Tesla stock valuation: Is Tesla really worth more than Ford and GM?

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Much has been made about Tesla  recently surpassing $50 billion in market cap which means it has a higher valuation than Ford and briefly GM. Telsa founder and CEO Elon Musk took some time away from building electric cars, rocket ships, and hyper loops to comment on the milestone via Twitter.

First, he celebrated the rally in Tesla share price mocking by those shorting the stock…

Then he responded to a comment on the high valuation of Tesla stock.

A good discussion on stock valuation ensued and ultimately Musk agreed with an important point made about stock valuation…

While the point made about stock valuation is valid, it still doesn’t mean that the market is correctly considering the risk-adjusted portion of that formula. Risk is traditionally accounted for through the capital asset pricing model or CAPM. A very important portion of the CAPM is r or the risk-free rate. The risk-free rate has been held down by the Fed’s monetary policy keeping interest rates low for so long and valuations for EVERY risky asset have been skewed. The more risky the more overvalued they are.

I’ve previously discussed a similar situation with the market overvaluing Netflix. It’s not that I don’t like Musk or what he is trying to do, it’s just the math doesn’t work.

So is Telsa really worth more than Ford or GM?

Recent Tesla Stock Rally

Tesla has been on a tear since the election and is up over 60% since November.

Tesla

Tesla P/E Ratio vs. Ford and GM

If looking at relative valuation metrics such as P/E then Ford and GM look very cheap at a 6.4x P/E for Ford and 5.26x P/E for GM. But Ford and GM have perpetually low P/E multiples so that has to be taken with a grain of salt. Tesla still has negative EPS so there is no measurable P/E multiple.

Analysts currently expect Tesla EPS to turn positive in 2018 with an estimate of $1.23. Based on Tesla’s current share price of $304 that a forward P/E of 247x. By comparison, Ford trades at a forward P/E of 6.62x and 5.59x so no one is buying Tesla based on trailing or forward P/E multiples.

Tesla Future Cash Flow Valuation

2017 will be a very important year for Tesla as the Model 3 is expected to be unveiled in July. Revenue is expected to rise from $7 billion in 2016 to $11.4 billion in  2017. Due to ongoing capital expenditures, free cash flow will continue to be negative at least through 2017.

Analysts expect positive free cash flow in 2019 and by 2021 expect free cash flow of $3.7 billion. Remember the risk-adjusted future cash flows Musk tweeted about? The longer amount of time it takes for cash flow to turn positive, the more risk that must be factored into the valuation. $1 in cash flow next year is worth more than $1 in 2021.

One of the easiest stock valuation models is the perpetual free cash flow to the firm (FCFF) model. A better model is to predict future revenues and cash flow for the next 10+ years but I’m not going to take the time to do that if this simple valuation model doesn’t even make sense.

Value of firm = FCFF1 / (WACC – gn)

where,

FCFF1 = Expected FCFF next year

WACC = Weighted average cost of capital

gn = Growth rate in the FCFF (forever)

Source: Dr. Damodaran at Stern NYU

Let’s assume analysts are correct and FCFF will be $3.774 billion in 2021. We then need to plug-in WACC and a growth rate. Using Bloomberg’s calculated beta of 1.38, cost of equity of 12.2%, and  cost of debt at 2.9% the WACC is 10.7%. I will assume the rate of growth is better than the overall economy at 3.5%. Remember, this is perpetual growth so we would expect the growth rate to decline over time to normal levels.

$3.774 billion / 10.7% – 3.5% = $52,417 or $52.4 billion. Wow, incredibly close to the current stock market valuation of $49.6 billion. The problem is the formula is providing a valuation in 2020 since we are using 2021 free cash flow. We need to discount that valuation back to the present to determine the current market value.

To do that, simply use the WACC and discount the valuation 3 years to the present from 2020 to 2017.

$52,417 / (1.107^3) = $38,639

So what does this tell us? The value of the entire firm is $38.6 billion IF Tesla were to generate $3.7 billion in free cash flow forever and we are using the proper risk and growth measures.

To value the stock, we then have to subtract the preferred stock and net debt from the valuation.

$38,639 value of firm

– $1,152 prefered

– $6,854 debt

+ $3,393 cash

__________

$34,026 is the value of all Tesla common stock

Divide by the total number of shares of 161.6 million and the fair value of shares is $210.55. This would mean the market is overvaluing the shares by 44%.  

Oddly enough the stock price was below $210 as recently as December but the market enthusiasm for Tesla has run wild.

Risks to the Tesla Valuation

That simple valuation might not be the best method to value the company but it can at least provide a starting point to determine if the market is reasonable. Maybe Tesla can grow more than 3% forever. Maybe free cash flow will be greater than $3.7 billion in the future or maybe free cash flow is positive next year rather than 2021. If that happens then my valuation is undervaluing the company.

There are plenty of factors that change the valuation but time is a very important factor in any valuation model. Next years earnings and cash flow are much more important than what product 10 years down the road.

Conclusion

Tesla might become the leading US automaker in the future but how long will that take? At this point, they are only selling about 76k cars a year.

It would be sweet to be free from the grips of oil but there are many risks Tesla will face along the way. If oil prices remain lower due to increased supply, will consumers rush to adapt to electric? Will Tesla be able to overcome the lobbying efforts auto dealers are pushing to prevent Tesla from selling their cars directly to consumers? Will individuals even need to own cars in a future with on-demand self-driving cars provided at a reasonable service cost from the likes of Uber? There are many questions (risks) that have to be factored in.

So buy Tesla because you believe in Musk, believe in electric autos, or because you like popular stocks but not because of the valuation.

 

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