Tesla has been one of the most successful and most debated publicly-traded companies, It’s a brand that has a devoted following that also has plenty of skeptics. In its most-recent quarter, however, the company continued to deliver strong numbers despite a very challenging operating environment. The question — and it’s a big one — is how big can the company become? That answer may lie in whether you believe Tesla is a car company or a tech company. Anirban Mahanti has your answers and he joins 7invesitng Now to explain.

Transcript

Sam Bailey  0:14  Welcome to 7Investing Now, a show that teaches you how to take a long term view on investing by better understanding what’s happening in the market now.

Dan Kline  0:27  Good afternoon, and welcome to the Monday edition of 7Investing Now or the five in the morning edition because we are taping of course, with Anirban Mahanti. My name, of course, is Daniel Brooks Kline, I am the host of the program, we take a look at some of the investing news of the day and put a long term perspective on it. Anirban, how are things over in Sydney, Australia?

Anirban Mahanti  0:50  Oh, things are getting better. You know, we are getting out of lockdown. Schools are opening today, which is why we are doing this at 5am for me, so that, you know, I can get on with organizing the school day. But yeah, things are looking better. But it’s still dark outside.

Dan Kline  1:04  I had to explain that to my wife. I said, Oh, it’s the first day of school. And I’m like, well, it’s not probably not traditionally, the first day of school. It’s the first day of post lockdown. But time is meaningless. Everything is very strange. That perspective, you are either drinking a very tiny cup of coffee, or that is an espresso, I am not sure. But we’re going to talk about Tesla’s (NASDAQ: TSLA) recent earnings. And I’m going to throw out some facts and figures you put into an article, and I’m just going to let you rip. I’m going to sit in the background a little bit more than I usually do. So Tesla’s gross margin hits 30.5%. That was driven by higher volumes out of Shanghai, more model Y’s, more model S’s. Are those good numbers compared to other automakers?

Anirban Mahanti  1:45  Yeah, so those are excellent numbers. Excellent in the sense that if you think about what the other automotive automakers doing, say, Toyota, does, you know, high teens in gross margin. GM does, you know, 12% 15% or so. So, of course, there’s Ferrari, which does close to 50, 55%.

Dan Kline  2:07  Well, when you charge 200 grand per car, or whatever it is, there’s some room for margin, there.

Anirban Mahanti  2:12  There is some room for margin. So it’s not quite like a Ferrari yet, but it’s very much industry leading otherwise for mass market production. So yeah, it’s a fabulous number. You know, 30.5%, very, very high.

Dan Kline  2:28  Will, margins get better as more factories come online, I mean, even things like you don’t have to move cars as far to deliver them?

Anirban Mahanti  2:35  Yes, that’s a great question. So as you know, as they get on with their continent, per continent strategy, and some of these factories are still not at full speed. So when these factories get to full speed, there is some margin, that they’re taking costs for things that are not yet producing things as we put it this way. So yes, there is a margin expansion opportunity for sure. So it’s pretty exciting, you know, can Tesla get to Ferrari like margin? While being a mass producer, that would be very, very interesting.

Dan Kline  3:04  That’s a challenge because if they’re going to go with cheaper, like lower end cars, you know, a true say, $30,000 car even to compete with like a, like a high end souped up Toyota Corolla, you’re not going to have the same margin is if you’re selling like $70,000 pickup trucks. So it’s really going to be a question of where the volume is. But it is very impressive on a relatively small amount of cars that they’re delivering. Still hundreds of 1000s. But but not, you know, it’s not four, but it’s also not millions, that they’re delivering these numbers. Cash flow has gotten pretty solid as well. So in the most recent quarter, they generated a free cash flow of $1.3 billion at an income from operations hit $2 billion. This was a company that not that long ago, we were worried about cash flow, like we were talking about, are they going to have to do like an uncomfortable cash rates? Now they did some comfortable cash raises some, some sell some stock when things were great, just to put some cash in the bank, which is a I actually wish they had done more. But are they at the point where that’s just not even relevant, where they’re just operating on a on a cash flow basis, profitably, and we don’t have to worry about the sort of like, you know, oh, my God, is Tesla going to run out of money, which maybe was always a false narrative?

Anirban Mahanti  3:37  Well, I think right now, there’s a king of the hill in many ways, right? They’re very, very cash generative at this point, is the free cash flow, they increased capex, so they’ve increased the pushed up their capex to about $1.82 billion in that range. So they’re built, they’re putting money on the ground and generating a lot of return out of that money that they’re putting on the ground. And that’s going great for them. Then, I mean, you know, as you as you rightly pointed out, those cash raises that they did their, their balance sheet looks like a tech balance sheet, their net cash $14 billion. This is not like an automotive company, who’s you know, net cash position will be like negative 50 billion or something like that. So they’re they’re in a very comfortable position very cash generative. They’re retired all the heavy interest, the basically the process of retiring all their debts that they were paying, like extraordinary amounts.

