Are Tesla Shares Out of Juice?

After Musk's post, Tesla shares rallied, but, at the time of publication, shares in the company are down over 32% over the last six months, and 28.8% year-to-date. The downward tear is partly due to a recent announcement that quarterly year-on-year deliveries had fallen for the first time since 2020.

This is quite the turnaround from the situation a few years ago, when Tesla shares were making fund managers a lot of money. In November 2021 Tesla shares reached an all-time high topping $400 (£315.28). The shares traded at a forward price to earnings ratio ("P/E") of 98, which was roughly 80% over the Morningstar-assigned Fair Value Estimate.

We also took a sceptical view of the company on an episode of our podcast Investing Compass shortly after the all-time high.

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What is Tesla's Business Model?

Tesla is one of the largest battery electric vehicle automakers in the world. In less than a decade, the company went from a startup to a globally recognized luxury automaker with its Model S and Model X vehicles.

The company competes in the entry-level luxury car and midsize crossover sport utility vehicle markets with its Model 3 and Model Y vehicles. Tesla also sells a light truck—the Cybertruck, and a semi truck. The company plans to launch an affordable SUV and luxury sports car in the future.

Tesla aims to retain its market leader status as EVs grow from a niche market to reaching mass consumer adoption. We forecast EVs will reach 40% of global auto sales by 2030. To meet growing demand, Tesla opened two new factories in 2022, which increased its production capacity. Tesla also invests around 4% of its sales in research and development, focusing on improving its market-leading technology and reducing its manufacturing costs.

Key Morningstar Metrics for Tesla Shares

• Fair Value Estimate: $195 
• Morningstar Rating: 3 stars;
• Morningstar Economic Moat Rating: Narrow;
• Morningstar Uncertainty Rating: Very High.

For EVs to see mass adoption, they need to reach cost and function parity with internal combustion engines. To reduce costs, Tesla focuses on automation and efficiency in its manufacturing process, such as reducing the total number of parts that need to be assembled in a vehicle. The company also began designing its own batteries. Tesla's goal is to reduce costs by over 50%.

To reach functional parity, EVs will need to have adequate range, reduced charging times, and availability of charging infrastructure. Tesla’s extended-range EVs are already at range parity with ICE vehicles. The firm also continues to expand its supercharging network, which consists of fast chargers built along highways and in cities throughout the U.S., EU, and China. The range and supercharger network help eliminate road trip anxiety, or the functional barrier to mass market EV adoption.

Tesla is also attempting to take a larger share of its customers’ auto-related spending, which includes selling insurance and offering paid services such as autonomous driving software.
It also sells solar panels and batteries used for energy storage to consumers and utilities. As the solar generation and battery storage market expands, Tesla is well positioned to grow accordingly.

Are Tesla Shares a Risky Buy?

We assign Tesla a Very High Morningstar Uncertainty Rating, as we see a wide range of potential outcomes for the company. Read more about how to evaluate business risk in a company.

The automotive market is highly cyclical and subject to sharp demand declines based on economic conditions. As the electric vehicle (EV) market leader, Tesla is subject to growing competition from traditional automakers and new entrants. As new lower-priced EVs enter the market, Tesla may be forced to continue to cut prices, reducing its industry-leading profits. With more EV choices, consumers may view Tesla less favourably.

The firm is also investing heavily in capacity expansions that carry the risk of delays and cost overruns. Likewise, its research and development efforts are an attempt to maintain its technological advantage and generate software-based revenue, but there is little guarantee these investments will bear fruit. Tesla chief executive Elon Musk now owns a little less than 15% of the company's shares and uses it as collateral for personal loans, which itself raises the risk of a large sale to repay debt.

Tesla also faces environmental, social, and governance (ESG) risks. As a car manufacturer, Tesla is subject to potential product defects that could result in recalls, including its autonomous driving software. We see a moderate impact should this occur.

But another risk involves employee retention. If Tesla is unable to retain key employees, such as Musk, its favourable brand image could decline. Should the company not be able to retain production line employees either, it could see delays. We see a low probability but moderate materiality for both risks.

