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Bear of the Day: Tesla (TSLA)

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I just wrote about Tesla (TSLA - Free Report) as Bear of the Day two weeks ago and outlined how the stock's ability to maintain lofty expectations near $350 was all dependent on the company's ability to maintain lofty expectations for production of the new Model 3.

When the company reported Q3 earnings on Thursday, we already knew they had fallen short of a Model 3 production goal of 1,500 cars in the quarter. Tesla produced its first Model 3 cars in Q3 and reached 260, which led to 222 deliveries versus Wall Street expectations ranging from 1,000 to 2,000.

But what investors were now hoping to hear this past week was that the company was still on pace to meet their goal of 5,000 cars per week in December -- even though many analysts felt that was becoming increasingly unrealistic.

On November 1, the company revealed that this goal should now be achieved by March as they fix certain known and manageable "bottlenecks" in the production logistics.

Why is the Model 3 production ramp so important to Tesla?

Because it's what investors are betting will turn the company into a huge cash-generating machine. Here's what I wrote last month...

Where's the Growth?

Some of the bulls had expected Tesla to turn consistently profitable in 2018. Others have anticipated production delays with the new Model 3 and see the company as able to deliver its first profitable year in 2019.

The shifting sands here are typical not only of a new car company but also of one with such a transformational business model.  

What the bulls hope is that Model 3 demand will be strong and that Tesla is able to generate 25% gross margins on the vehicle at a price point in the mid-$40,000s.

Despite the big Q2 earnings beat in August which helped propel shares back to the all-time highs above $385 that were first achieved in June, earnings estimates have been headed down.

Two months ago, the consensus EPS projection for this year was a loss of $6.39. That has since fallen back to ($6.84).

The 2018 consensus dropped from a loss of $1.12 to ($1.23) in the past 60 days.

Oppenheimer analysts felt compelled to drop their 2017 EPS estimate from ($4.95) to ($7.02).

And yet they remain in the camp of seeing a profitable 2018, sticking with their far-above-consensus profit projection of $1.64 next year.

All About the Model 3 Sales

What turns the potential earnings lever into next year to go from a loss of $7 to nearly profitable? The Model 3.

Tesla produced its first Model 3 cars in the quarter and reached 260, which led to 220 deliveries versus Wall Street expectations ranging from 1,000 to 2,000.

As Tesla ramps up Model 3 production to many tens of thousands of cars, revenue growth is expected to skyrocket from this year's $11.89 billion -- already 53.5% growth vs. 2016 -- to $19.64 billion in 2018.

To see why, let's first look at what kind of sales Tesla has in its other models. The company reported 26,150 cars delivered in total in Q2 which was ahead of consensus forecasts. The breakdown among leading cars was 14,065 Model S deliveries and 11,865 of the Model X.

But these are luxury models that could reach some degree of market maturity or saturation in the near future. KeyBanc analysts see that Model S run rates continue to decay while the X appears headed toward a plateau.

Part of Tesla's "master plan" is to reach a much broader market for sustainable transportation with the Model 3, where the company's stated goal is to produce 500,000 cars per year.

Every 100K cars at $44,000 is equal to $4.4 billion in sales. And if the company can really achieve 25% gross margins, the profits will start to flow through to the bottom line.

The key, besides achieving production goals, will be Tesla's Gigafactory and its ability to produce enough low-cost batteries for the Model 3.

Q3 Highlights That Helped Send Shares Below $300

Tesla incurred adjusted loss of $2.92 per share in third-quarter 2017, wider than the Zacks Consensus Estimate of a loss of $2.45. The company had reported earnings of 70 cents per share in the prior-year quarter.

The reported net loss in the quarter was $671.2 million compared with the year-ago net income of $21.9 million.

Revenues increased to $2.98 billion from $2.30 billion registered in third-quarter 2016. The figure also surpassed the Zacks Consensus Estimate of $2.92 billion.

Tesla delivered 26,137 vehicles in the third quarter of 2017. In third-quarter 2017, the combined sales of Model S and Model X grew 4.5% from the year-ago figure.

Revenues from Automotive sales increased to $2.36 billion in the reported quarter from $2.15 billion a year ago.

Energy generation and storage revenues soared from $23.3 million in the third quarter of 2016 to $317.5 million in the reported quarter.

Services and Other revenues increased to $304.3 million from $126.4 million in the year-ago quarter.

Tesla’s Q3 automotive gross margin was 18.7%, declining 628 bps (basis points) from Q2 2017 due to considerable rise in manufacturing expenses of the Model 3.

Energy generation and storage gross margin declined 368 bps sequentially in the quarter to 25.3%.

Financial Position

Tesla had cash and cash equivalents of $3.53 billion as of Sep 30, 2017 compared with $3.39 billion, as of Dec 31, 2016.

Net cash used in operating activities amounted to $300.6 million in the third quarter compared with net cash provided of $423.6 million a year ago. Capital expenditures jumped to $1.12 billion from $247.6 million in the year-ago quarter.

Business Expansion and Outlook

In third-quarter 2017, Tesla opened 18 new stores and service locations and added 126 new Supercharger stations.

Currently Tesla expects to deliver around 100,000 units of Model S and Model X in 2017, up 30% from 2016. However, the company intends to sequentially cut down production of Model S and Model X by 10% in the fourth quarter in order to divert more resources toward the production of Model 3. This will result in a decline in the inventory level of finished Model S and Model X vehicles.

The company expects Model 3 gross margin to reach break-even level by the end of fourth-quarter 2017 as a result of higher capacity utilization. Also, the company expects to achieve the target gross margin level of 25% in 2018.

The company also anticipates a capital expenditure of approximately $1 billion in fourth-quarter 2017.

The Bears Show Their Teeth

Since Tesla's report on November 1st, the analysts who have been correctly bearish on the lofty expectations for the company and the stock dug in their heels and lowered price targets (PT) further.

JPMorgan dropped their PT from $195 to $185.

Goldman Sachs dropped their PT from $210 to $205.

BofA/Merrill Lynch analyst John Murphy maintained his Underperform on Tesla with a PT of $155. Murphy is negative on the cash burn rate, with another capital raise on the horizon in 2018 and noted the slow Model 3 ramp offers little hope for that situation at present.

Meanwhile, a bull who had just raised his price target from $317 to $379 in October, acknowledged that longer-term risks remained...

Morgan Stanley analyst Adam Jonas maintained his Equalweight rating on Tesla and kept his price target of $379 after the November 1 TSLA report.

Jonas said in his report after the Tesla quarter that the Model 3 slippage is a near-term buying opportunity but noted that longer-term risks remain for the company given Tesla's liquidity position in a challenging industry that is highly dependent on friendly capital markets.

Bottom line: If you are a long-term Tesla bull who sees and believes in the coming revenue ramp from the Model 3, a good buying opportunity could be around the corner this quarter. I know I'll be seriously looking at the stock under $250.

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