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The Catalyst For Tesla Is Production

This article is more than 7 years old.

Tesla Motors makes sexy cars, but cannot produce enough of them to make money. Elon Musk, Tesla’s CEO, recently promised to increase production capacity ten-fold by the end of 2018. Gorden Lam says that achieving this goal is the catalyst that will resolve the key uncertainty holding back the stock.

Gorden started his Marketocracy fund in February, 2007. His returns have averaged 10.52% since then, which compares favorably to the S&P 500’s return of 4.24% over the same period. Over the last 5, 3, and 1 year periods, his performance would rank him in the top quartile of U.S. equity fund managers. Before taking anyone’s investment advice, you should always check out their track record. Click here to see Gorden’s.

Ken Kam: What does the market expect from Tesla?   

Gorden Lam: Ratings from most analysts are on the fence with half recommending a sell and the other half recommending a buy. Either you love the stock or hate it. The haters fear that, although Tesla makes great cars, it can’t produce them fast enough for the company to be profitable. In fact, CEO Elon Musk recently moved up his promise of manufacturing 500,000 vehicles from 2020 to 2018.

To put this in perspective, Tesla produced about 50,000 vehicles in 2015, including both the Model S and Model X. The doubters think Tesla can’t deliver half a million cars by 2018 especially when the company has been consistently experiencing shortcomings on the number of vehicles being delivered.

The doubters also believe that Tesla is burning cash much too quickly.  The company started in 2003 and went public in 2010. Since then, the company has managed to earn a profit in just one three-month period. The rest of the time Tesla has always had losses.

There's very little net positive cash flow coming in. It’s burning more cash that it currently has in reserves; and that means it will need to find a way to raise cash soon. Tesla is projected to spend about $2 billion in 2016 alone. Their cash reserves at the end of 2015 were only about $1.2 billion.

Kam: What is the market missing?   

Lam: While many argue that the company is burning money too fast, much of its gross cash flow is going toward building the proper infrastructure. This includes the Gigafactory, its lithium-ion battery factory in Nevada, which will be one of the world’s largest. It also includes its network of Superchargers. These are recharging stations designed and built specifically for Teslas and located between major cities. They are capable of recharging 80% - worth about 170 miles - of your Tesla vehicle in 30 minutes - and it's free for all Tesla vehicles with perhaps the exception of the Model 3. Tesla currently has about 624 stations with 3,708 Superchargers located throughout the country and that number continues to grow. No other car manufacturer has invested in that kind of infrastructure.   

Regarding the market’s concern about Tesla’s ability to ramp up production, first generation cars will always run into issues on the assembly line. Here’s how it works: The production line is run at maximum output, building cars at a rapid rate and then it’s shut down to inspect the vehicles for any flaws. The manufacturing process is then retooled to fix any problems that have been uncovered after which the production line is turned back on, and it's running at full capacity again.

Production may be slow for the first few months, but once a flawless run has been achieved, you can expect an instantaneous ramp-up, not a slow gradual one. Thus, while I do anticipate delays, all the bugs will be worked out such that Tesla will be able deliver 500,000 vehicles a year by 2018 - as long as the batteries are available. This is a key uncertainty as batteries remain in short supply.

Kam: Are there any precedents for ramping up production so quickly?

Lam: Ford produced about 10,000 Model T’s in its first year. Only six years later, Ford was rolling off its assembly lines more than 500,000 Model T’s. By comparison, Tesla delivered 2,650 vehicles in 2012, 22,300 in 2013, about 33,000 in 2014, and just over 50,000 in 2015.  

If Tesla simply keeps pace with Ford’s Model T, it should have no issues producing 500,000 cars by 2020.  Remember, when Ford first started building vehicles for the mass market, its assembly line consisted entirely of manual labor. The manufacturing today is a lot more automated with sophisticated robots doing most of the work. Tesla has more than 160 robots in their Fremont manufacturing facility that can build and assemble a vehicle with speed and accuracy. It takes about six seconds for a part to be stamped out from its aluminum coils.

Today, there's still a significant amount of manual labor in Tesla’s building process, but that’s only because it’s still in its initial stages and needs to be tweaked and modified until it’s perfected. Once that’s achieved, the ramp-up speed will be significant. I estimate that Tesla will have produced over 450,000 vehicles by the end of 2018 if everything goes as planned.

Kam: You mentioned batteries as a potential bottleneck. What’s going on there?

