update 22-q3
1 November 2022
Rising interest rates and a looming recession are not the ideal macro backdrop for high growth companies like Tesla. That said, Tesla’s Q3 results do not disappoint and the company has once again delivered a strong overall result. A summary of the key aspects to note in this quarter’s update are outlined below.
Risk-free rate: the US 10-year Treasury bond rate at the time of this analysis is 4.08%. With rising interest rates, I have kept my original assumption of a higher rate for the next 2 years of 5%, following which the rate gradually reduces until a terminal base assumption of 3%.
Equity risk premium: Recalculating with the recent market volatility results in an updated operations adjusted equity risk premium of 5.98%. I have assumed this as constant for my base case assumption.
WACC: the above changes results in a WACC of 9.68% for Tesla.
At the time of this analysis, my revised valuation of the total equity in common stock for the Tesla company using base case assumptions is $729.46 billion. This translates to an estimated value per share of $231.01.
The screenshot below summarizes the DCF calculation to arrive at this valuation.
Disclosure: I hold a long position in TSLA shares at the time of publication of this post.
Update 22-Q1
2 July 2022
Market volatility and macroeconomic developments have resulted in changes to risk-free rates and equity risk premiums since my last post. This has a material impact to the WACC calculation. I have adjusted my analysis to account for these recent developments.
Risk-free rate: the US 10-year Treasury bond rate at the time of this analysis is 2.89%. With rising interest rates, I have kept my original assumption of a higher rate for the next 2 years of 4%, following which the rate gradually reduces until a terminal base assumption of 2%.
Equity risk premium: I had previously calculated the implied equity risk premium for the S&P 500 to be 4.86%, but recalculating with the recent market volatility results in an updated equity risk premium of 5.94%. I have assumed this as constant for my base case assumption.
WACC: the above changes results in an increased WACC for Tesla from 7.92% to 8.58%.
At the time of this analysis, my revised valuation of the total equity in common stock for the Tesla company using base case assumptions is $587.55 billion. This translates to an estimated value per share of $567.13.
The screenshot below summarizes the DCF calculation to arrive at this valuation.
Disclosure: I hold a long position in TSLA shares at the time of publication of this post.
valuation 22-q1
19 June 2022
At the time of this analysis, my valuation of the total equity in common stock for the Tesla company using base case assumptions is $778.94 billion. This translates to an estimated value per share of $751.86.
The screenshot below summarizes the DCF calculation to arrive at this valuation. The rest of this writeup will outline the base case assumptions used.
Disclosure: I hold a long position in TSLA shares at the time of publication of this post.
Revenue:
Tesla operates with 2 reportable segments: automotive and energy generation and storage. The automotive segment includes the design, development, manufacturing, sales and leasing of electric vehicles as well as sales of automotive regulatory credits. The energy generation and storage segment includes the design, manufacture, installation, sales and leasing of solar energy generation and energy storage products and related services and sales of solar energy systems incentives. In addition to these 2 segments, Tesla has a services and other revenue stream, which includes non-warranty after-sales vehicle services, sales of used vehicles, retail merchandise, sales by acquired subsidiaries to third party customers and vehicle insurance revenue.
My forecast for Tesla revenues has been designed with a 10-year high growth period, before stabilizing to a terminal growth rate. The revenue forecast has been built on 5 major revenue areas, with assumptions presented below for each:
Automotive sales: includes revenues related to cash deliveries of new vehicles. This also includes access to the Tesla Supercharger network, internet connectivity, FSD features and over-the-air software updates.
New vehicle sales: is the largest contributor, accounting for 60%+ to overall Tesla revenue. The methodology used to forecast is based on assumptions on global auto market growth, electric vehicle (EV) share of global market, and Tesla share of the EV market. Assuming a global auto market size of $2.83 trillion in 2020, I’ve assumed a growth rate of 0.50% year-on-year until 2030. This is a very conservative estimate, below global GDP growth or inflation rates, and well below the historical average rate of 3%-4% over the past 5 years. I believe the advent of ride sharing and autonomous technology will apply downward pressure on new vehicle sales. I believe we will however witness a rapid adoption of EVs. EV share of global auto market in 2020 was estimated at 4%. My base case assumes adoption of EVs will reach a 30% share of global auto by 2026 and a 60% share by 2030. I have assumed adoption will follow a S-curve, with the next 5 years seeing 40-50% year-on-year growth, following which growth rates will taper off. Tesla share of global EV market was estimated at about 25% in 2021. My base case assumes this to gradually taper down towards 15% over the next 10 years, accounting for increasing competition in the EV space. Applying these 3 sets of assumptions, new vehicle sales annual growth rate for Tesla over the next 10 years is estimated at 21.2%, noting a higher growth rate in earlier years due to S-curve adoption.
