How Independent Research Can Help You Make the Right Call on Tesla

By November 9, 2018 February 14th, 2019 General
Smartkarma How Independent Research Can Help You Make the Right Call on Tesla

To illustrate how valuable independent research is, we chose one of the most polarising companies among the investment community: Tesla.

Independent investment research offers an unmatched level of objectivity, free from any conflicts of interest and any inherent bias. That’s exactly what institutional investors need to base their million- or billion-dollar investment decisions.

All Hail Tesla’s Q3 Saviour: The Model 3

What’s not to like about proving Tesla naysayers wrong?

After having to put up with a barrage of distasteful behaviour by the company’s Chief Executive, from smoking weed live on radio to tweeting a baseless “funding” claim, 3Q2018’s “truly historic quarter” surely came as a welcome reprieve for Tesla bulls.

Tesla’s first quarterly profit since 2016 was largely attributed to the rockstar performance of the Model 3. According to the company’s 3Q2018 update, the Model 3 was the best-selling car in the US by revenue and the fifth best-selling car by volume.

Tesla Model 3 revenue in comparison to other sedans in the US

While that looks well and good on the surface, the rankings also show the Model 3 is starting to pose a real threat to its US competitors in the sedan category.  

Priced averagely at US$54,000, approximately half of the customers showing up to buy the Model 3 are trading in cars initially purchased for less than US$35,000, says ANTYA Investment Inc.’s Neeraj Monga, who publishes on Smartkarma. That puts the entire gamut of Honda Accord, Toyota Camry, and mid-sized Volkswagen cars in the line of fire.

Monga’s finding further implies that “Tesla has pricing power because the high price point of Tesla’s entry vehicles has not deterred customers from paying up.”

Times Are Good, Time to Short

Be that as it may, some of the best shorting opportunities present themselves during the optimism that follows the release of champagne-popping earnings.

These are times when sky-high investor confidence sends share prices through the roof and buying momentum hits the gas, with herds of ill-informed investors jumping mindlessly on the bandwagon.

Short sellers love such frenzied market reactions.

To understand why, let’s re-examine Tesla’s supposedly “positive” quarter.

Cash Problems Persist

As investors parse the significance of the consensus-beating financial performance, it is hard not to wonder whether this return to profitability marks a symbolic turning point in Tesla’s fortunes.

Independent research firm SC Capital, which publishes on Smartkarma, thinks not.

In their opinion, a sticking point remains in the buffer (or lack thereof) between the company’s free cash flow (FCF) and debt.

While the FCF of US$881 million reported in Q3 provides some leeway in repaying debts of US$1.3 billion coming due over the next five months, cash and equivalents still represent less than a third of quarterly sales, SC Capital says. By comparison, most automakers have at least a quarter’s worth of sales on their balance sheets.

Tesla cash and equivalents - Smartkarma

Automotive sector cash and equivalents - Smartkarma

“Tesla’s financial condition is still very fragile unless it can continue to generate positive FCF,” the research firm writes.

“Unfortunately, we don’t think Tesla’s Q3 numbers can be replicated: Model 3 demand was largely pulled forward in Q3, its price has already been cut, capex was extremely constrained (20 percent below consensus), and depreciation – at 99 percent of capex – has peaked. This all points to at least negative FCF in Q4 (we estimate – US$200 million in negative FCF in Q4).”

Safety Will Outlast Productivity

If balance sheet figures appear to be nothing more than harbingers of bad news, why not look elsewhere to spot glimmers of hope?

Here’s one: A fresh bout of operational productivity resulting in a 30 percent fall in manufacturing costs has helped Tesla improve gross margins in Q3.

Still, there’s only so much more efficient assembly lines can become before output plateaus. Tesla will need to rely on other mechanisms if it is to sustain future growth in the longer term.

One other area of growing strength on which Tesla could capitalise is safety. “Tesla noted it received a 5-star safety rating in every major category and noted it has the lowest probability of injury vs. its peers,” says Rickin Thakrar of Global Equity Research, who publishes on Smartkarma.

This is big news, but here’s something bigger: Software improvements to neural networks are also helping Tesla’s autonomous vehicles improve accuracy in tasks like identifying cars and traffic lanes.

If investors recall, a fatal crash as recently as March had surfaced questions on the safety and reliability of Tesla’s self-driving program. Now, with past software bugs addressed, autonomous driving might actually give Tesla a market edge.

Tesla autopilot - Independent Tesla research on Smartkarma

“Tesla noted it has millions of cars with full autonomy capability, whereas others will not, which [the] company thinks will give a major advantage,” Thakrar writes in a report.

Investing time and resources into strengthening overall vehicle safety bodes well for Tesla’s future. It paves the way for establishing greater trust among customers, which sets a precedent for instilling greater brand loyalty.

Strengthening the Circle of Leadership and Accountability

Given what investors had to deal with in the past few months, it’s going to take more than a bunch of safety hacks to restore lost investor confidence.

Robyn Denholm’s appointment as Tesla’s new Chairperson could not have come at a better time. An independent member of the Board since 2014, the Chief Financial Officer of Australian communications giant Telstra had also spent seven years as a finance executive at Japanese automaker Toyota.

Denholm’s pick aligns with one of several recommendations made by independent analyst Vicki Bryan, discussing how Tesla could reinvigorate its top brass.

“Tesla’s new Chairperson must be a truly independent, seasoned auto industry veteran who can demonstrate management strength, show operating prowess, and help begin to restore the company’s shredded credibility,” Bryan opines through an Insight published on Smartkarma in early October.

Research Independence, Reinvented

Biased research can be misleading and one of the greatest causes of bad investment decisions. Unbiased Insights and a diverse range of ideas is what Smartkarma stands for.

As a global investment research network, Smartkarma accommodates a community of more than 400 independent Insight Providers, which continues to grow to this day.

The above examples demonstrate how the best Insight Providers produce differentiated and well-grounded Insights. Taken together, these diverse viewpoints equip investors to make more informed investment choices.

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