Tesla (TSLA)’s current valuation undervalues the company’s market potential. Using a DCFO with a WACC of 13% and FCF at $2-$15 billion per year, I obtained an equity valuation of $983. In my opinion, the market has failed to understand the potential of the company’s self-driving technologies currently under development. If investors, clients, and suppliers continue to finance the company’s operations, the share price will creep higher in the coming years. Keep in mind that many analysts foresee significant FCF growth from 2022-2023.
Tesla Makes R&D Investments In Markets That Grow Massively
Tesla manufactures fully electric vehicles, and also focuses on energy generation and storage systems. The company’s most relevant business segment is the automotive business segment with $29 billion and 93% of the total amount of sales. I will focus on this business segment since I believe that the largest part of growth in the coming years will come from this activity:
Let’s talk about the automotive business segment. In my opinion, the largest part of the company’s total valuation is attributed to activities that Tesla is not currently selling. In my DCF model that I will discuss later, the valuation of the terminal value represents more than 90% of the company’s valuation. With this in mind, I don’t think that discussing the model X or the new Model S makes a lot of sense. The market is buying shares because of products that Tesla will announce in 2027, 2030, or 2040. With this in mind, I believe that the product that will most likely make Tesla a massive corporation is the self-driving software.
As mentioned in the most recent annual report, the company is still developing new systems with neural networks and data analysis that will most likely improve the performance of the self driving performance:
We have expertise in developing technologies, systems and software to enable self-driving vehicles using primarily vision and radar-based sensors. Our FSD Computer runs our neural networks in our vehicles, and we are also developing additional computer hardware to better enable the massive amounts of field data captured by our vehicles to continually train and improve these neural networks for real-world performance. Currently, we offer in our vehicles certain advanced driver assist systems under our Autopilot and FSD options. Although at present the driver is ultimately responsible for controlling the vehicle, our systems provide safety and convenience functionality that relieves drivers of the most tedious and potentially dangerous aspects of road travel much like the system that airplane pilots use, when conditions permit. As with other vehicle systems, we improve these functions in our vehicles over time through over-the-air updates. Source: 10-k
The expected sales growth of the autonomous vehicle is quite impressive, thus Tesla’s sales growth will also be significant. According to experts, the market will grow at a CAGR of more than 39% from 2019 to 2026:
The global autonomous vehicle market size is projected to be valued at $54.23 billion in 2019, and is projected to garner $556.67 billion by 2026, registering a CAGR of 39.47% from 2019 to 2026. Autonomous vehicle also known as self-driving vehicles uses artificial intelligence (AI) software, light detection & ranging (LiDAR), and RADAR sensing technology. Autonomous Vehicle Market Size
Studying and trusting in the new technologies developed by Tesla is very relevant. Keep in mind that the company continues to increase the amount of funds invested in research and development. We are talking about yearly expenses of $1.49 billion in research and development, 5% of the total amount of 2020 sales. If we take into account the total amount of money invested in R&D, I believe that most investors will be expecting brilliant innovations in the coming years:
Tesla’s Balance Sheet Is Very Stable
I don’t think investors really care about the company’s balance sheet. In my opinion, the future sales and cash flow of Tesla matter the most. With that, I need to show that the company’s financial situation is very solid. On March 31, 2021, the company had $17 billion in cash in hand with $52 billion in total assets. The company’s asset/liability ratio is 1.8x:
The company reports debt of only $9 billion. If we assume 2022 FCF of $4.5 billion, the company’s leverage is equal to 2x FCF, which I don’t believe is worrying. Tesla does not need a lot of debt financing because customers continue to pay in advance. They are financing the company’s operations, which is extremely beneficial. Customer deposits are worth $745 million with deferred revenue worth $1.29 billion:
Free Cash Flow Is Going To Explode Up From 2022-2023
Most analysts believe that from 2021 to 2023, the company’s sales are going to increase quite a bit. Analysts believe that sales will increase from $31 billion in 2021 to more than $82 billion in 2023. Without debt, Tesla is also expected to report FCF of $7 billion in 2023, more than 2.5 times that of 2021:
I have based my assumptions on the figures reported by other analysts for the years 2021, 2022, and 2023. For the years 2024 and 2025, I have used sales growth and FCF growth figures that are close to that in 2021-2023. I obtained FCF of $15 billion in 2025, and 2025 sales of $167 billion:
Source: My Assumptions
