Vertical Group's Gordon Johnson is hardly on Elon Musk's holiday card list: two months ago, Johnson explained why, far worse than even more analyst estimates, there was a gaping $3.4 billion funding hole in Tesla's balance sheet. Well, after yesterday's glaring attempt at
stock manipulation deep value investing by Elon Musk, Johnson is now officially at the top of Musk's shit list because overnight the outspoken and contrarian analyst just downgraded Tesla to a street-low price target of $93 (from the not that much more generous $99 target previously).
Why did the Vertical Group analyst take a machete to his price target?
One main reason: according to Johnson's calculations, the cancellation rate on Model 3 is a disastrous 66%, up 33% YTD, or as Gordon says, "Boy… that’s a Lot of Model 3 Cancellations."
Here are the details from Gordon:
Our work (Ex. 1) implies a 66% cancellation rate for the “euphoric” day-1 Model 3 reservations of ~140K. When applying this figure to our est. for 582K in gross reservations through mid-Apr. (i.e., 518K in gross reservations 7/31/17 + 7.55K/month in new reservations 7/31/17-to-4/15/18 [or 64K] to account for a monthly cancellation rate of 1% as of 7/31/17), we calculate sales from 582K in early Model 3 reservations of just 197K – we remind our readers that in mid-Apr. ’18, TSLA sent out configuration invites to US-based non-owners who made reservations one day after reservations opened up to the public (i.e., 4/1/16); from this, one can imply in mid-Apr. ’18 TSLA had fully exhausted Model 3 reservations made 3/31/16 (i.e., day one); furthermore, as of mid-Apr. ’18, all US-based owner reservations were complete.
Exhibit 1: Tesla Day-1 Take Up Rate Analysis – 66% of Day-1 Reservations (excl. Deferrals) Canceled as of 4/15/18
Moreover, the bearish analyst notes:
(a) over the 5/15/16-to-7/31/17 timeframe, after the initial Model 3 buying euphoria waned, TSLA experienced new orders of just 145K (link for 5/15/16 reservations; link for 7/31/17 reservations), or ~2.5K/week, with net reservations (i.e., adjusted for cancellations) up by just ~1.6K/week over this same timeframe, &
(b) based on TSLA’s 5/2/18 statement (link) that Model 3 net reservations “exceeded 450K”, or >460K when adjusted for deliveries of ~10K cars 3Q17-to-1Q18, when netting this against TSLA’s net reservations of 455K as of 7/31/17 (link), net orders for Model 3 cars increased by a dismal 5K units over the 8 month period 7/31/17-to-5/2/18, or 139 cars/week (this is not a typo).
In short, Johnson summarizes that "either Model 3 cancellation rates have spiked from the initial euphoria period of 3/31/16-to-4/30/16, or new reservations have virtually disappeared."
So what does it all mean?
Well, based on the assumptions we’ve made in Ex. 1, & assuming TSLA hits its ramp-up target of 5K cars/week of production in 2Q18, the company will exhaust all pre-orders sometime in 1Q19 (i.e., 197K in sold reservations as of 4/15/18 - 42K 2Q18 Model 3 cars sold - 60K in 3Q18 - 60K in 4Q18 - 60K in 1Q19 = -25K in pre-ordered cars sold). Beyond this point, TSLA will be selling the lower-priced/lower-margin version of the Model 3, negatively impacting company fundamentals. Moreover, assuming TSLA achieves its 5K car/week output rate & 55% of sales are US-based (as they were in ’17), its share of the US luxury car mkt would have to balloon to ~32% (a feat no car maker has been able to achieve – the Mercedes C-Class currently sits at the top with 17.3% mkt share – Ex. 2).
Exhibit 2: Tesla Motor Club Website Survey – reservation holders deferring vs. configuring
Thus, beyond 1Q19, the Vertical Group analyst notes that Model 3 sales will be limited by demand vs. supply, & growth for TSLA will likely depend on new product introductions (i.e., Model Y, TSLA Semi, & TSLA roadster).
Yet, with the timeline for such introductions, according to Elon Musk, roughly 2 years out (i.e., for new production facilities), not to mention Mr. Musk’s tendency to assume overly optimistic timelines, we believe investors will be forced to question TSLA’s valuation as a growth stock imminently (while we expect Elon Musk to use a lot of one-time items to try to achieve profitability in 3Q18 & 4Q18, as discussed below, we feel this rests largely on TSLA’s ability to sell a record number of ZEV credits, which may prove difficult).
In short, we believe TSLA’s ability to show material revenue growth beyond 1Q19 will prove extremely difficult; in fact, until new products are introduced (i.e., likely 3yrs from now, or 2021), we see TSLA’s ability to continue growing sales in the double-digit percentage range beyond 1Q19 as acutely compromised.
Then, in addition to analyzing Tesla's ZEV credit program (which Johnson believes Musk will have to unleash to achieve profitability in H2), and taking a look at the potential upside for Powerwall sales in Puerto Rico, the analyst notes what is arguably the biggest risk for TSLA, namely the tide of competition; here Johnson calculates that Tesla has already lost ~33% of its European EV share YTD 2018 vs. 2017. The details below:
With information now available on European EV sales thorough Apr. ’18 (link), as detailed in Ex. 9 below, we note a number of new EV & PEV cars have entered the European mkt YTD ’18. And, while many say competition is not a risk for TSLA, the numbers coming out of Europe suggest, strongly, otherwise.
What do the numbers say? Well, importantly, over the Jan.-to-Apr. ’18 period vs. Jan.-to-Apr. ’17, we note the following key findings:
(1) TSLA has seen its combined Model S & X sales fall by 12% y/y on an absolute basis,
(2) TSLA has seen its market share fall by 33% y/y in Europe, &
(3) while TSLA, alone, was bigger than the entire Volkswagen (“VW”) brand in ’17, VW is now more than 2x the size of TSLA in Europe in the EV space.
Consequently, at risk of stating the obvious, with a bevy of pure BEV cars with >200 miles of range slated to enter this US mkt this year & next, we see outsized risk to TSLA’s ability to continue selling its Model S & X, as well as Model 3 vehicles at current margin levels (we remind our readers that the $7.5K Federal Tax credit awarded on each TSLA car will likely get cut in half beginning 1/1/19, further depleting the company’s competitiveness).
As a reminder, here is a side by side comparison of upcoming BEV product offerings:
And the pipeline of EV offerings over the next 2 years.
Putting all of the above together, this is what Vertical's now model looks like:
Update to Our Model – as detailed in our bottom-up TSLA segment model below (Ex. 10), our 2018 rev/EPS ests. adjust to $20.3bn/-$11.86 vs. $19.1bn/-$14.30 prior (Street $19.7bn/-$7.16); our 2019 ests. edge to $24.6bn/-$8.73 compared to $20.3bn/-$11.86 previously (Street $28.5bn/$2.28). In short, in our view, as it becomes clear to investors TSLA will not be profitable in 3Q18/4Q18 (as Elon Musk has stated), at the same time new 100% BEV cars with over 200 miles of range begin selling into the global markets (i.e., the Jaguar i-Pace will be available June 2018, followed by the Audi eTron in September 2018, the Hyundai Kona in November 2018, & the Nissan LEAF [230 mile range] in December 2018 – Ex. 7), we believe fear will begin to “set-in”.
Finally, the proposed valuation: "Applying a 0.725x multiple to our new 2020 rev est. of $21.7bn (Street $34.7bn), our year-end 2019 price objective edges modestly lower to $93/share (-73% downside from today’s closing price) from $99/share previously."