Not Just Any 'Electric' Stock

05/16/2013 9:45 am EST


Alex Daley

Chief Technology Investment Strategist, Casey's Extraordinary Technology

This car manufacturer has endeavored to do things differently from the beginning, and that may give it interesting potential, says Alex Daley of Casey Daily Dispatch.

Compared to most other fledgling automakers, which rely on shared assembly plants or rented space from the big players, Tesla (TSLA) is much better off.

In 2008, founder Elon Musk took advantage of the financial crisis to purchase and retool a state of the art GM/Toyota manufacturing facility called "NUMMI." In theory, NUMMI is capable of producing 500,000 cars per year.

But if the Tesla is going to grow into a sales behemoth, it's going to have to prove it can shatter the ceiling imposed on most other electric cars: They have failed to consistently break above 5,000 units per quarter.

Assuming Tesla can actually buck this trend, it would need to drive demand at a heavy annual rate to get there. On December 31, 2012, the company boasted a total of 15,000 reservations for its cars. So far this year it has delivered 4,750, according to a statement ahead of earnings.

And sales need to rise 14.6% each quarter to maintain the velocity toward that 500,000-car goal. That's an impossibly lofty bar for a new brand still limited just to direct sales. Expect news about a dealership network sometime very soon, if there's to be true hope to reach this goal.

What's important is steady marginal growth for the Model S, through the introduction of Model X, and the eventual "GEN III" car, targeted at the mainstream market with a competitive midsize sedan price point.

As the company introduces lower-end cars, average revenues per car will drop (as will margins, in theory). Thus, the many projections I've come across that assume revenue per car is stable are not feasible.

So long as a company shows no signs of slowing growth, the market can award them a high P/E ratio for a long period of time. Google (GOOG), for instance, maintained a high P/E ratio-well above 60-for much of the first few years of its life on the public markets.

However, among all American stocks (excluding real estate trusts, which trade on different factors altogether)-even at today's all-time stock market highs-only a handful of companies with multibillion-dollar market caps trade at multiples of greater than 35 times current and forward earnings, including:

  • Facebook (FB)
  • LinkedIn (LNKD)
  • Netflix (NFLX)
  • Crown Castle International (CCI)
  • Equinix (EQIX)
  • ARM Holdings (ARMH)
  • Regeneron Pharmaceuticals (REGN)

All of those are technology companies in one fashion or another. Technology businesses are far less capital-intensive, have no real necessity for debt, and generate much stronger margins.

Tesla, by contrast, will enjoy roughly a 25% gross margin by the close of 2013, if all things work according to expectations. By comparison, established automaker Daimler AG (makers of Mercedes) enjoys gross margins of 21%. BMW has 18%, and it's 14% for Toyota (TM), 13% for Ford (F), and 9.9% for lowly GM (GM).

Tesla may find a way to maintain a 25% margin if it stays 100% luxury. If Tesla goes downmarket too early, it could see those numbers erode quickly...and that surely would spook the market away from those multiples we discussed above.

Still, don't fret too much if you're a Tesla investor. Most startup automakers would kill for those numbers at the same size.

No other electric comes even close to delivering what the Tesla Model S does. And if the company can do the same in the lower price segment, it will have Apple-esque lines queuing up for the next one, thereby maintaining much of that pricing power.

Don't underestimate Musk. If anyone will be there waiting to supply those drivetrains with open arms, it will be him. Right now, it's Tesla's market to lose.

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