Supercharger sales: growth is challenging to forecast as there isn’t a lot of guidance on Tesla long term strategy or deployment plans for superchargers, other than an increasing number of Tesla vehicles on the road will require more superchargers stations and connectors. There are currently ~25,000 superchargers in service. I have assumed a conservative growth rate in superchargers at 1/5th the growth rate forecasted for new vehicle sales. I have assumed 10 EVs charged daily per supercharger, an average $10 per EV charged, with 1% price inflation year-on-year to calculate the forecasted supercharger revenue per year.
FSD sales: requires a high degree of confidence in Tesla engineers being able to deliver on autonomous driving, a huge innovation that is extremely difficult to achieve. The product is currently in beta and making improvements, however I expect will only start to meet consumer expectations in 3-4 years. Today Tesla has about 100,000 customers who have paid for FSD, translating to ~10% of new vehicles sold per year. I have accordingly factored in a gradual growth rate, starting from 10% and gradually reaching 80% take-rate after 10 years. I have assumed take-rate accelerates in years 7-10 once the product is proven and customer confidence is high. I have assumed average FSD revenue per customer at $10,000 with 1% price inflation year-on-year.
Automotive regulatory credits: have played a big role in Tesla’s early days, but I expect these revenues to reduce over time as more competitors electrify their fleets, requiring them to purchase less credits from Tesla. I am forecasting a –5% decline in year 1 with a gradually accelerating decline % until there is $0 revenue from regulatory credits by year 10.
Automotive leasing: as a % of total automotive revenue is 3.95% for TTM. I have assumed 3.95% remains constant as a base assumption.
Energy generation and storage: growth has been somewhat volatile historically given the emphasis and focus placed by the company on automotive sales. There average growth rate from 2019-2021 was ~23%, with 2020 and 2021 at 30%+, while 2019 was -1.5%. Knowing that the company’s focus will continue to be automotive, I have assumed a base case growth rate of 5% for the next 5 years, following which reduces to 3% for years 6-10. This is conservative, and will be adjusted if there is an indication in future earnings that there will be an increased focus on this segment in the future.
Services and revenue: as a % of total automotive revenue is 8.22% for TTM. I have assumed 8% constant as a base assumption.
Operating margin:
Operating margin = Adjusted EBIT / Revenue. I have adjusted EBIT to capitalize R&D and operating leases. TTM operating margin is 17.74%. I have assumed operating margin gradually increases year-on-year until it reaches 22.5% by year 10. Tesla’s core competency and strategy is to be the “machine that makes the machine”. I expect investments and innovation in manufacturing technology will result in reduced COGS over time with scale, leading to increased operating margins. A terminal base case of 22.5% is justified comparing with other high-end manufacturing technology firms, specifically Apple with an operating margin of ~30%.
Tax rate:
Tesla’s effective tax rate is 10%. The US marginal tax rate is 27%. I expect the effective tax rate to gradually move towards the marginal rate over time ultimately reaching 27% as the base case terminal assumption.
Reinvestment rate:
Reinvestment = capital expenditures – depreciation + change in working capital. I have adjusted capital expenditures and depreciation to capitalize R&D. Reinvestment rate (RIR) = Reinvestment / EBIT*(1-t). The TTM RIR is 35.43%. However, the latest quarter RIR is 80%+. I have assumed an 80% RIR for the next 5 years followed by a gradual decline to 17.50% base case assumption. This high RIR is to support the aggressive sales growth assumptions.
Return on capital:
Return on capital (ROC) = EBIT*(1-t) / (Debt + Equity). The TTM calculated ROC is 17.62%. Implied ROC = EBIT*(1-t) growth rate / RIR. Implied ROC during the high growth period is high, ~32.5% on average with higher ROC expected in the early years before tapering off. When compared with forecasted calculated ROC, there is a large variance up until around year 7, following which we see convergence. Important context for Tesla for the initial year divergence, and a seemingly high implied ROC, is that a big portion of Tesla’s free cash flow is sitting in cash. Cash does not deliver high return (<1%), and unless it is used to pay off debt or buyback equity, it does not help improve the ROC %. I believe the true return on investment for Tesla in key investments (example: giga factories) will have a ROC of >50%, and coupled with EV adoption market trends, should justify the high growth rate and implied ROC.
