Is Tesla Worth $1 Trillion?

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The way I look at Tesla is they're trying to reinvent the way the industry operates. The electric car, the powertrain, the software, the way cars are sold, and the whole industry is following. So the car is probably the first edge that Tesla will lose. And the question for Tesla is how long the other edges continue and what new edges potentially Tesla will build.

Welcome to the Barron's Streetwise Podcast. I'm Jack Howe. The voice you just heard is Philippe Bouchois. He's an analyst at Jefferies and one of the leading bulls on Tesla stock. In a moment, he'll share with us the rational investor's case, not the fan's case, not the momentum chaser's case, but the rational investor's case that Tesla shares remain attractive even after an astonishing run. We'll also examine the bear case against Tesla stock, and we'll look at why car stocks in general are already doing crazy things this year and why this year and next could be a transformative period for the industry. Listening in is our audio producer, Jackson. Hi, Jackson.

Hi, Jack.

You drive, if I'm not mistaken, a Subaru Outback.

That's right.

Did you know that the Outback was a top-selling vehicle last year in the Portland, Oregon metropolitan area?

I was not aware.

Now you're in Seattle, and there the top vehicle is a Toyota RAV4 hybrid. And I'm just wondering if you see any local rivalry. I mean, do you like, do you like pull up to a stoplight in your Outback and is there a RAV4 there that kind of gives you the eye and revs the engine and says like, you know, go back to Portland, Outbacker? Is that sort of thing happening at all?

That's exactly what happens every stop sign.

That's exactly what I was afraid of. Let's be kind to each other, compact SUV drivers. Jackson, I want you to guess which are the 3 top-selling vehicles across the entire US last year.

All right.

It's got to be a truck.

There are 3 trucks.

No way. Ford F-150.

That's first.

The next one is a Chevy.

The Chevy Silverado 1500 actually fell to third last year. It got passed by the Ram 1500. Little switcheroo in second and third place. Ford is always in first.

Got it.

I'm giving you 2 out of 3 on that one, Jackson. Hang on. I still have a New Year's Eve noisemaker here to celebrate. Actually, that sounded sadder than I anticipated, but you get the idea. The U.S. as a whole is definitely a pickup market, and I think that's important for understanding the uptake of electric vehicles. EV penetration is just 4% in the U.S., compared with low teens rates in Europe and China. Credit Suisse predicts that EVs will make up more than half of U.S. sales by the end of the decade. For that to happen, we'll definitely need electric pickup trucks, and that's just what we're getting. Ford's launching one this spring. GM just said that it's debuting an electric Silverado in 2023. Both of those will come in versions that cost around $40,000 and versions that cost closer to $100,000. Pretty sure, Jackson, that those are for suburban show-offs like you that never get any mud on your Carharts.

Hey, man, I got a ton of mud on my Carhartts. I was just taking a walk with my Labradoodle and a Toyota Tundra came and splashed me with a puddle.

I'm sorry that happened to you, buddy. Now, Ram's parent Stellantis says it'll have an electric pickup by 2024. There are loads of other EVs coming, including SUVs from Chevy in 2023. That'll start at $30,000. So the menu of available U.S. vehicles will totally change over the next 2 years, just as Credit Suisse says we're headed for a boom in demand because pandemic sales have been held back by shortages. With so much at stake, car stocks have been volatile. Tesla, Ford, GM, Rivian All of them had double-digit percentage swings at different points this past week. Tesla jumped on stronger-than-expected deliveries but then gave it back during a broader slide for growth stocks. Ford soared after saying it would sharply increase production of its new electric pickup. GM gained ahead of its electric Silverado announcement and then gave some back when investors learned that Ford would have a 1-year head start. And startup Rivian tanked after early backer Amazon announced a deal with Ram for delivery trucks. I wanted to learn more about what effect all this new electric vehicle competition will have on the company that arguably got the push toward electrification jumpstarted, Tesla. So I checked in with someone who advises investors on Tesla and other car stocks. Hi, Philippe, it's Jack Howe from Barron's. How are you?

Yes, I'm all right. How are you?

