Buy Tesla Motors: The Apple Of Automakers Has Only Just Begun To Realize Its Potential

July 2, 2012  | 3 comments  |  about: TSLA, includes: AAPL, F, GM

Every so often, a company comes along that has the potential to change the industry it is in. Walmart (WMT) did that with shopping. McDonald's (MCD) did that with dining. And Tesla Motors (TSLA) is set to do so in automobiles.

Tesla was founded with one goal: to change the automotive industry, to use the methods of Silicon Valley, not Detroit, to alter the way that people drive. And in just under 2 years of existence in the public markets, Tesla has done more than just generate a great deal of press. The company has also delivered great returns to shareholders, rising over 60% since its IPO, handily beating the S&P 500 (SPY).

(click to enlarge)With the rollout of the Model S sedan now underway, and the Model X crossover set to arrive in driveways in 2014, we believe the best is yet to come for Tesla, and believe that now is a good time to initiate a long-term position in this company.

The Apple of Carmakers: Luxury, Not Electricity

Tesla has been written about often here on Seeking Alpha, and the company is often compared to GM (GM) or Ford (F), with critics arguing that Tesla will not be able to compete with more established American car companies and their electric offerings, such as the Chevrolet Volt. The fact of the matter is that Tesla does not need to. The company's competitors are not GM or Ford. It is companies like Mercedes-Benz, BMW, and Audi.

Tesla's Model S, with the cheapest model starting at $49,000, is designed for the luxury market. The Model X is the same. Tesla's cars are not meant for the mass market. Were Tesla to sell its cars en masse, it would tarnish the brand's cachet, and thus damage Tesla's profit potential. One of the central tenets of luxury is the cachet a brand has with its customers. A Mercedes is considered a luxury car not just because it costs much more than a Corolla or Focus, for example. It is a luxury product because far fewer people have one. If everyone were to have a Mercedes, it would lose its luxury status. Tesla understands this, and a look at where the company's existing and planned stores are reveals this to be true.

Tesla currently has stores on 4 continents, and they are located in key, upscale markets such as Sydney, Geneva, Tokyo, Paris, Santa Monica, New York, and Newport Beach. Tesla's stores are placed in affluent cities because those are where its target customers live. Placing a Tesla store next to a suburban GM dealership may expand the number of people who live next to one, but it does nothing to actually increase sales. On the contrary, doing so would tarnish the Tesla brand. And it is those stores, in addition to its cars, that make Tesla the Apple (AAPL) of carmakers.

Calling a company the Apple of something often evokes condemnation from that companies critics, who often see it as an insult to Apple (we fail to see why this causes so much consternation). In this case, however, we believe there is almost no way to avoid this comparison. Both Apple and Tesla were founded by visionary men who many thought were ahead of their time (Elon Musk and Steve Jobs). Both companies have built a great deal of brand equity with the public, and their stores are constantly packed with visitors and prospective customers. And both companies offer a product that other companies offer alternatives to for much less, but that customers still love.

Jefferies, in its latest note on Tesla (which it rates as a buy with a $39 price target), argues that, "if Apple made a car, this [Model S] would be it. Our two behind the wheel test drives of the Model S confirmed our thesis that this is the best performing performance sedan under $100k." Tesla's stores are modeled based on those of Apple, which is the gold standard in retail. Tesla's use of Apple's retail strategies is no accident given that fact that George Blankenship, a former Apple retail executive,is Tesla's vice president of sales & ownership experience. The company's stores receive, on average, 4,000 visitors every week, something that is unheard of in the auto industry. Tesla will open 10 new stores this year, and around 25-30 in 2013, as it works to meet its stated goal of delivering 20,000 Model S sedans in 2013.