WACC:
Risk-free rate: has been determined noting Tesla is a US based company that has USD as its primary reporting and operational currency. Assuming USD as our currency of choice, US Government Treasury bonds in local currency (USD) is generally considered as stable and certainly (relatively) risk-free given the current our current geopolitical macro environment. I will use the US 10-year Treasury bond rate. The US 10-year Treasury bond rate at the time of this analysis is 3.24%. With rising interest rates, I have assumed a higher rate for the next 2 years of 4%, following which the rate gradually reduces until a terminal base assumption of 2%.
Equity risk premium: calculation is based on Tesla’s operations. I start with the implied equity risk premium for the S&P 500 by forecasting the expected growth in cash payouts of earnings for the next 5 years, based on aggregate analyst estimates, and subsequently assumed the risk-free rate of growth in perpetuity post the 5 years. Given Tesla’s global operations, the equity risk premium needs to be adjusted with relevant country risk premiums. Tesla is currently predominantly a manufacturing company, with a global supply chain. Hence, I’ve factored both revenue markets and manufacturing locations as key drivers for country risk. I have assumed a 40-60 weight to revenue and manufacturing respectively. I’ve applied a slightly higher weightage to manufacturing since at this point in time, Tesla sales are supply constrained, as opposed to demand constrained. This creates a greater burden on its manufacturing operations, and so I’ve weighted those locations higher. Additionally, Tesla’s long term core competency, as stated by the company, will not be its product but “the machine that makes the machine”. This should increase the importance of the manufacturing locations. I have calculated the country risk premiums by referencing the country default spread and comparing the variance against the US default spread. Some areas of Tesla reporting are only provided at a regional level, and for those calculations I have applied a GDP weighted risk premium. he Tesla operations and geography adjusted equity risk premium at the time of this analysis is 5%, and I have assumed it to remain constant as base case assumption.
Equity beta: is a weighted levered beta based on the company’s operations by industry. The majority of Tesla’s current revenues are from automobiles, but the company is also heavily invested in becoming a leader in green energy, storage, services like automobile insurance, and real-world artificial intelligence. I have started with the company’s revenues for each business line as a foundation to determine the weights. However, revenues alone do not reflect the quality (profitability) of each business area. Using EV/revenue aggregates for each industry as a reference, I am able to estimate the value for each of Tesla’s businesses. This provides a slightly better representation of the value and quality of each business that can subsequently be used to determine the business exposure weights. Industry betas are calculated using a simple average across firms’ beta, taken as a weighted average of 2-year and 5-year weekly return regression betas, with 2-year betas weighted 2/3rds. Industry unlevered betas are calculated with the formula = Beta / (1+ (1-tax rate) (D/E)), where D = Total debt, including lease debt, and E = market value of equity. Both debt and equity are aggregated across firms in an industry to calculate D/E. Weights have been based on estimated Enterprise Value (EV) for each area of business using EV/revenue aggregates for each industry as a reference. Finally, using Tesla’s D/E ratio to the unlevered industry betas brings us to the appropriate levered beta for each business line. Applying the business exposure weights, we arrive at the enterprise beta. The Tesla business operations driven bottom-up beta at the time of this analysis is 0.95. I have assumed this to gradually increase over time to 1.06 terminal base case, accounting for an increased debt ratio of 15% in the future.
Interest coverage default spread: is estimated by comparing Tesla’s interest coverage ratio the average default spread for similar companies, mapped to their average company rating. With an interest coverage ratio of 24.63, Tesla has the highest rating (AAA), mapping to a default spread of 0.67%. I have assumed this to remain constant.
Debt to capital ratio: for Tesla is currently extremely low at 1.71%. This is extremely positive in the current macroeconomic climate, which anticipated interest rate hikes. However, over time I assume Tesla will gradually move towards a terminal debt ratio of 15% as my base case assumption. Note: I have used market values of debt and equity to calculate the debt to capital ratio.
WACC: is currently calculated at 7.92%, with a cost of equity of 7.99% and cost of debt of 3.91%. WACC is estimated to increase to 8.67% in the next 12 months, primarily driven by a rise in the risk-free rate, following which I assume a gradual decline to a terminal WACC of 6.50%, driven by a stable risk-free rate of 2% and an increased debt ratio of 15%.
Terminal growth rate:
I’ve assumed terminal growth rate in FCF to match the risk-free terminal rate, anticipated to be 2%.
Equity options:
Tesla has stock-based compensation that includes stock options, restricted stock units (RSUs), and employee stock purchase plan (ESPP). Utilizing the Black-Scholes pricing model, I have estimated the value of all outstanding options for each category of stock-based compensation separately, which at the time of this analysis amounted to a total value of all outstanding options of $88.17 billion. The tax adjusted value of these options is $64.36 billion.
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