Vitaliy Katsenelson's Contrarian Edge: Tesla is like a SpaceX rocket to stock investors, but the car maker’s bond holders are down to earth

Vitaliy Katsenelson's Contrarian Edge: Tesla is like a SpaceX rocket to stock investors, but the car maker’s bond holders are down to earth

17 Jul    Finance News

Tesla’s TSLA, +0.01% market capitalization is nearing $300 billion. It’s now the largest car maker in the world, even larger than Toyota Motor Corp. TM, +0.45%, which produced almost 9 million cars in 2019 and has a market capitalization of around $175 billion.

Tesla stock is trading at 45 times very rosy — and improbable — 2024 earnings. Tesla’s market cap implies that investors believe that production will go up more than 20-fold from the 400,000 cars a year it currently produces to 10 million cars.

Bondholders take a decidedly different view of Tesla. As the stock-market valuation of Tesla races to the moon, its debt rating is earthbound. Tesla, the world’s largest automaker, gets a Caa1 rating from Moody’s Investors Service for its senior unsecured debt, while S&P Global gives Tesla a B- credit rating. Put simply, Tesla’s bonds are considered junk. (By comparison, Toyota is rated A+, GM GM, -1.49% is rated BBB).

Read: Tesla’s stock is forming a bubble and new buyers should buckle up for a crash

Plus: 7 risks for Tesla’s stock that Robinhood traders would be wise to heed

Red light, green light

When I wrote a 37-page series on Tesla I opened it with this quote from F. Scott Fitzgerald: “The test of a first-rate intelligence is the ability to hold two opposed ideas in mind at the same time and still retain the ability to function.” An analysis of Tesla and the automotive industry today requires holding a lot of opposing ideas.

I have made the analogy that the transition from internal combustion engine (ICE) cars to electric motors is akin to the transition from dumbphones to smartphones. It’s a domain shift. So maybe this will bring higher margins for Tesla, as happened for Apple AAPL, -0.20% with the iPhone. Unlike other car makers, Tesla is vertically integrated: It manufactures most of the components that go into its cars (including seats); thus it gains from the economies of scale.

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Also, software plays a bigger role in a Tesla than in a traditional car. There is self-driving, over-the-air updates, and an iPad-like interface that powers all the controls, for starters. So if advanced software helps Tesla get higher margins than traditional car companies, it in fact may not have to make as many cars to get to Toyota’s profitability. Bulls would even argue that self-driving alone may send Tesla’s margins soaring. I’ll pour cold water on that argument: Full autonomous driving is a good decade away.

It will take years, maybe even a decade, for Tesla to produce enough cars to justify its valuation.

Most importantly, going from 400,000 cars to many millions a year is neither easy nor cheap. The market confuses Tesla with Silicon Valley tech companies. Yes, Tesla is much more a technology company than your typical ICE car company is. It creates its own software and even the microprocessor that powers self-driving, but it still cannot escape the reality that it has to bend a lot of metal to produce its electric cars.

Unlike Facebook FB, +0.45% , which a decade ago could increase its user base 10- or- 20-fold by spending a few hundred million dollars on data centers, Tesla will require an incredible amount of capital to increase production many-fold. To produce fewer than half a million cars, as it does today, Tesla needed a $25 billion investment in property, plants, and equipment. This is where bits meet atoms and face financial gravity. Tesla is barely breaking even today and will need to raise and invest hundreds of billions of dollars to increase production enough to grow into its current valuation.

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Then there is an element of time. Tesla has been stuck at producing 90,000 cars for the last eight quarters. It can only blame the coronavirus for a quarter or two. Getting to an annual production of even a few million cars will require time — a lot of time. A lot of dirt has to be moved, permits issued, equipment installed, people hired. It will take years, maybe even a decade, for Tesla to produce enough cars to justify its valuation. Today’s market valuation assumes Tesla is already there — that the capital has been raised and spent and that it cost nothing.

So, how does one invest in this overvalued market? Our strategy is spelled out in this fairly lengthy article.  

Vitaliy Katsenelson is chief investment officer at Investment Management Associates in Denver, which owns Tesla put options in client portfolios. Katsenelson is the author of “The Little Book of Sideways Markets” (Wiley). 

More: Longtime Elon Musk critic has a strong message for investors looking to bet against Tesla

Also read: Tesla’s earnings on tap: Will a loss end its blowout stock rally?

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