That's Philippe Uchois. He's an analyst at Jefferies who upgraded Tesla to buy in December 2018 and has been mostly bullish since then, especially now. The average analyst has a price target of $900 a share, which is lower than the stock's recent price. Philippe has a price target of $1,400 a share, which recently implied 35% more upside for the stock from here. I asked Philippe to describe what made him first turn bullish a few years ago.

I found myself in San Francisco the last quarter of 2018. If you remember, third quarter of '18, Tesla had become profitable for the first time. I saw that plant like a month after they had posted those numbers. I looked around. My background is manufacturing before I became an analyst. I looked around and it was like the good, the bad, and the ugly. Some of the work there was state-of-the-art, the welding, the robots. Some of the equipment was quite antiquated. And if we looked at the assembly process, it was just, I mean, to be blunt, it was a bit of a mess. And I thought, well, if this company can be profitable at that level of industrial disorganization, that's an interesting thing to consider.

When Philippe says San Francisco, he means nearby Fremont, home to Tesla's original factory, which it bought from General Motors in 2010 and where it still makes all 4 of its vehicles: the S and X and 3 and Y. Philippe's case was a counterintuitive one. Some of Tesla's manufacturing looked antiquated, and he thought, if the company could turn a profit like this, imagine how well it can do once its manufacturing improves. At the time, Tesla already had a plant for batteries called Gigafactory 1 in Sparks, Nevada, and one for its solar business called Gigafactory 2 in Buffalo, New York. Since then, it's opened Gigafactory 3 in Shanghai for its newest vehicles, the 3 and the Y, and it's working on new Gigafactories in Berlin and Austin, Texas. Philippe says he was also struck by the details of how and when Tesla collects cash.

Typically in car manufacturing, you pay your suppliers after you have been paid for the cars you sell. And that situation is extreme at Tesla because they sell directly to you and me. So in theory, the receivable days you wait for your cash is very few days, and you pay your suppliers between 60 and 70 days later. So when you grow very, very fast, you tend to build up a lot of deferred payments to suppliers, and you get paid right away. So your cash generation comes from profitability, but also from the timing difference between when you get paid and when you pay your suppliers.

There's another company that comes to my mind when I think of payment timing, and it's Amazon. When a company collects cash from its customers faster than it pays its suppliers, it creates an ongoing float of free cash that it can use for investment, especially if it's also growing quickly. Tesla's free cash flow was an estimated $3.4 billion last year. It's expected to more than double that figure this year to $7.4 billion. That's extraordinary growth, but the figures are still small relative to the company's stock market value of more than $1 trillion. I hear a lot of chest-thumping when it comes to this stock, and I get it. Some investors have made a lot of money from it, and others have missed out on sensational gains. And so some of the arguments I hear are emotionally charged and maybe math-light. Just keep in mind that it's possible to be optimistic about Tesla's future but to also believe the stock price already more than reflects that optimism. Let me give you an example. JP Morgan's Tesla analyst has had an underweight rating on the stock for years. His price target is $295, implying a collapse for the stock of more than 70%. Looking at that, you think, wow, this guy really hates Tesla. But he pointed out at the end of last year that his price target implies a market value of more than $300 billion, edging out Toyota as the most valuable carmaker in the world, even though Toyota produces 10 times as many cars as Tesla. To me, that's someone who's optimistic about Tesla, just not nearly as optimistic as other investors. By the way, if you think that price target of $295 is extremely low, it's nothing compared to the one we'll come to in a moment. Now back to our Tesla bull, Philippe. He's realistic about the coming competition for electric vehicles.

Where Tesla may be lagging still a little bit is on the constant quality. There are recurring issues of quality. People are not happy about the paint, not happy about the panel gaps, some of the fit and finish, some of the materials used are sometimes a bit of a letdown when you think about the price point of the cars. Although you could argue people see more value in the software than maybe in the quality of the materials. But there's an ongoing kind of catch-up that Tesla is making on those issues. But it's likely that the generation of EVs coming out of the traditional carmakers, Ford or Volkswagen, etc., will not have to go through that learning curve because for them, the challenge is elsewhere. It's the software, it's the battery. It's not the fit and finish or the build quality or the materials. And so they're basically moving on different planes.

