TSLA has had a great run over the past 5 years and despite the massive sell off since the start of the year, if you had invested 1 year ago you would still be up 20%. Strong leadership from Elon Musk combined with retail the fervor and growing institutional acceptance has allowed TSLA to significantly outperform the market for several consecutive years. While I am a fan of Musk and believe in his vision and in TSLA as a long-term company, I believe the current macro environment presents significant headwinds and TSLA stock is poised to under -perform.
Commodity Prices / Macro
I’ll start this section with one of my favorite charts that continues to turn more bearish – 2s/10s gap.
As I have detailed in other articles (see: A recession is inevitable, don’t be fooled by bear market rallies), the 2s/10s spread reversal has a 100% predictive history of a recession in the United States since the 1970s and after President Powell’s continued warmongering this week, the curve is likely to invert further.
While market expectations (i.e. fed funds futures) are slightly less hawkish than the dot chart, both the dot chart and fed funds futures have risen significantly during of this week’s Fed meeting. Not only are financial conditions already extremely tight, but they will become even more so in the weeks to come. That’s bad news for a high-growth cyclical company like Tesla.
The scale of car price increases for both new and used cars in 2021 was staggering. Both indices remained roughly stable for 25 years from 1995 to 2020, then increased by more than 20% (nearly 50% for used cars) in 2021, due to low nesting rates and trends home/work from home that have encouraged car ownership, especially during COVID lockdowns. Car sales (like other consumer durables) are very sensitive to rate increases (Powell said so himself in his testimony to Congress in June) and there is likely to be a return to the substantial average of these sales.
Ford and GM have already started pricing in some of this bearish outlook, most notably with Ford’s bearish forecast update earlier this week, but Tesla has remained relatively unmoved. This again strikes with overly optimistic fervor around this headline, but I would caution that Tesla will be subject to the same bearish headwinds as the rest of the auto industry. Not to mention that high-end products generally show a greater wealth effect than cheaper alternatives and should therefore suffer more in a recession (this has not happened so far, because incomes have not still much lower). Overall, the consumer is still strong and has significant savings (especially the affluent consumer), but housing prices are already showing signs of weakening, which is often the biggest source of wealth for many middle- and upper-middle-income consumers, and households reported plunging into COVID savings. I believe demand destruction will begin to occur in this category within the next 6 months.
The only brief periods of underperformance for TSLA stocks came during periods of heightened market volatility and fear. This is consistent with my view that TSLA is a relative “bubble” (I know that’s a dirty word around TSLA investors but works well in this situation) and during times of high uncertainty, underperformance should accelerate as investors are less able to maintain their “greedy” expectations.
VIX is currently near the bottom of its channel (note that VIX has peaked >80 in the last two bear markets and is still near its long-term average currently). This is a further sign of market complacency.
Focus on Tesla
Overall, I was very impressed with Tesla’s business performance in 2022. Tesla has done a great job of ramping up production in 2022 despite production setbacks in Shanghai. Berlin’s production has already exceeded 1,000 cars per week and Austin’s production is expected to soon exceed 1,000 cars per week. The Cut Inflation Act battery production credits are also expected to boost margin for the coming quarters, and further savings will be realized from the ramp-up of the Austin and Berlin plants. Profitability grew nicely with EBITDA LTM margin at ~21% and finally caught up in quantum to F and GM peers. TSLA also significantly improved its cash balance, rising to more than $18 billion in the second quarter. Production and shipments increased significantly year-on-year despite supply chain setbacks.
Tesla currently has negative net debt and given the company’s improving profitability profile, there is virtually no risk of insolvency. Although TSLA has been reluctant to issue more shares in recent years, this option is still on the table and TSLA’s premium valuation is a huge competitive advantage over competitors thanks to its lower cost of capital. . It’s part of the Elon Musk halo effect and part of why I’m a long-term supporter of the company – Elon is a master at winning favor in the capital markets.
I have almost nothing negative to say about the company in its current state. I think the market is somewhat complacent about the risk of competition from other automakers entering the EV market. Given the favorable market sentiment towards EVs, I expect competition to generally increase in the coming years (not to mention increased competition from Chinese EV manufacturers in the Chinese market). I don’t have a strong opinion on Tesla’s market share, and I think the huge TAM for electric vehicles will give Tesla plenty of profit opportunities in the future. I’m no expert, however, and I’m sure many of the readers of this article and other commenters have better opinions on consumer tastes and industry competition.
I’m also sure the bulls are tired of the bears reporting valuation disparities because they just haven’t mattered over the past three years, but it goes without saying that TSLA is trading with a massive premium to its industry peers (a premium spread that has closed somewhat as TSLA’s profitability has improved). Where this gap starts to matter is when the industry begins to sell off as a whole, the top performers will generally see their multiples contract more on an absolute basis as the gap between the winners and losers shrinks.
A good example of this is HR in the furniture industry, an industry that is equally discretionary and rate sensitive (see my HR article for additional comments). RH has traded at a substantial premium to the rest of the furniture industry for nearly two years due to its premium brand reputation and operational excellence, but like the industry as a whole sold out, RH saw his most peer-relative multiple contract. While I never see TSLA trading below any of its peers on a multiple basis, I do see the potential that the relative pain is actually greater for TSLA as the industry contracts (assuming my call for industry contraction is correct).
The TSLA Put/Call ratio is slightly below the market which is currently near 1.00 and short-term interest in TSLA is low at 2.32%, indicating relative complacency among investors given the meteoric rise in TSLA shares over the past 3 years.
The TSLA implied theft is still below its 52-week average (I think the general market theft is discounting right now) and the put-call spread is barely above its 250-day average. Even if you’ve long believed in TSLA and don’t want to sell, at least consider covering yourself, because insurance is still relatively cheap.
TSLA bulls won’t like this chart, but a somewhat messy head and shoulders pattern has emerged in 2022 with strong support around $200 and resistance around $350 (although this has been temporarily penetrated) . This would imply a downside in a bearish case near the pre-COVID highs of $60, which is in line with my broader market outlook. If you draw the head at the resistance level around $300 you would see a drop to around $150 which is close to YE 2020 levels. in this bear market, but I believe that in the next 6 months we will see the pre-COVID highs of the S&P and NASDAQ tests, and while TSLA has seen a substantial advantage over the major equity indices over the past year, I personally seek to take gains or hedge downside risk. I’m not sure TSLA is actually trading up to $60 given the company’s fundamental improvements over the past 2 years, I’m showing this chart more to highlight the downside risk. For too long, TSLA investors have been complacent Evaluation risk, and I believe the paradigm shifts as market volatility increases and TSLA will see its premium erode for some time. This will present a great buying opportunity at the bottom of this bear market.
In conclusion, TSLA is a well-managed company that has enjoyed spectacular stock market performance for several consecutive years. The auto market is expected to calm down considerably in the near future, and I think we may have already seen a peak in demand for this cycle. As the industry collapses, Tesla being the relative outperformer over the past three years is expected to suffer more than its competitors based on valuation.