The 10 Most Important Variables For Tesla
Introduction:
At ELM Responsible Investments, we try to identify companies that are not only driving positive change for the environment and society but also investing in innovation and adding to their intangible asset base. With all the data and information available today, investing based on easily observable data such as Price / Earnings ratio is no longer enough. We think insights and analysis of intangible assets, such as a company’s R&D capability, culture, future products etc., are much more important for long-term investors.
Tesla is the most significant position in our Global Fund, and by focusing on their R&D capability, culture, and future products, we think the valuation stacks up. We have identified 10 Key Value Drivers, which are the most important variables for the long-term valuation of the company, and based on our assumptions of these variables, we think the forward returns are very compelling.
You can use our valuation calculator and input your assumptions for the ten variables and see how the valuation changes. Yes, future vehicle deliveries, profitability and investment rates are all important, but you will notice that the variables associated with Tesla’s Full Self Driving (FSD) feature are very important drivers of future valuation.
What is FSD?
FSD is Tesla’s autonomous vehicle offering, considered one of the most difficult Artificial Intelligence (AI) challenges we face. Alphabet-backed Waymo and others are also working on autonomous vehicles, but Tesla is way ahead of the pack given the vast amount of data they possess.
Tesla owners can subscribe to the FSD feature for US$15,000 annually in selected regions. With FSD, the car will drive itself and act like your driverless Uber service.
We all know that the utilisation rate of cars is low – most cars only get used for a few hours a day. With FSD, the vehicle's utility will increase significantly as different household members can utilise one vehicle. For example, in my family, if we had FSD, the Tesla could take my wife to work, come back home, drop off the kids to school, fit in a grocery shop, pick up the kids from school, and then pick up my wife from work. Without FSD, we would either need two cars, rely on public transport or a car share service. When considering these alternatives, the value of FSD to our household is much greater than the cost of US$15,000 annually. Unfortunately, this feature is not available in Australia yet, but as the technology continues to improve, we expect more regions to approve this technology.
How Vital is FSD to the Valuation of Tesla?
We think the current market capitalisation of Tesla does not include the upside from FSD. Over 4 million Teslas have been sold over the last 5 years, and we think another ~1 million vehicles will be sold in the second half of 2023. We need to ask ourselves three questions regarding FSD and its impact on Tesla’s valuation:
1. What percentage of the total Tesla fleet will take up FSD in the future?
2. What will FSD cost in the future?
3. What will the incremental profit margin of FSD be in the future?
The most straightforward question to answer is the third… FSD will be a software update, which we think will attract software-type gross profit margins closer to 80%-90%.
The second easiest question to answer is the second… we need to think about the value to the consumer, and then determine the price. As I mentioned, the alternative to FSD is buying a second car, relying on a car share service or public transport. The annual cost of buying a second car (including the purchase price, annual insurance and registration costs etc.) will be the upper bound of the price of FSD, and the cost of public transport and a car share service will be the lower bound. The current price of FSD is US$15,000 annually and we assume it will cost US$20,000 per annum as the technology improves.
Next, we need to consider the percentage of the total Tesla fleet that will take up FSD as an option in the future. Approximately 7% of the Tesla fleet has subscribed to this feature today, paying the annual subscription fee. We assume 20% in the future as the technology improves and more jurisdictions approve the feature.
Using our valuation calculator, you can input your assumptions and see how it impacts the company's long-term valuation.
What About the Other Variable?
In addition to the three variables associated with FSD, the other variables that we consider are:
1. Average Selling Price of a Vehicle
2. Vehicle Deliveries
3. Vehicle Profit Margins
4. Capital Expenditure
5. Operating Expense
6. Cost of Capital
7. Terminal Growth Rate
All these variables are essential for the long-term valuation of Tesla.
What do the Bears say?
I often hear from Bears that “Tesla is expensive because more competition is coming, and their growth will slow.”
CEO Elon Musk is targeting 20 million vehicles per annum in the future, but with increased competition, this target may be aspirational. I think however, they have a good chance of getting close to that goal given Tesla’s competitive advantages. They are only one of two profitable electric vehicle manufacturers, and profitability allows them to cut prices and take market share. But even if they do fall short of Musk’s long-term vehicle delivery goal, the opportunity from autonomous vehicles is significant enough for us to remain invested.
Conclusion:
Homing in on the Key Value Drivers and using our valuation calculator allows us to focus on what matter to long-term valuation. For Tesla, we see the opportunities in long-term vehicle deliveries and the value potential through FSD. Furthermore, the valuation we have determined here is only for the Tesla Motors segment. The company has additional opportunities in energy storage, supercomputing, and robotics which we don’t think is fully appreciated by the market.
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