The calculation of the WACC is not obvious. The company’s beta is very high because there is a significant amount of trading volatility. Most analysts out there obtain a beta that is close to 2 because of the recent volatility in the share price. Notice that in 2019 or 2020, Tesla had a beta that was closer to 1. If we use a beta of 2, the WACC is equal to 18%, which I believe is not fair. I took a look at other technological companies to understand what could be the company’s beta and WACC in the coming years. Certain financial advisors over the internet are reporting a WACC that is closer to 8%, which, I believe, may be too low. The company does report significant equity risk. Taking into account these assumptions, I decided to use a WACC of 13% because I consider that in the near future, the company’s beta will gradually decline. Note that the cost of debt does not really matter in this case because the debt weightage is small:
Source: My Assumptions
With my previous assumptions and capital expenditures at $17 billion to $34 billion a year from 2023 to 2025, the FCF is $2-$15 billion per year. Using a WACC of 13%, the sum of the free cash flows is equal to $26 billion:
Source: My Assumptions
Now, with the WACC at 13%, a terminal FCF of $17 billion, and a long term growth rate of 12%, I obtained a terminal value of $1.9 trillion. Tesla reported sales growth larger than 50% for the last 15 years. In my opinion, a long term growth rate of 12% can be easily justified by showing the company’s sales growth chart:
With all these numbers, the present value results in close to one trillion. With a share count close to 1.1 billion, the implied share price is equal to $983:
Source: My Assumptions
Source: My Assumptions
Some Of The Most Relevant Risks
Tesla depends on the production of lithium-ion battery cells. The company partnered with Panasonic, which started its production in 2017, so it has limited experience in cell production. If, for any reason, Tesla suffers supply disruptions, the company’s sales may decline. As a result, FCF will most likely decrease leading to a likely decline in the valuation of the company:
Our plan to grow the volume and profitability of our vehicles and energy storage products depends on significant lithium-ion battery cell production by our partner Panasonic at Gigafactory Nevada. Although Panasonic has a long track record of producing high-quality cells at significant volume at its factories in Japan, it has relatively limited experience with cell production at Gigafactory Nevada, which began in 2017. Any mishandling of battery cells may cause disruption to the operation of such facilities. While we have implemented safety procedures related to the handling of the cells, there can be no assurance that a safety issue or fire related to the cells would not disrupt our operations. Any such disruptions or issues may harm our brand and business. Source: Annual Report
The current valuation of Tesla is based on the future free cash flows and sales growth. Investors trust the company’s projections, and respect the management. I believe that the level of confidence is at its maximum level. With this in mind, here comes one of the most relevant risks for the company. If suppliers, customers, analysts or investors stop trusting the company for whatever reason, the company’s future valuation could decrease quite a bit, which could be a disaster because we have seen that both clients and suppliers finance the company’s current operations:
In order to maintain and grow our business, we must maintain credibility and confidence among customers, suppliers, analysts, investors, ratings agencies and other parties in our long-term financial viability and business prospects. Maintaining such confidence may be challenging due to our limited operating history relative to established competitors; customer unfamiliarity with our products; any delays we may experience in scaling manufacturing, delivery and service operations to meet demand; competition and uncertainty regarding the future of electric vehicles or our other products and services; our quarterly production and sales performance compared with market expectations; and other factors including those over which we have no control. In particular, Tesla’s products, business, results of operations, statements and actions are well-publicized by a range of third parties. Source: Annual Report
There is another clear risk for Tesla that most experts are currently disclosing. There is a growing amount of competition in the electric vehicle market. As Mark Fields, former CEO of Ford, noted very recently, everyone is coming to the party with great products. The EV market competes in prices among other variables. It means that Tesla may see its FCF margins diminished in the next ten years. If this happens, investors will be expecting the total valuation to decline:
Source: Seeking Alpha
Like most analysts, I believe that Tesla will be able to deliver significant sales growth and FCF from 2021-2023. With massive investments in R&D and the self-driving market growing at a CAGR of 39.47%, Tesla will become larger in the coming years. Assuming a WACC of 13%, FCF is $2-$15 billion per year. Also, with a terminal FCF of $17 billion, Tesla’s share price may be worth more than $983. Other financial analysts may use different assumptions, and may obtain different results. However, with the FCF expectations given by most analysts, I expect most DCF models to show that the current share price undervalues Tesla’s market potential.
Disclosure: I am long TSLA.