There’s an an interesting aside here. The interesting aside is that their their debt, which is very minimal at this point, is still rated as junk, which I think is fascinating. I think they’re waiting for their death to become rated at like having investment grade rating where they can get, you know, borrow at really low rates, and they’ll probably yank up the the debt, the debt profile at that point.

Dan Kline  5:41 So they’re sitting on about $14 billion in cash is, is that just going to get plowed back into the business?

Anirban Mahanti  5:48  Um, I think you know, from his company’s experiences, my guess. Based on their so called near death experience for the model three ramp, I think this is a company that’s going to always carry 10s of billions in cash on their balance sheet. But they are going to generously put free from the free cash flow they generate, they should be even more free cash flow generative in the fourth quarter of the year, they’re going to put that back into the factories.

There’s already two that are coming, the big one coming out at Austin. They moved the headquarters to Austin, and then the big one in Europe. There’s already lobbying going on as to you know, whether India gets a factory or who else gets another factory? I wish didn’t, they don’t actually build one in India. India doesn’t have a very good track record of actually attracting companies. And you know, having them build factories and actually having them turn out. Ford actually is closing its plant in India.

Dan Kline  6:43  Anirban, you drive a Tesla. Where do they ship that in from?

Anirban Mahanti  6:48  So mine actually got shipped from Fremont. But all the ones, you know, that are now shipping in Australia are actually coming from China, Shanghai. So Shanghai is actually been doing the bulk of the exports. You know, the Shanghai has been holding that. And whereas Fremont has been mostly just serving now, North America, because the demand has just been that strong. So Fremont is no longer exporting. Which is why if I want a Model S, I actually have to wait until 2022. To get what, I can’t get one. Even if I want to spend that money, I actually this is a unique situation where you want to spend the money, but you can’t get it.

Dan Kline  7:25  So let’s talk about demand. Every manufacturer, every auto manufacturer has had like a vague press release or press conference, where they lay out their plan to be fully electric by 2030. But the plan is basically just a press release and some model numbers. Tesla’s actually doing it. Are they in a position to grow, not just because hey, people love Tesla’s but because sort of everyone is saying you need to be an EV. And they’re kind of the most practical way to be an EV. Obviously, there are other players, but they’re either niche players or like, I’m not so sure if I want like Ford’s third electric vehicle. Like it doesn’t feel like like any of the old line companies, and maybe maybe Volkswagens an exception, are delivering cars that I necessarily want. Maybe Toyota will get their bread, perhaps working with Apple (NYSE: AAPL). But is this just a case of where like, the market for Tesla is going to meaningfully shift and will that be a lease market not a sales market because of the price point?

Anirban Mahanti  8:21  Um, you know, this, these are great questions. So I think if I look at the broader landscape, the demand so there was a, there was a, there was a comment from the CFO in the call. And by the way, Elon Musk actually gave the call which made the conference call very, very much like a traditional conference call. The CFO almost behaving like a CEO or COO. Especially I really like this guy Zack Kirkhorn. Heprobably making the CCO. But that aside, I think they they commented that the demand has been so high that they’ve been taken aback as well. They didn’t expect this kind of demand. So that’s probably a turning point for EVs in general.

As you rightly again pointed out, Volkswagen Group actually has probably the most credible EV strategy behind Tesla. And I think they are going to be a formidable competitor in the years ahead. Some of the other ones are interesting, because, you know, some of the other ones don’t really have an EV strategy. They have an Eevee strategy on paper, which, which I’ve been saying this for a long time, I think in many of the many traditional OEMs are going to turn into contract manufacturers for big tech.

Because I think big tech is going to make make vehicles for obvious reasons like so Waymo is they’re doing you know, autonomy well, why wouldn’t they make a vehicle which is contract manufacturer by somebody else? Apple you know, we have been hearing these rumors of Apple talking with this person that person. Nissan, Hyundai, and KIA, Toyota, whoever, right? There’s a lot of speculation so I think Apple is gonna make one with some of them. You know, it’s gonna be probably in either in partnership or contract manufacturer by someone else.

Are vehicles gonna be leases or sales? That’s hard to tell that lease is still a small percentage at this point it is.

