Cracks In The Dam At Tesla

I previously covered electric vehicle (EV) maker Tesla Inc’s (NASDAQ: TSLA) second-quarter earnings in Tesla Shares Surge Following Its Largest Loss Ever.

The title is self-explanatory. Tesla reported a record loss, but Tesla CEO Elon Musk has an uncanny way of reassuring investors that everything is just fine. As he did so in the previous earnings call, Tesla shares moved higher.

Broken Promises

I have covered advanced biofuel companies for more than a decade, and just about all of them did the same thing. They consistently overpromised and underdelivered, until they finally ran out of money and declared bankruptcy. 

I am not sure that Tesla will share the same fate, but management is demonstrating the same pattern. Elon Musk frequently says grandiose things to investors that fall far short of his projections. Thus far, this tactic has helped to prop up Tesla’s share price.

Investors may finally be running short on patience. Last week Tesla reported a new record loss of $619.4 million, almost double the second quarter’s record $336.4 million loss. Musk had a difficult time reconciling the quarter given the optimistic statements he had made following the previous quarter.

In a nutshell, revenues were up by 7% from the previous quarter, and 30% year-over-year (YOY). The number of units sold rose, but the average selling price per unit fell by 10% compared to the previous quarter. Expenses that rose by nearly 20% from the previous quarter were the single biggest line item contributing to the record loss. 

Elon Explains

Things got really interesting on the earnings conference call because Musk was confronted with some of his earlier statements. 

During the previous quarter’s conference call, Musk had stated: “What people should absolutely have zero concern about, and I mean zero, is that Tesla will achieve a 10,000-unit production week by the end of next year.”

Zero concern. That’s a statement of absolute confidence, and Musk’s credibility should be judged on such statements. But when questioned about this previous claim by analyst Ryan Brinkman from JPMorgan Chase (NYSE: JPM), Musk replied that it is “a bit too early” to make such a forecast, adding:

“But I mean, if you extrapolate from 5,000 units towards the end of Q1, we do want to call upon significant CapEx until we are confident about cash flow on Model 3, so then that’s a question of how long it takes to implement. I mean, that’s where you get to 10,000 units a week for Model 3, which is a number we are confident can be sustained from a demand standpoint.”  

So the absolute confidence about 10,000 units a week has now turned into “we need significant capital to get to 5,000 units a week.” Another example of overpromising and underdelivering. This is significant because those huge production projections are largely what supports Tesla’s lofty valuation.

Getting Sued for Overpromising

Tesla has also been widely criticized for exaggerating its self-driving capabilities. In fact, they are facing a class action lawsuit as a result. The company began charging customers $8,000 a year ago for its “Full Self Driving” feature.

In January of this year, Musk said that “3 months maybe, 6 months definitely” that Full Self Driving features would noticeably depart from Enhanced Autopilot features. Ten months later, that still hasn’t happened. 

Tesla’s share price, which had risen above $380 in the weeks following the second quarter results, began to fall leading up to the release of third-quarter results. Following the release, the share price briefly dropped below $300 for the first time in five months.  

Congress May Kill a Key Tax Credit

One more significant risk factor looms for Tesla. Electric vehicles are currently eligible for a $7,500 federal tax credit. But the tax bill that is being pushed by Republicans with support from the President would eliminate that tax credit.

If Congress eliminates the credit, it will prompt some Tesla customers to request a refund of the $1,000 deposit they previously put down to reserve a Model 3. If a large percentage of customers do this, the dam could break and put Tesla in a precarious financial position.

There is no question in my mind that Tesla is fundamentally overvalued, but it has long been a cult stock whose value is strongly influenced by the personality of its CEO. Shareholders are also confident that the future will be electric, and Tesla will be an industry leader.

This May Not End Well

I agree that EV sales will grow rapidly for many years, but Tesla faces numerous challenges — one of which is increasing competition in the space. They are facing a cash crunch, and they will not be able to fund growth from cash anytime time soon. That means a heavier debt load, and/or issuance of more shares.  

Nevertheless, cult stocks are risky shorts. These companies can trade at irrational values for a long time. Tesla can reverse direction quickly based on the optimistic projections of Elon Musk. Of course, it won’t be that way forever. Eventually, the company has to deliver, or its value is going to be sharply reduced. 

Stay tuned.