Additional ESG risks include potential patent litigation as the company relies on new technology to improve its EVs and energy storage systems. We see a low probability, but moderate materiality should this occur. Tesla may also face regulatory issues in some US states due to laws that require automakers and dealers to be separate. Again, we see a moderate probability but low materiality.

Read our February Analysis: Should I Buy Tesla Shares After Earnings?

Are Shares in Tesla Cheap Now They've Fallen?

Our Fair Value Estimate for Tesla is $195 per share. In 2024, we forecast Tesla's deliveries would be roughly flat, versus 1.8 million in 2023. We forecast lower average selling prices as Tesla will likely have to cut prices in key markets, such as China, in line with peers. We also forecast automotive gross margins will be 18% in 2024, in line with 2023 results.

Longer term, we assume Tesla delivers a little over five million vehicles per year in 2030. This includes fleet sales, which are an expanding opportunity for the company. Our forecast is well below management's aspirational goal of selling 20 million vehicles by the end of this decade. However, it is nearly three times the 1.8 million vehicles delivered in 2023.

Our forecast assumes Tesla slightly grows its Model 3 and Model Y deliveries and ramps up volumes of the light truck, named the Cybertruck, to around 100,000 deliveries per year – far below management's goal of 250,000.

We forecast Tesla will launch its affordable SUV with initial deliveries coming in late 2025, and a ramp up in 2026 at a pace similar to the Model 3 ramp up in 2018, the first full year the vehicle was sold. We think deliveries of the affordable SUV will exceed those of the Model Y and Model 3, as the lower price point should attract a larger consumer base.

We think Tesla will be successful in continuing to reduce its manufacturing costs on a per vehicle basis. We forecast segment gross margins will recover to the mid-20% range by the end of the decade, well above the 19% level generated in 2023, but below the 29% margin achieved in 2022.

Addtionally, we assume revenue growth and margin expansion from autonomous software sold on a subscription basis. We also assume the successful growth of the insurance business and increased profits from the charging business result in long-term profit growth and margin expansion in the services and other segment.

In energy generation and storage, we assume the business averages over a 20% annual growth rate during our 10-year forecast, primarily driven by accelerating demand for energy storage systems.

While we forecast ESS prices to decline, the fall will largely be driven by cheaper battery costs, which should not affect profitability. As volume grows, unit costs should fall. Combined with recurring revenue from long-term power purchase agreements and AI trading software, we expect the business will turn profitable and generate gross margins in line with peers such as Enphase and SolarEdge.

Additionally, we assume Tesla's overhead expenses continue to decline as a percentage of sales as the company benefits from operating leverage as deliveries grow. As a result, we forecast companywide operating margins will return to the mid-teens levels by the end of the decade in line with the 17% achieved in 2022, and well above the 9% margin in 2023.

To fund this growth, we assume Tesla will need to spend over $100 billion in capital expenditures over the next decade. Our base case also adds the present value of Tesla's autonomous vehicle ride-hailing (robotaxi) business, which accounts for roughly 7% of our total valuation. This figure assumes Tesla captures a 2.5% market share across the combined markets of the US, European Union, and China, and charges $0.75 per mile. Finally, we add the present value of Dojo's artificial intelligence training services and the present value of humanoid robot sales, which accounts for less than 1% of our total valuation combined.

Tesla: What Else Could Happen?

Given the wide range of outcomes for Tesla, we also model additional scenarios. Our downside scenario fair value estimate is $90 per share. In a downside scenario, we assume Tesla delivers under four million vehicles in 2030. We also assume cost reductions do not materialise as planned and Tesla is forced to cut prices amid increasing competition.

This keeps gross profit in the high teens to low-20% range, in line with the 19% generated in 2023. We also assume Tesla gets no benefit from autonomous driving software and sees slower growth in the insurance business. Finally, in this scenario, we assign no value to the company's ancillary businesses, including robotaxi, Dojo's AI training services, and humanoid robots.

Our upside scenario fair value estimate is $400 per share. In an upside scenario, we assume Tesla delivers over 9 million vehicles per year by 2030 and the company further benefits from cost reductions in excess of our base-case forecast. We also assume greater adoption of autonomous driving software and faster growth in the insurance business.