Dan Kline  10:13  I only bring it up because from my you know, like I do financially, well. My wife has a nice job, certainly not as nice as your wife’s job. But like, you know, we’re reasonably comfortable. And I looked at the lease price for a Tesla, and it’s a little bit more palatable to me than the purchase price for a Tesla. So it’s like, it’s something that, you know, two years from now I’m doing like 15% better, or, you know, or we don’t live someplace that’s crazy expensive, which we do at the moment. It’s not weird for me to think about leasing a Tesla. I actually drive too many miles to lease a Tesla, but like, the economics of it seemed like it would make sense for like, I don’t know what upper middle income? I don’t know how you define things like I’m doing fine. But like, you know, people who might buy a new car, which is actually something I’ve never done. That’s sort of why I brought up the leasing piece

Anirban Mahanti  11:00  So I think the the well, so the lease price here, too, seems more affordable. I mean, the only thing with the lease is it’s I think the lease versus sales is also how it has gone largely due also with a of interest, an upfront cost spending, of course, but there’s also the question of total cost of ownership and whether or not if you sold the vehicle, how much would you get? Or if you trade it in? How much did you get and things like that, that come into play. So I’m not sure I mean, the what the answer is we I mean, I would just say, I don’t know, I don’t know what the situation is going to be.

But maybe if the goal is to smaller vehicles. Their strategy is to go to large scale EVs, in which case actually, they want leases, because they want people to have the car, pay for it, then when the car is depreciated for years, they take it back and turn it into a robo taxi. That has been their strategy and plan. If the plan is going to work out that leasing is going to be actually their strategy of selling even more and make it very attractive. So I think that that could have a relationship with robo taxi, although honestly, I think the robo taxi is is some number of years away. So but yeah, I think the leasing fits in very nicely with the robo taxi strategy.

Dan Kline  12:18  Yeah. And there could be an interim play on robo taxi where they partner with an Uber, or Lyft, or somebody and they take those cars and put them into a fleet. I think that could happen in markets in the US where Uber has to make people employees or quasi employees, we won’t get into that whole political debate. But there are some tipping points there. We talk a lot about maybe Apple going into the car space. We don’t really talk about Tesla sort of quietly becoming Apple. This is a company that that’s also selling services. That’s also you know, would it be crazy to you, if I said, like, Tesla makes an anything in the next five years, like, you know that Tesla quietly has like an AR division that we don’t know about like, like, it doesn’t seem that crazy. Is Tesla becoming more of an Apple?

Anirban Mahanti  13:04  Well, Tesla does gaming already, right? It has it has it has got games in the cars that you know, and it’s it’s got the new model S’s and X’s, they’ve got PS, you know, five or four equivalent, you know, processing capabilities sitting in the car for gaming. So, Tesla has autonomy. Tesla’s doing a lot in the artificial intelligence space. Tesla’s doing a lot in the, you know, in the energy space, especially with the virtual power plants and energy trading programs that they run. So it’s very much a software company. The interesting thing, the interesting comment from the CFO, again, on the call was that right now, we are not, they’re not really recognizing much of the software revenue. Basically, right now, it’s a hardware play. But they do think that in the years to come, they’re going to be a good mix of software and hardware, which is basically where Apple is now today. Right? I mean, you know, is earning a lot from services revenue.

So if I had to speculate, I would speculate that Tesla would be a services company, much earlier than Apple became a services company. So and that would change the gross margin dynamics heavily in favor of, you know, becoming much higher gross margin business much more profitable and with more operating leverage. Which already is pretty good. So that I mean, they’re industry leading already that industry-leading in in operating margin and things like that. But you know, and they’ve hit those margins well ahead of expectation or the expectation that they had said. So it could be very interesting to see this.

Dan Kline  14:38  We are heading into the home stretch here going to wrap things up quickly. So just a couple more questions. Raw materials and chip shortages have been a problem. We’ve seen. Tesla’s acknowledged it’s been a problem, but they seem to be able to solve it. They seem to be able to shuffle things around whereas other manufacturers like but we’re closing factories for six weeks or we won’t be making the you know, the Volkswagen, whatever the Jetta for six months. Is Tesla just better at this because they’re they’re not using old line thinking.

Anirban Mahanti  15:08  I would say…I think yes is the answer, but I’ll caveat by saying that their volume is is lower than a Volkswagen right. So they’re not at that scale of making hundreds of millions or 10s of millions of vehicles. They’re making, you know, there are like a million run rate right now. So what Tesla’s doing is right now is agility. So basically saying, Okay, there’s a shortage for the airbag chip, which probably cost like $2. So it’s really low and chip. It’s not available, okay, can we go you know, an attack either whoever or Bosch whoever makes it is not available is not good. Try and use another one, can I change the form where multiple chips, integrate them together, and then just use them instead of, you know, multiple of these other chips.

So they’ve been doing a lot of agile thinking, they’ve been doing a lot of work with the supply chain. I think a lot of that stuff is agility, a lot of that stuff is also the lower volume. A lot of the stuff is also got to do with they being willing to pay more, because you know, a lot of the chips that they use probably are higher end compared to some of the chips that other cars use, just because of their design being more is relatively new compared to others. Yes, I think that’s played a big role. I think that – I personally think that this, I can’t believe that we will have a long term shortage of airbag chips, and this inner seatbelt sensor chips and stuff, stuff that we have always produced in very high quantity. And, you know, the whose price have been falling constantly for, you know, for several years, or decades. I just think those should resolve with respect to raw material. That’s, again, I think raw materials should also moderate.