Different planes. Tesla has mastered the software and the battery and the things that make electric vehicles different. Legacy carmakers are ahead on the finish and consistency and build quality. But as Philippe told me, If you've figured out something no one else has figured out, and if you haven't yet figured out something that 90 others have figured out, there's a good chance you're going to solve your problems. So Philippe expects Tesla's build quality and consistency to catch up soon. And he says legacy carmakers have a bigger problem.

Whereas everybody's focused on Tesla being overvalued, if Tesla is such a disruptive power and will gain share, which is very possible, What if it's GM, Ford, Volkswagen, and others which are overvalued? Because they will lose their share of the profit pool quite quickly.

For now, Philippe has a buy rating on Ford and a hold rating on General Motors. Ford stock actually outperformed Tesla last year. The bear case for legacy carmakers is that they'll gain sales of low-margin electric vehicles while losing sales of high-margin gasoline vehicles. The bull case is that demand for gasoline vehicles will remain solid for years, and as companies invest less to make them, margins will push even higher, creating a long and lucrative gasoline farewell tour, as one analyst puts it.

I'd go to that concert series.

Let's move on to self-driving cars. Philippe says Tesla and GM's Cruise division are leading and that Alphabet's Waymo division appears to be stagnating. He says Tesla has taken a different approach than the others.

What most of the industry, and it includes GM Cruise as well, has been looking at sensors and trying to sense the environment of the vehicle. And principle is based on redundancy. The more sensors you have, the more data points you have, and therefore you avoid mistakes or errors because you have with suspenders and a belt. And then also most of the solutions are still very reliant on mapping. So the sensors complement the maps. On the Tesla side, they're trying to some extent duplicate the way the human brain works. The cameras are the eyes, they sense. As a goal, a Tesla could be autonomously driven without a map, because what basically makes the car behave is its environment. It's not where it is located on the map.

In the end, Philippe says, self-driving cars could end up like personal computers or high-end cell phones, with maybe 2 main operating systems in the U.S. and 2 in Europe, and perhaps something different in China. I asked about Tesla's valuation. Can the car industry as a whole even produce enough profit to make Tesla worth a trillion dollars? Philippe says the car industry is just the start, and it serves as proof that Tesla can figure out difficult things. You fight for pennies in the car business, he says. If you can make it there, you can make it anywhere. He says Tesla stands to prosper in powering homes with solar panels and batteries, and that a big slice of consumers' lives will one day be addressed by Tesla. He also thinks the company is redefining the economics of the car business.

What started with the over-the-air update, the day that Tesla was able to upgrade a car It improved the life expectancy and the real value of that car. And he was able to sell services to improve the product, where historically the product is very, very static. Not only does it age as soon as you drive off the lot, but it also was designed 3 or 4 years earlier. So the technical choices you get in a car in 2020 were set in 2016. So what Tesla did is completely change the value proposition of the car as a product.

Thank you, Philippe. His price target, remember, is $1,400. And JPMorgan's underperform rating comes with a price target of $295. While looking over analyst targets recently, I noticed one that was set to $67, and I thought it might have been a typo. It wasn't. That's next after this short break.

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Welcome back. Ever wonder what life is like for an extreme outspoken Tesla bear? Meet Gordon Johnson.

You know, I've answered the phone and people have just yelled curses and like, I don't understand why people would be threatening my life for expressing an opinion. That I think is well researched and backed up by facts.

Well, I wish that wasn't happening to you. You don't deserve that.

I appreciate it.

You see what I mean about this stock evoking strong emotional responses? I mean, let's be kind to each other regardless of— Jackson, some stirring music please. Regardless of differences in Tesla takes, bulls and bears can get along peacefully. I mean metaphorically, you know, not in nature. Pretty sure if an actual bull met an actual bear in nature, it would be a disaster. Fur flying everywhere. I'm betting on the bear because either it wins or it climbs a tree. Unless we're talking about a polar bear, because there won't be any trees around. But polar bears are big, and a bull would not do well in that kind of cold.

