Shares of electric vehicle manufacturer Tesla (NASDAQ: TSLA) are down almost 50% from all-time highs, valuing the company at $660 billion by market cap. The EV giant has trailed the broader markets by a wide margin in the last two years after creating massive wealth over the past decade. For instance, Tesla stock rose by 32,000% between its IPO in July 2010 and November 2021.

Similar to other companies, Tesla has been wrestling with a range of issues in recent quarters, including rising interest rates, inflation, supply chain disruptions, a sluggish macro environment, and lower consumer spending.

These factors have negatively impacted Tesla’s revenue growth rates and profit margins. Let’s dive deeper.


How did Tesla perform in Q3 of 2023

In the September quarter, Tesla reported revenue of $23.35 billion and adjusted earnings of $0.66 per share. Analysts forecast the EV disruptor to report revenue of $24.1 billion and earnings of $0.73 per share in Q3. While sales grew 9% year over year, its gross profits fell 22%, and operating profit narrowed by 52%.

Tesla’s CEO Elon Musk emphasized he remains worried about rising interest rates as it has increased the cost of debt significantly. Musk stated, “If interest rates remain high or if they go even higher, it’s that much harder for people to buy the car.”

Tesla continues to expand its portfolio of battery-powered vehicles, but rising competition from new-age players and legacy manufacturers is also acting as headwinds for the company. 

Moreover, Tesla confirmed the production of the Cybertruck remains on track, with first vehicle deliveries scheduled for November 30th. Currently, the Texas factory can manufacture 125,000 Cybertrucks each year, and this segment will remain unprofitable for at least a year post-production.


Tesla and the Bottom Line

Tesla enjoyed a first-mover advantage and economies of scale. Due to an expanding economy and lower competition, Tesla could price its cars at a premium and benefit from outsized profit margins. For instance, the EV giant ended 2022 with an operating margin of 17%, much higher than its peers such as Ford (NYSE: F), Mercedes-Benz, Volkswagen, and Toyota. But Tesla’s margin advantage has eroded in the past year.

While Tesla increased sales by just 9% in Q3, its:

COGS increased by 18%
Operating income fell 52%
And GAAP EPS fell 44%

It reported a free cash flow of $848 million, a decline of 74% compared to the year-ago period. Tesla has lowered its average selling prices, negatively impacting its profit margins. Moreover, the launch of the cybertuck and investments in artificial intelligence and other research and development projects are weighing on its bottom line.


Legacy auto manufacturers are under pressure

EVs are costly, and a higher pricing environment has lowered consumer demand drastically in the last 18 months. Several legacy auto manufacturers, such as Mercedes-Benz and Ford, are selling their EVs at a loss to maintain market share.

Earlier this month, Ford claimed that customers are no longer willing to pay a premium for EVs, and itU+02019s now postponing $12 billion in planned spending in the EV segment. It suggests Ford will decelerate its EV spending and gradually ramp up its manufacturing capacity instead.

While Ford’s EV business unit increased revenue by 26% in Q3, its operating losses almost doubled to $1.3 billion. In the first nine months of 2023, Ford’s EV segment has reported an operating loss of $3.1 billion.

Mercedes-Benz, too, remained wary of challenges in the EV market, with the company’s CFO calling it a “pretty brutal space” during the earnings call in Q3.

Alternatively, Tesla had access to low-cost debt for most of the 2010s and leveraged lower interest rates to fuel its expansion plans. However, higher yields and interest expenses in 2023 make it riskier and more expensive for auto manufacturers to increase balance sheet debt.


What does this mean for Tesla stock and investors?

Analysts expect Tesla’s adjusted earnings to narrow by 26.3% to $3 per share in 2023. It suggests Tesla stock is priced at 70x forward earnings, which is quite steep for a company struggling to post consistent profits.

Generally, a company that enjoys pricing power and expanding earnings is valued at a premium. In the last few years, the EV space has attracted new players such as NIO (NYSE: NIO) and Lucid and established players including Toyota (NYSE: TM), Ford, and General Motors (NYSE: GM), making it difficult for Tesla to keep growing the top line rapidly.

As interest rates have gained pace, Tesla is focused on making its cars more affordable and maintaining demand. However, this has resulted in narrower cash flows and profit margins.

Given these factors, Tesla’s valuation might move significantly lower in the next 12 months. If Tesla ends 2023 with $3.2 billion in free cash flows and increases the metric by 30% to $4 billion in 2024, the stock should be valued at $400 billion, even if we assume it trades at 100x future cash flow. It suggests a drawdown of over 40% from current levels.

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