Tesla Stock (NASDAQ:TSLA)
After the company’s bombshell announcement that it will cut prices by up to 20% on the Model 3 and Model Y, we remain pessimistic about Tesla, Inc. (NASDAQ:TSLA). Since inflationary pressures and borrowing rates are rising, we see the price decline as a warning that Tesla is at a disadvantage.
Taking a pessimistic view, we believe that Tesla’s margins will be squeezed by the price cut as input costs, particularly battery prices, continue to climb. The Inflation Reduction Act (IRA) may increase demand, but we anticipate that more is needed to make up for the reduced margins soon.
We lowered our price target on Tesla stock late last year, citing the company’s deteriorating electric vehicle (“EV”) market share and our expectation of muted revenue growth owing to macroeconomic headwinds. We are sticking with our sell recommendation for the time being because we think Tesla’s recent price decrease. However, it may help demand and keep the company’s EV market share, negatively impacting sales and gross profit margins.
In comparison to the S&P 500 Index (SP500), which is down about 7% over the same period, Tesla stock is down by over 34% over the last year.
Tesla stock price is near its two-year low. Although the company’s profits for Q4 2022 are above forecasts, we are not too bullish since the full impact of the price reduction on margins is not yet visible. Tesla’s leadership in the electric vehicle market has us optimistic about the company’s future. However, we anticipate that the firm will face challenges in 2023 on two fronts: (1) maintaining market dominance in the face of rising competition and (2) rising consumer expenditure and production costs due to macroeconomic headwinds. As we expect more selling pressure due to worse margins after the price reduction, we advise investors to sell their shares. We think investors intending to enter the EV market should hold off until 2024 when conditions should be more favorable.
Margin Losses From Price Reduction Are Inevitable
Even if the increase in average selling price (ASP) for Tesla automobiles over the last year is wonderful news for customers, we feel it is poor news for investors. Tesla began the year by slashing prices by as much as 20% in China, the United States, and Europe. We think the price reduction will increase Tesla’s addressable market and increase car sales in the short term. However, we also believe this will be at the cost of Tesla’s profitability and reputation as a premium EV manufacturer.
- Weighting on margins
We’re not too surprised that Tesla is attempting to promote demand by cutting costs, given the heightened likelihood of a recession due to inflationary pressures and increasing interest rates. Tesla’s first price cuts were in Asia, where they were met with enthusiasm from the Chinese market. In the second week of January, Tesla’s EV registrations in China hit 12,654, a 500% increase over the previous week’s total of 2,110. Since American consumers may get a tax credit of up to $7,500, we anticipate more demand in that country and Europe.
While Tesla has gotten all the press for its price cuts, it’s crucial to remember that it’s not alone. XPeng Inc. (XPEV) announced price reductions last week, a competitor to Tesla in the same price range, and Huawei-backed Aito the week after. Although on the surface, this seems to be a boon for Tesla, we anticipate it will negatively impact the company’s margins shortly. Because of this, we are worried about Tesla’s 1H23 gross margins, which is the amount left over after all expenses have been deducted. Following the price decreases, we anticipate poorer gross margins for Tesla due to the lower per-car price and the greater cost of manufacture.
Still, Tesla is dealing with rising raw material prices as it works to expand its electric vehicle production. One of the most persistent patterns has been a decrease in battery pricing; in 2017, the average pack price for lithium-ion batteries, as measured by BloombergNEF’s annual lithium-ion battery price survey, rose by 7% to $151/kWh.
We expect that the rising cost of batteries will result in higher prices for EVs produced by manufacturers, including Tesla. Rivian and General Motors aren’t the only ones in the EV market feeling the pinch of increased prices and a lack of pricing flexibility. Even if demand picks up, we expect Tesla’s price decreases to hurt the company’s bottom line.
- Reputation as a maker of high-end EVs
We are pessimistic about Tesla shares because we think the company has exhausted all other options to combat the growing competition from electric vehicle (EV) startups and established automakers expanding their EV lineups. After having a 79% share of the U.S. electric vehicle industry two years ago, Tesla’s share dropped to 65% in 3Q22 due to price competition. To no one’s surprise, Tesla has given in to the broader economic climate and lowered pricing to appeal to buyers in the sub-$50,000 area.
Tesla bulls see the price drops as a good thing, as they anticipate that the increased volume and more competition will result from the new rates. The CEO’s assurances of more demand in the wake of price reductions and the company’s 4Q22 financial performance contribute to the optimistic outlook.
We fear the company’s reputation as a premium EV manufacturer will suffer due to its aggressive discounting. Price cutbacks have inverted Tesla’s market strategy during the last two years, when the demand has outpaced supply, leading us to assume that the electric vehicle manufacturer has been cornered. Given the surplus of available vehicles over the number of buyers, we expect Tesla to lower its pricing.
Deliveries of the Model 3/Y by Tesla were 0.6% higher than production in FY2021, but in FY2022, production was higher by 4% than deliveries. While we anticipate that demand after price reduction will enable demand to outstrip supply in FY2023, this will have a detrimental effect on Tesla’s automotive gross margins and reduce profitability. The automotive segment’s gross margin for Tesla fell from 27.9% in the previous quarter to 25.5% this quarter. Therefore, we advise selling TSLA shares at the current price.
Valuation
Despite last year’s massive drop, Tesla stock is still quite pricey. Compared to its industry peers, this stock sells at a premium of 4.7x EV/C2024 Sales. Rather than focusing on growth and profits in the future, we think investors would be better served by waiting for the value to become compressed and represent the company’s current earnings more properly.
News from Wall Street
Overall, investors on Wall Street see bright prospects for Tesla. There are now 42 analysts following the stock; 25 have a “buy,” 12 have a “hold,” and the remaining 11 have a “sell.” Wall Street’s optimism is likely due to Tesla’s dominant position in the electric vehicle (EV) industry and the company’s recent price drops, which have increased the size of its potential customer base. Currently, one share of stock will set you back $201. On the sell side, price targets range from $198 to $193, with $198 being the median and $193 representing the mean.
Considerations for the Stock Portfolio
Despite Tesla’s price reductions for the Model 3 and the Model Y, we have a pessimistic outlook on the firm. As its electric vehicle market share declines, we think Tesla is playing defense. Moreover, we think Tesla is putting volume ahead of profit margins to stimulate sales. As the firm confronts high costs of raw materials, we anticipate that the lower pricing will pressure margins and profitability.
Since its 52-week high of roughly $384 in early November, Tesla stock has fallen below $200 per share or almost 48%. We advise investors to hold off until after Q2 2023 to observe how the price reduction affects Tesla’s profitability and how the market responds to Tesla’s more reasonably priced models. We advise investors to sell shares of Tesla, Inc. at their current prices as we anticipate a further decline in TSLA stock due to worse margins in 1H23.
Featured Image: Freepik @ suwin