Lam: The innovation and advancements in lithium batteries for cars are changing very rapidly.  Tesla will supply batteries for their vehicles and also home battery packs for Solar City (SCTY). Solar City will provide home batteries for homeowners who have solar panels that want to store the excess power they generate. This eliminates the need for providing the excess power back to the utility company at low wholesale rates or the option to be completely “off the grid.” “Off the grid” meaning that you are no longer restricted to live in an area that’s dependent on a local utility with available power lines.  Meanwhile, the energy density of the battery is improving by 5% a year and that means the batteries will hold a longer charge without the need to make the batteries larger.

The bottleneck issue is really about lithium hydroxide, a key ingredient in Tesla’s batteries.  According to Benchmark Mineral Intelligence, Tesla will need about 24,000 tons annually of lithium hydroxide, out of a market last year of only 50,000 tons.  It's the only area of the electric vehicle supply chain that Tesla does not have ownership or control over.  The issue is not about sourcing the raw materials, but obtaining them at an attractive price point to lower the cost of the car. The good news is that lithium batteries continue to come down in price. In 2009 a lithium-ion battery pack costs $1200 per kwh, but it could get down to as low as $250 by 2020 with the Gigafactory complete and a more effective supply chain.  That would make the price of electric cars comparable to gasoline cars.  

Kam: Other automakers are beginning to ramp up to bring to market more electric vehicles this year. Do you feel that will dampen demand for Tesla vehicles?   

Lam: Now that Tesla has more than 400,000 reservations for their Model 3, many automakers are scrambling to put all their resources in developing an EV that would compete with Tesla.  They're in panic mode. Ford just purchased one of the first limited edition releases of the Model X for about $200,000 just to dissect the car and examine it. No one took EVs seriously until now.  

But Tesla is in a market by itself. The concept of the electric car has existed for years. The major automakers have been trying to develop electric cars for the mass market throughout the 1990's but unfortunately, none of them were able to create enough demand to merit any continued production. Just five years ago, if you asked what people thought of electric cars, they'd tell you that EV cars lacked power, have limited range, are inconvenient, and look like something only a tree-hugger would drive (no offense to any tree-huggers out there).

Kam: What do you mean?

Lam: Tesla was the first company to ever create an electric car that people desired. Tesla vehicles are sleek, fast, a pleasure to drive, and have a comparable driving range that would rival most other cars on the market.

For example, when the Toyota Prius was first released in 2001, it had all the rage about gas savings and a creating a greener environment. I remember my uncle - who's an accountant – saying, "Although the Prius has great gas mileage, its price tag does not justify the savings in gas.  It would still be a lot cheaper to buy a non-hybrid." Keep in mind that my uncle lives in Hawaii where gas prices are among the highest in the nation. He is very frugal, does value calculations before making any kind of purchase, is not an early adopter of technology (he just recently upgraded from AOL's 56k internet dial-up to high-speed internet!), and is not into fancy cars. Yet he recently purchased a Tesla Model S! He was so excited to show me all the features of the car that he could not stop talking about it as we drove to dinner. He even reserved a Model 3 for his wife. This is a common trait among Tesla owners - they love their Tesla.

The point is, consumers see value in an $80,000 Tesla that they can’t get anywhere else. The Model S is actually not an expensive car when you compare it to other luxury cars on the market. It looks sexy - like it just came off a James Bond movie set. It's one of the safest cars on the market - so tough it even damaged one of the test machines. A driver walked away unscathed while slamming into a concrete barrier at over 100 mph.  

Whenever there is a problem discovered with one of the Tesla vehicles, such as with the doors, a wireless signal gets beamed to the car overnight to update the software and to rectify the problem. A driver can program the car to open the garage door, back itself out of the garage, and be waiting and ready to go.  It’s like owning your own Batmobile or "Kit" from the TV series Knight Rider.

In the future, you can summon your Tesla to pick you up from the airport or even from a bar if you're too intoxicated to drive. 100% self-driving is not here yet, but Tesla is constantly updating their software for when it arrives.

Kam: Do Tesla vehicles have any other advantages?

Lam: Yes: driving range. Tesla Motors is the only company that has a range of 265 miles for its Model S P90.  The Model 3 will have a range that starts at 215 miles when fully charged. All other EV vehicles produced by Ford (F), Nissan (NSANY), Daimler Benz (DAI.DE), BMW, Chevy, Kia, Fiat, & don't even come close. All their pure electric vehicles have ranges below 120 miles.  I think if it were that easy to create an EV with a range that's similar to Tesla's, everyone else would have done it by now

Moreover, no other manufacturer has even begun to invest in the type of Supercharger infrastructure that Tesla is building across the country.

