The stock market has been extremely volatile and unpredictable in 2020, and perhaps no stock has exemplified this volatility more than Tesla (ticker: TSLA). Tesla rallied about 500% in the first eight months of 2020 but crashed about 30% in the first nine days of September.
Tesla stock bulls typically argue that the company is dominating the nascent global electric vehicle market, and comparing the stock and its valuation to legacy auto stocks is irrelevant. At the same time, Tesla bears often point out that the stock’s valuation is extremely high even compared with high-growth tech stocks, and Tesla will face an unprecedented wave of new competition in the next couple of years.
Doug Kass, president of hedge fund Seabreeze Partners Management, says he has resisted shorting Tesla for years. However, with the stock up more than 800% over the last 52 weeks, Kass says he could no longer sit on the sidelines. Kass finally pulled the trigger by shorting Tesla stock in late August at a price of $2,014, which represents a post-split price of about $403.
“It can now be argued that Tesla’s shares represent not only a good short-term short, but, at current prices, the stock may represent the largest single bubble — as measured by market capitalization of nearly $400 billion — in history,” Kass says.
But Tesla’s valuation is only one of a number of concerns he has about the stock.
Tesla’s Unproven Model
Tesla once again eked out a profit in the second quarter of 2020, but short sellers like Kass take exception to the way Tesla is generating income. Tesla reported $104 million in net income in the quarter based on generally accepted accounting principles, or GAAP. However, it also reported $428 million in regulatory credit sales in the quarter.
Tesla collects these regulatory credits for its electric vehicle sales and sells many of the credits to other automakers. These legacy automakers need the credits to avoid regulatory penalties until they roll out their own EV models. For now, Tesla can sell these credits at a 100% profit, but analysts say Tesla’s window of regulatory credit sales is closing.
Kass says without regulatory credit sales, core auto sales are clearly not profitable.
“Adjusted for the sale of emission credits, Tesla has never been profitable in its 17 years of existence,” despite having no competition and no need for advertising, Kass says.
He is skeptical of Tesla’s valuation until it can prove that its auto business can be significantly and consistently profitable.
[READ: 7 Best Auto Stocks of 2020. ]
Competition Is Coming
Another red flag for Tesla is that the company will face its first true wave of EV competition in the next two years. In the first half of 2020, Tesla accounted for about 80% of U.S. EV sales, according to Loup Ventures. However, only 16 EV models are available in the U.S., five of which are Tesla’s. By the end of 2021, competitors are expected to introduce an additional 20 EV models to challenge Tesla’s leading market share.
Kass says the first batch of new competition comes from highly rated new models from Polestar, Audi and Volkswagen (VLKAF). Tesla has been the first company to corner the EV market. But Kass says Tesla has a shallow competitive moat and no meaningful proprietary EV technology to set it apart from competitors, many of which have a century of experience in producing and marketing high-quality automobiles.
Priced for Perfection
Finally, Kass and many other Tesla short sellers are extremely skeptical of the stock’s valuation. Even after a nearly 30% September sell-off from recent highs, Tesla shares trade at a forward earnings multiple of 121 and a price-to-sales ratio of about 13.8. That valuation is a steep premium to legacy auto stocks Ford Motor Co. ( F), General Motors Co. ( GM) and Toyota Motor Corp. ( TM), which average a forward earnings multiple of 10.3 and a price-to-sales ratio of 0.51.
“Faced with an onslaught of competition, Tesla’s market cap is now nearly four times that of Ford, General Motors and Fiat Chrysler ( FCAU) combined — despite selling only about (400,000) cars per year, compared to the big three’s sales of 17 million units,” Kass says.
Tesla’s revenue was down nearly 5% last quarter, but many Tesla bulls say the automaker is more like a high-growth tech stock than an auto company. Unfortunately, valuation comparisons to large-cap tech stocks Apple ( AAPL), Amazon ( AMZN) and Microsoft Corp. ( MSFT) still paint Tesla as overvalued. Tesla’s forward earnings multiple is more than double the average of these tech giants, and its price-to-sales ratio is more than 50% higher.
While there’s no question that Tesla has shaken up the global auto industry, its spiking share price has already priced in a significant degree of long-term success. Tesla bears like Kass are skeptical that the company will ever be able to live up to, much less exceed, those sky-high expectations.
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