Though Tesla was founded with the purpose of changing the automotive industry, the truth is that this is not what the company does on a day-to-day basis. Elon Musk wants to grow the overall electric vehicle market and usher the automotive industry into a new era. And while Tesla certainly helps with that goal, in keeping with its founding purpose, that is not what the company does on a day-to-day basis. Tesla is selling a luxury product for the wealthy, not a mass market vehicle designed to meaningfully boost the market share of electric vehicles. Cars like the Nissan Leaf, priced at over $10,000 less than Tesla's low-end Model S, are what will meaningfully expand electric vehicle sales to the mass market. Tesla will likely never gain a majority of the electric vehicle market. But it doesn't have to. The wealthy love Tesla's cars, and they are willing to pay up for the privilege of being able to drive one. The reviews the Model S has received all seem to indicate one thing: this is a car meant for the luxury, not mass markets.

Financials & Valuation: Profitability is Approaching

As appealing and wonderful Tesla's automobiles may be, the company's status as a public company means that eventually, Tesla must go beyond mere revenues: it must begin posting profits. With the Model S, the company will finally reach profitability, and we discuss the company's financials below.

In 2011, Tesla posted revenues of $204.242 million, and over the last 5 years, has grown revenues at an average of 389.06% per year. And growth is set to continue in 2012 and 2013. The consensus Reuters estimate calls for Tesla to post revenues of $600 million in 2012, and $1.7 billion in 2013. That represents growth of 193.769% in 2012 and 183.333% in 2013. But what is more important than that is the outlook for Tesla's profitability, which is also encouraging.

In 2011, Tesla lost $2.53 per share, as the company prepared for the rollout of the Model S and continued to work on the Model X crossover. And while the company is set to lose $2.44 per share in 2012, profitability is set to arrive in 2013 (the discrepancy between Tesla's stated 2011 loss on its 10-K and the figure Reuters reports is due to charges Reuters chose not to include in its earnings figures).

(click to enlarge)Tesla is set to swing to profitability in 2013, most likely in the second quarter, as the consensus estimate is for a loss of 1 cent per share in Q1 2013.

(click to enlarge)In the meantime, Tesla's balance sheet is strong enough to sustain the company. Tesla ended its most recent quarter with $243.579 million in cash, and it has just $20.194 million of debt due in the next year. By the second quarter of 2013, the company should be profitable (for the record, Tesla has $116.938 million in net debt).

Tesla is currently burning cash, but its burn rate has narrowed. In its latest quarter, the company lost 86 cents per share, but its operating cash burn amounted to 48 cents per share. Given the non-cash nature of some of Tesla's largest expenses so far, such as stock-based compensation and depreciation, we estimate that Tesla will be operating cash flow positive in either the fourth quarter of 2012 or the first quarter of 2013.

Based on 2013 earnings estimates of 64 cents per share, Tesla is trading at 48.891x 2013 earnings. While certainly not cheap, that is not that expensive for a company set to grow revenues by nearly 200% annually over the next 2 years. Furthermore, that valuation must be looked at in a long-term time horizon. Tesla's long-term potential is bright, and we believe that there is ample growth ahead to justify such a valuation. Furthermore, with over 44% of Tesla's float sold short, due to skepticism surrounding the company, we believe that the stage is set for a potential short squeeze in coming quarters as the company rolls out the Model S.

Conclusions

We believe that Tesla has only just begun to realize its potential, and think that long-term investors should add to or initiate positions in Tesla Motors at this time. Tesla is selling more than an electric car. It is selling a luxury product, and the company has demonstrated that it can sell that product at a premium price. The Tesla brand has a great deal of cachet, and in the coming months and years, that cachet will only grow as Tesla expands across both the United States and the international market. Tesla's best days are ahead of it, and shareholders who invest in the company at this point in time should, in the long run, be rewarded for their belief in this company.

Disclosure: I am long AAPL, MCD.

Additional disclosure: We are long MCD via a mutual fund that assigns the company a weighting of 1.1%. In addition, we plan on initiating a long position in TSLA sometime this week.

 By Ivan Deryugin.:Helix Investment Management