Kam: How much time are you willing to give this investment to play out?  

Lam: About 3-5 years.  Tesla will have some delays, as this is common among first generation design of automobiles and especially for a startup that's building from the ground up. Plus, the stock price is highly volatile and very sensitive to any positive or negative news. Tesla’s stock chart looks like a roller coaster. The stock seems to take a dive each time a delay is announced from the company. A number of hedge funds have publicly announced that they are shorting Tesla. There's a lot of people trading the stock rather than holding on to it as a long-term investment.  As of mid-May, about 25% of shares had been sold short. A significant number of traders are betting that Tesla's share price will fall significantly, in which case I would be a buyer.  In fact, I'm hoping for a pullback to the $150-$160 range so I can accumulate more shares.

Kam: Why is $150-160 your strike point?

Lam: This is based on the support level reached in February this year. It's difficult to value Tesla's share price based on its financials. At the current price of $220 per share, Tesla has a market value of $32 billion. That may seem expensive when you compare it to a company like Ford Motors Co. which has a market value of $52 billion and sold 2.6 million cars in 2015, but Tesla is a disruptor and this is only the beginning.

Kam: If you are right, what is the upside?

Lam: I see the stock trading near $450 a share in about 3 years. This is based on the revenue the company will generate after producing 500,000 vehicles.  Tesla is estimated to generate $8 billion this year and $16 billion next year.  My estimate is that they'll hit sales close to $30 billion by the end of 2018.

Kam: Are there any potential catalysts that you are looking for?   

Lam: The obvious one is Tesla being successful at producing 500,000 vehicles by 2018.  For many investors to have faith in Tesla, it needs to be a mass market producer of vehicles, and that faith has resurrected after seeing 400,000 pre-reservations for the Model 3.  Even if Tesla is able to produce 500,000 cars a year, it may still not be able to generate a profit due to the ongoing investments to improve the company's operations and infrastructure, but at that point, I think the finances will be enough to sustain building more cars and to continue work on R&D. Elon Musk has a long-term vision for Tesla to make electric cars the majority of vehicles on the road.  Profit will eventually follow.

The other factor that needs to fall in place is the availability of the batteries – and its key ingredient, lithium hydroxide - to complete these many vehicles.

Kam: Are there any other reasons to buy the stock?

Lam: Tesla has a huge advantage because all they do is build electric cars. They designed their infrastructure from the ground up. Other car companies may dabble in a small sector of EV but the majority of their manufacturing is focused on combustible engines.  Now those large companies are starting to panic and are contemplating if they should shift their resources to compete in the EV market. Volvo has vowed to expand its line of hybrid and electric cars from two to five by the end of this decade. Even Volkswagon will be trying to build electric cars to compete with the Tesla Model 3 claiming a range of 300 miles. But as long as traditional vehicles are their main source of profits, they will struggle to make the transition to where Tesla already is.

For long-term investors, Tesla is more than just an electric car company selling luxury electric cars at premium prices. Elon Musk has a much larger vision than to simply make money for Tesla. His goal is to eliminate global warming and create a greener environment.  Imagine, recharging your car with just the sun. This is all attainable with the use an electric car and solar panels installed at your home. No more burning of fossil fuels that pollute the environment, no more independence on foreign oil. In a recent survey, 83% of EV drivers said they had solar panels at home or considered installing them to experience a true zero-emission driving experience and most EV drivers would definitely consider their second car to also be an EV if it had longer range. The survey validated that future vehicle ownership will be part of a more connected, electric based, mobile-lifestyle powered by renewable energy.  Tesla could be right at the center of all that change.

My Take: Investing in Tesla is a chance to score a homerun at the risk of striking out.  In situations like this, few investors will follow the company closely enough to get out in time if the facts start to go against them.

Consequently, for many people, the decision about whether it’s a good idea to make an aggressive investment like this depends a lot on who is monitoring the portfolio.

Gorden’s consistent top quartile ranking among U.S. equity mutual fund managers suggests he will do a much better job than most investors.

To explore whether Gorden’s strategy makes sense for you, schedule a One-on-One with Ken Kam.

About my column.

Disclosure: I am the portfolio manager for a mutual fund advised by Marketocracy Capital Management, an SEC registered investment advisor. Before relying on the opinions expressed in this article, you should assume that Marketocracy, its affiliates, clients, and I have material financial interests in these stocks and may hold or trade them contrary to these opinions when, in our view, market conditions change.