Tesla, Inc. (NASDAQ:TSLA) posted disappointing results for the September quarter, falling short of consensus expectations in terms of revenue growth and profitability. While a single quarterly miss may not heavily impact most companies, for Tesla, it reflects a significant negative catalyst. Investors had long expected Tesla, an electric vehicle (“EV”) company, to maintain steady growth with higher margins than traditional automakers. The market placed a premium on Tesla’s valuation, with shares trading at a 500% EV/Sales premium compared to competitors.

However, with Tesla’s growth below 10% year-over-year and operating profitability aligning with legacy automakers, the company’s story is ripe for reassessment. Elon Musk’s misstep with the Cybertruck further highlights the risks associated with overly ambitious and unconventional management decisions.

Tesla’s Q3 Reporting Shocks Investors

Tesla’s Q3 results, released on October 17th, were broadly unsatisfactory, leading to a more than 16% drop in share price within five days, while the S&P 500 (SP500) experienced only a 3% decline.

Investors reacted strongly to the numbers presented, as Tesla’s revenues for the three months ending September grew by only 9% year over year, disappointing compared to the expected $1 billion higher revenue. Notably, Tesla’s core business, automotive sales, recorded a meager 5% growth during the same period. Margins also experienced a significant decline, with the gross margin dropping by over 700 basis points to 17.9% and operating margin dropping by 964 basis points to 7.6%. Earnings per share fell short of consensus estimates at 66 cents, despite some positive one-time factors mitigating the impact.

Cautious Conference Call Tone Highlights Challenges

Tesla’s Q3 conference call struck a cautious tone, with CEO Elon Musk expressing concerns over macroeconomic factors like rising interest rates, consumer strength, and affordability. Musk also highlighted challenges associated with the Cybertruck launch and volume ramp-up going into 2024.

“I mean, we dug our own grave with Cybertruck … Cybertruck’s one of those special products that comes along only once in a long while. And special products that come along once in a long while are just incredibly difficult to bring to market, to reach volume, to be prosperous.”

“I do want to emphasize that there will be enormous challenges in reaching volume production with the Cybertruck and then in making a Cybertruck cash flow positive … [it will take] a year to 18 months before it is a significant positive cash flow contributor.”

Tesla expects the highly-anticipated Cybertruck to negatively impact profit margins and free cash flow. Musk’s comment that the expected volume may be closer to 250,000, significantly lower than some bullish investor expectations, added to the concerns.

“I think we’ll end up with roughly 0.25 million Cybertrucks a year. I don’t think we’re going to reach that output rate next year. I think we’ll probably reach it sometime in 2025. That’s my best guess.”

The commentary from Tesla’s management also indicated potential headwinds in terms of future production volume. Shanghai’s production is not expected to significantly increase in Q4, and the ramp-up in Austin and Berlin will be gradual due to various challenges. This gradual ramp-up may suggest weaker demand, particularly in China, where competition against local rivals is intensifying.

These factors call for caution in expectations for Tesla’s 2024 deliveries. Despite implementing price reductions, Tesla’s decision did not translate into increased vehicle sales, potentially indicating weaker-than-expected demand.

The Tesla Story Faces Challenges

Tesla’s current valuation, with an approximately 70x EV/EBIT multiple, assumes ambitious growth and margin targets. However, Q3 results failed to support these assumptions. With revenue growth already falling below double-digits in Q3 2023, the projected geometric average growth rate of around 15% CAGR through 2035 appears increasingly unreasonable. Similarly, the operating margin decline trend raises doubts about achieving the projected 12-14% margin at the end of the growth cycle. Tesla’s operating margin now lags behind the average S&P 500 company and has only a slight advantage over the average automaker.

Valuation Poised for a Downward Rerating

While some argue that Tesla is not solely an automotive company given its various revenue streams, it still heavily relies on automotive sales, accounting for over 85% of revenue. Therefore, it is reasonable to value Tesla as an automotive company until proven otherwise. Based on achievable assumptions for Tesla by 2035, a fair implied share price of $95.55 suggests a double-digit valuation.

Potential upside for Tesla’s share price could come from successful product launches, such as the Cybertruck and Model 2, with higher-than-expected demand. Enhanced production capacity and increased efficiency could strengthen Tesla’s margins. Non-auto segments, including Network Services, Mobility, 3rd-Party battery/FSD licensing, Energy, and Insurance, may also contribute to upside potential. Tesla’s brand, reputation, and global expansion efforts can drive positive sentiment.

However, it is crucial to recognize that speculative retail investors heavily engage with Tesla stock. In a speculative market scenario similar to 2020-2021, Tesla could experience significant price upside due to speculative fever.

Investor Takeaway

Tesla’s Q3 results significantly fell short of expectations, signaling a need for reassessment. Share price rerating towards a double-digit valuation is likely by the end of 2024. As Tesla remains predominantly an automotive company for now, it should be valued as such. A fair implied share price of $95.55 reflects reasonable assumptions for Tesla’s future performance. Investors should closely monitor the company’s progress and reevaluate their expectations in light of recent developments.