of policy rate increases” to prevent overtightening the economy in its ongoing efforts to “restore price stability” per the recently released July policy meeting minutes.
Yet, on the flip side, Tesla’s higher beta also warrants downside risks, with the stock potentially dropping by more than broad-based market declines during a downturn. For now, markets are still in early stages in the anticipation of an improved macroeconomic outlook. Recall that the Fed’s ultimate goal is to tame inflation, not stifle growth, as it continues with monetary policy tightening. And although inflation appears to be structurally improving, there is still some way to go with July inflation at 8.5% (core inflation 5.9%) and the central bank’s target at 2%, which implies continued rate increases, though potentially at a slower pace.
However, as discussed in the foregoing analysis, Tesla’s valuation prospects continue to be supported by solid fundamentals. This is further corroborated by its outperformance against the broader auto and EV peer group – Tesla not only boasts the “most productive car factory in the U.S.”, industry-leading market share, and competitive profit margins from a fundamental perspective, the stock has also outperformed by bleeding the least this year compared to its auto and EV counterparts.
Tesla’s upcoming three-for-one stock split is also expected to provide some near-term respite to its market performance. While the last round of stock splits in August 2020 saw Tesla’s share price soar towards new heights, the upcoming three-for-one split is expected to post much milder gains. Taking Google (GOOG / GOOGL) and Amazon (AMZN) as proxies (both of which have recently completed 20-for-1 stock splits in the latest bear run), both stocks have only posted gains in the mid-teens since completing their respective stock splits, while succumbing to declines in the period between their respective splits’ announcement and completion. This is a vast contrast to Tesla’s achievements in summer 2020 when the stock rallied as much as 60% over the span of about two weeks between the time that the five-for-one split was announced and completed. Considering the volatile market climate today, we expect Tesla’s upcoming three-for-one stock split to be beneficial to the stock’s near-term performance given the anticipated influx of retail interest on improved affordability (the Tesla stock is a retail favourite), but at a moderate extent similar to those observed in recent stock splits by Google and Amazon.
Final Thoughts
Strong fundamentals remain the core driver of long-term investment returns and Tesla continues to demonstrate that it has the growth and profitability to sustain continued valuation upsides. And ahead of anticipated improvements to the broad-based market climate, the stock is also expected to benefit from outperforming upsides given its high beta. While current market sentiment has not demonstrated an immediate recovery yet, which points to further volatility still over coming months, the Tesla stock is expected to perform better than most given continued positive surprises to its operational achievements as well.
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