After 2.5 frenetic days at CES, we’d report the following key takeaways: 1) Multiple industry leaders are acknowledging (primarily behind the scenes) that deployment of Level 4 / 5 Autonomous Driving technology without safety drivers is farther away than most public targets. At the same time, demand for consumer-targeted safety / convenience systems (primarily Level 2+) continues to accelerate. 2) Reinforcement of the narrative that the next generation of high-volume internal combustion engine / transmission families will be the last one for many automakers.
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Demand and Margin (i. e. pricing) concerns have driven a sharp change in sentiment since mid-Dec. These types of concerns have always proven to be unfounded, and we believe this will be the case again, as we continue to see TSLA as a high-conviction Outperform. Shares are down 15% since Dec 14 (vs S&P -4%) and back to levels directly post-Q3 results. At 12.6x the 3Q18 EBITDA run-rate, valuation is compelling given our belief that Tesla can grow volume at a 5-year CAGR of 30%+. We have raised our 4Q18 EPS forecast to $2.57 from $1.92, reflecting stronger than expected deliveries.
Most major U. S. OEMs and Suppliers will provide 2019 guidance in mid- to late-January… at our Detroit Auto Show Conference (Jan 15-16), or when they deliver Q4 earnings late January/early February. Management teams are pulling these forecasts together now. And they are doing so amid an unusually large number of market uncertainties (i.e. China, Europe, and NA production; company specific concerns for Ford (China, UK), JLR (China, UK), GM (discontinuing models), and local Chinese OEMs (declining at a double-digit rate in their domestic market). Based on our discussions with Industry Management teams we suspect that most will incorporate an extra dose of conservatism into their 2019 Guides. We are fine-tuning our estimates for Lear, Visteon, and Autoliv as we intend to take the same tack (e.g. today, we are fine-tuning our 2019 net new business backlog estimates, initially provided in early 2018, to reflect updated market and FX assumptions). See pages 3-6 for more details.
The current auto sales run rate in China, if sustained, would imply a 10% sales/production decline in 2019. Europe won’t be easy either, as production headwinds spill into 1H19. The U.S. has been relatively strong, but we remain concerned about affordability headwinds. Given these uncertainties, we question why OEM/Supplier margin expectations are up from 2nd half 2018 levels.
Tesla’s volume growth opportunity has been clear for some time, but persistent cash burn made it impossible for the broad investor community to evaluate the margin profile and the company’s ability to self-fund capital growth. In turn, substantial external funding needs made the risk profile unfavorable. This has limited the investor pool to essentially “true believers”, driven persistent short interest, and kept the market cap largely range-bound for 4 years.
Late Sunday night (12/02/18), President Trump tweeted that China had agreed to reduce the tariff on vehicles produced in the U.S. and exported to China (China had increased this tariff from 15% to 40% in August). In addition, the U.S. will refrain from ratcheting up tariffs (would have gone from 10% to 25%) on $10.4 bn of Chinese made Auto Parts that are imported to the U.S. Although we have no detail as of yet, and these actions are contingent on the U.S. and China making progress towards a permanent trade agreement over the next 90 days, this development could have meaningful positive implications for U.S. Automakers and Suppliers:
Once a quarter, we comb through corporate filings and summarize the most noteworthy datapoints. At a high level, developments during the quarter reinforced our view that investors should be Underweight Autos and Auto Parts, Underweight Dealers, and Overweight a relatively small selection of companies that fall into the Auto 2.0 category. In our view the U.S. Auto Cycle is in its 8th or 9th inning, with looming pressures on vehicle affordability. China is experiencing its first real Auto Industry downturn, and we are not convinced that the Central Government will step in to specifically prop up Autos. Europe also faces a number of challenges: These include potential trade risks (7% of Europe produced vehicles are exported to the U.S.), political risks (Brexit), and regulatory risks (vehicles more expensive to produce, at the same time that pricing has become more challenged).
The company confirmed our view that the production ramp of Model 3 to 7k units/week (from 4.3k avg in Q3) could be achieved with limited additional capex (we believe incremental headcount needed is also limited). Given higher labor / D&A / overhead absorption we believe an incremental 50k units of Model 3 production can add 280bp’s to overall Model 3 gross margin. The mechanics of higher volume should more than offset any reduction in ASP from the introduction of lower priced versions of Model 3.
Non-GAAP EPS of $2.90 (vs cons $0.03), EBITDA of $1,150mln (16.7% margin), and FCF of $881mln all blew away Street expectations. It’s only one quarter, but we see this as a proof-point that Tesla earnings power is likely to outperform that of traditional automakers. We are raising 2018 / 2019 / 2020 EPS est’s to -$1.33 / $9.20 / $10.50 from -$5.36 / $6.65 / $10.25 and upgrading to Outperform.
Tesla lowered the entry level price for Model 3, by adding a Mid-Range (MR) Rear-Wheel Drive (RWD) option to the line-up, priced at $45k. They removed the Long-Range (LR) RWD option (prev priced at $49k) and kept pricing the same on the LR All-Wheel Drive (AWD) vehicle ($54k).
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