Some of these things, they have a better position, though, because I think the raw material side is is an interesting one. Because they’re the only credible large scale EV maker, they’ve gone into these long term contracts, which have actually helped offset some of the, you know, absorb the price increases that are the other car companies would see if they need those batteries.

Now the battery prices go up. But you know, they you know, they have the suppliers absorbing some of that cost. Of course, in some cases, they have good, you know, sharing arrangement while you’ll absorb some and you’ll absorb some and things like that. But my My comment would be that this is not like actually, this is this setup is not a good setup for anybody trying to ramp their EV production today. This is a bad situation to be in, where things are not available. The raw material supply, you know, raw material cost is highly variable going up and down and it’s in the high side right now. So it’s a bad situation if you’re a Tesla competitor, without scale. And that will include many of the OEMs, which don’t have scale on the on the EV side have scaled on the on the Ice Age vehicle side. So yeah.

Dan Kline  17:55  So I have to say I love agile thinking. So you know, I spent a few years four years running a factory. And when I started doing that, I didn’t know anything about running a factory. So if a customer called me and they wanted some impossible quantity of goods, I always said yes. And then just figured it out. Because you know, it’s a lot better when you sell stuff. And like we did some of the Tesla things. Like we set up workstations in the in the parking lot. We you know, wheeled and dealed for raw materials and did the things you could do. And it was a really interesting lesson in sort of, you know, how do you manage things. And I was making very simple products compared to a Tesla.

But there were times where like, it was like me in between like sales trips, standing out there with anybody, I can round up just making stuff. And you know, in some ways I love that ethos at Tesla. One final question Anirban Mahanti. Is Tesla undervalued. That almost seems like ridiculous to say, but I’ve been wrong not owning Tesla for like three; I mean, I haven’t ever owned it, but I didn’t really think about owning it until two years ago. And the fact that I don’t own it is bad. I’ve lost a lot of money not owning Tesla. Is Tesla undervalued right now.

Anirban Mahanti  19:01  Yeah, so the one way to think about this is if you look at the non GAAP EPS, the earnings per share, over the trailing 12 months, it’s like it had over $5. So this is a company with real earnings with real free cash flow, real factories, and stuff that people love. So all of those things are there. And then if you look at the PE, it’s somewhere around the 200 range, or under 200 range. Right now, the share price is around 900 or something. So while it’s about 200 times earnings for a company, for automotive company is pretty high, which is yes, but not every company right now also has earnings growing at 100% plus. Which is where Tesla is right now because of the stage of the business and so on. So you wouldn’t value it like 20 times earnings or 15 times earnings right now. You could value this if it hits steady state at some point at like you know 12 times 15 times earnings, but this is a company with the production goals of the production goals of 50 percent plus increase over the next 10 years. That’s a pretty crazy goal. And there’s a lot of leverage and software and things like that, that we’re not accounting for.

So if you consider the growth trajectory, and how the margins could go up, you could claim that this is actually undervalued. I own the shares. I’ve owned it for many, many years. And I continue owning it, largely because that looks that reason that I think it this is one of those very interesting scenarios where a company which to some people looks undervalued, looks overvalued, to others. And this is what I call a highly debatable stock, a stock which has got a lot of bears and bulls on its side. Those tend to be if they work out to be examples of, you know, holdings that you want. So, and I think optionality is not priced in is what I think personally.

Dan Kline  20:49  And for full disclosure, I did buy some Tesla in my son’s custodial account, but he puts like, 30% of his Wendy’s paycheck in every couple of weeks. So it’s like $75 worth of Tesla that like fractional shares are awesome, because now my son can track a company that that’s really interesting. And, and honestly, if you’re 18 years old, putting 75 You know, $50, whatever it isn’t every couple of weeks is really gonna be a lot of money when he’s older, which is an important lesson for any of you student members who are watching.

At 7Investing. We offer an $84 a year student membership. So if you’re a student, a full time student, you log in and you have trouble signing up for that just hit us up at info@7investing.com. That is how you get in touch with us. So once again, info@7investing.com or if you want to follow us on Twitter, you can do that. That is @7. That is the number seven, investing on Twitter. I will tweet out I actually did a Fox Business Podcast, a pretty big show really interesting one this weekend. We’re talking about multi level marketing. That’s not really a stock market topic. But it is really interesting and a lot of people end up sort of getting sucked into those companies. And basically I gave you a big red flag, not even a yellow flag a big red flag on any of those companies. Thank you to Anirban Mahanti. Thank you to JT Street. Thank you, Sam Bailey. We will be back on Wednesday. Thanks everybody.