“Gross margins do matter. However, they matter less than the money that winds up in the company’s bank account after all is said and done. Tesla Motors Inc (NASDAQ:TSLA) makes nice cars, and I don’t doubt that it will sell everything in its limited production runs. However, that does not seem to be enough … to do more than merely break even on an operating basis.”
That was me two weeks ago. Is there egg on my face? I guess you could say that.
Today, Tesla shot up by as much as 20% after revealing that it now expects profitability on both adjusted and GAAP bases, and that it sold 250 more cars than originally expected. The company also expects to be “near breakeven” on an operating cash flow basis and projects gross margins in the mid-teens.
I’m very curious to see how Tesla Motors Inc (NASDAQ:TSLA) will reach profitability without breaking into positive operating cash flow territory when the latter figure was most recently $130 million closer to breakeven than its net income for the past four quarters. Net income can be gamed with one-time items and other accounting gimmicks, and without positive free cash flow, the company is still going to need to show strong progress toward that eventuality to prove that it’s worth more than larger and more established automakers.
Exploring Tesla’s future
Speaking of those larger automakers, how exactly does Tesla stack up on valuation?
| Automaker | P/E | Forward P/E | Price-to- Free Cash Flow |
|---|---|---|---|
| Ford | 9.3 | 7.4 | 14.3 |
| General Motors | 9.5 | 4.7 | 25.6 |
| Toyota | 19.6 | 9.6 | 26.1 |
| 12.8 | 7.2 | 22.0 |
Source: Morningstar.
In order to reach a level equal to the average of these three big automakers, Tesla Motors Inc (NASDAQ:TSLA) would have needed to generate $400 million in net income for its last four quarters — with about $710 million in anticipated income for the upcoming four — and $230 million in free cash flow. Analysts expect a forward P/E of 34.1 for the electric upstart, nearly five times the valuation premium of its larger foes. That translates to net income of $150 million for 2013 — and with a similar valuation multiple applied to Tesla’s free cash flow, it would have to earn about $50 million in free cash flow over the course of 2013.
That would be a turnaround of $550 million from 2012’s results on both a free cash flow and a net income basis. That would be an exceptionally dramatic performance, as Tesla’s only expected to ship (at most) about 20,000 Model S sedans this year, an increase of more than 15,000 vehicles from 2012. A positive swing of $550 million implies increased profitability and free cash flow of more than $35,000 per car over 2012’s production, based on a very rough back-of-the-envelope calculation. Heck, to reach $150 million in net income for 2013, Tesla would need roughly $7,500 in profit per Model S, if all 20,000 sold.
That’s certainly doable — Porsche reported profit of about $28,000 per car just before the financial crisis, and even Ford and GM can produce profits nearing $10,000 per car on some pickup and SUV lines — but as Tesla Motors Inc (NASDAQ:TSLA) pushes for greater volume, it will become less feasible for the company to extract luxury-level profitability from more mass-market vehicles. Where is the sweet spot between greater volume and adequate per-vehicle profitability?