Jack, you know we don't get paid more if these episodes are longer, right?

What was I talking about? Right, Gordon. He tells me he started his career at big Wall Street firms like JPMorgan and Credit Suisse before starting his own firm called GLJ Research, which covers 20 stocks. He says he's very positive on uranium stocks and extremely bearish on cannabis, and that no one cares because all anyone wants to talk about is his view on Tesla, which he's covered since 2018. Gordon's chief criticism on Tesla is the valuation.

This is a company that is valued at a trillion dollars, right? Toyota, which is the highest margin auto company in the world, is valued at $250 billion. Toyota sold 10 million cars. Tesla sold roughly 900,000 cars. So for Tesla to get to a valuation that justifies where it's trading at today has to go from selling 900,000 cars a year to 40 million cars a year, which would mean they need to ramp like 2 new plants every quarter starting in Q1 every year for the next 10 years. Clearly that's not going to happen.

Gordon says that as new competitors introduce electric vehicles, Tesla will struggle to compete. He calls his price target of $67 aggressive, meaning he wonders if it's too high. He's not convinced by the argument that Tesla will enter new businesses and prosper in them. He points out that nearly all of its revenue today comes from cars and that the rest comes from a loss-making solar division.

So one of my competitors has them in every other business. They're in none of those businesses. Again, 95% of revenues from auto sales. They've been saying all these other businesses for years. So, you know, you could take McDonald's and say they're going to get into selling Nikes and chairs and pianos and add those valuations. But unless the company's investing the CapEx, which by the way, if you look at their R&D spend and their CapEx spend compared to other automotive manufacturers and/or, you know, battery manufacturers, um, it pales in comparison.

You heard Gordon say CapEx. That's capital expenditures or money invested in big-ticket things like plants and equipment. R&D is of course research and development. Wall Street predicts CapEx of $6.6 billion this year for Tesla. And $9.6 billion for GM. For R&D, the consensus estimates are $3.1 billion for Tesla and $7.6 billion for GM. I take Gordon's point, although I suppose that the same would be true of most industry insurgents taking on incumbents. I'm not picking a side on Tesla, by the way. One concern I have about it and other U.S. companies operating in China is whether they'll be able to successfully navigate tense political and trade relations between the two countries. Gordon says he has a different China concern. He says he thinks the plant there contributes all of Tesla's profits, and he wants to know more about the deal Tesla signed for that plant and how the costs are distributed. Tesla doesn't disclose profitability by plant. I can tell you that Morgan Stanley's Adam Jonas, who's bullish on Tesla, has a different view. He estimates that Tesla's Fremont plant operates at a 20% gross margin. Gross margin is the percentage of revenue left over after manufacturing costs are paid, and 20% is healthy for a carmaker. He also estimates that the Shanghai plant's gross margins are twice that high and that the coming Berlin and Austin plants could eventually achieve even higher margins. Gordon had other criticisms of Tesla's technology that I couldn't verify one way or the other. But the bottom line is he says other analysts view Tesla as a technology company and he views it as a car company. And the car business, he says, isn't easy.

Selling cars is not selling iPhones or shirts. You know, you're talking about going from selling a million cars to 2 million, right? Or even $3 million is exponentially harder than going from selling $500,000 to $1 million. This idea that car sales just grow exponentially, show me any case in history when that's been the case.

Thank you, Gordon and Philippe, and thank all of you for listening. Jackson Subaru Cantrell is our producer. He's been talking a lot of smack about RAV4 drivers, if I'm being honest.

Hey, we can all team up and say we don't like CRVs.

That's the top-selling car where I live. Subscribe to the podcast on Apple, Spotify, or other fine podcasting platforms. My Twitter handle is @JackHough, H-O-U-G-H. Full disclosure, I'm a terrible follow. See you next week.

Data is everywhere. When orchestrated properly, it sings. At Morningstar, we analyze and enrich data, making it actionable and powerful for you. Morningstar. Where data speaks.