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Is Tesla Stock a ‘Sell’ before Its Q4 Earnings?

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  • Tesla stock (NASDAQ:TSLA) has been on fire this year. The company’s market capitalization beat $100 billion amid the recent rally. Tesla will likely release its fourth-quarter earnings on Wednesday. The rally in the stock started after the company’s third-quarter earnings beat.
  • The stock has more than tripled from its 2019 lows including a 35% rise this year. However, many analysts think that investors should be cautious. Could the stock’s rally eventually come to an end after the fourth-quarter earnings release?
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Tesla stock

Tesla stock has been hitting new milestones over the last three months. The company’s market capitalization has crossed the combined market capitalizations of Ford (NYSE:F) and General Motors (NYSE:GM). Recently, Tesla’s market cap rose above $100 billion. Tesla became the second-largest automotive company by the metric. The rally in the stock started in October after the company posted a surprise profit in the third quarter. Since then, the stock has defied gravity and short-sellers have lost billions over the last three months. NIO (NYSE:NIO), a rival Chinese electric vehicle maker, has also rallied during this period.

Tesla will likely release its fourth-quarter earnings on Wednesday. Before we analyze whether the stock is a “sell” ahead of its fourth-quarter earnings, we’ll briefly discuss its fourth-quarter earnings estimates.

Fourth-quarter earnings estimates

The analysts polled by Thomson Reuters expect Tesla to post revenues of $7.0 billion in the fourth quarter of 2019. The company posted revenues of $6.3 billion in the third quarter and $7.2 billion in the fourth quarter of 2018. The lower revenues might seem intriguing since the company reported record deliveries in the fourth quarter of 2019. However, the lower revenues are due to the higher proportion of lower-priced Model 3 vehicles in the sales mix. Tesla lowered the Model 3 prices this year. Analysts expect the company’s gross margin to fall by 20 basis points sequentially to 18.7% in the fourth quarter. Note that this is the consolidated gross margin and not the automotive gross margin. The company will likely post a GAAP EPS of $0.78 in the fourth quarter, which is slightly lower than $0.80 in the third quarter.

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Can Tesla beat the estimates?

During the earnings call for the second quarter of 2019, Tesla CEO Elon Musk sounded optimistic that the company would be profitable in the fourth quarter. While Musk expected Tesla to breakeven in the third quarter, the company surprised markets by posting a profit. Meanwhile, in the third-quarter earnings release, the company talked about sustainable profit.

Tesla’s earnings estimates have varied. The company ends up posting a big earnings surprise, both positive and negative. However, more deliveries should help the company’s earnings in the fourth quarter. Meanwhile, along with the fourth-quarter earnings, markets will listen to what Tesla says about the 2020 delivery guidance. Last year, the company’s deliveries were above the lower end of its guidance. This year, the ramp-up of the China Gigafactory will likely boost the company’s deliveries.

Is the stock a “sell” before its Q4 earnings?

Only hardcore Tesla stock bears would doubt the company’s ability to report strong shipment growth in the foreseeable future. The China Gigafactory and the upcoming Europe Gigafactory would give the company a much-needed production scale. However, a section of the market is concerned about Tesla’s valuation. Recently, the company’s market cap crossed $100 billion. Even if we give a very generous 2022 PE multiple of 25x, Tesla would have to generate a net profit of $4 billion in that year.

Notably, profitability has been Tesla’s weak point. With new product launches and new capacity ramp-ups, I don’t expect Tesla to post the kinds of profits that its soaring valuation multiples imply.

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Electric vehicles

Some bulls said that Tesla’s autonomous technology isn’t accounted for in the valuation multiples and point to Waymo. Now, every bull market has its own story and the same analogy holds for stocks. For Tesla stock, the story was built on electric vehicle optimism. However, electric car sales have depended on government subsidies. China’s electric vehicle sales have fallen ever since the country lowered subsidies. In the US, Tesla cars aren’t eligible for the federal tax credit anymore. Also, a flurry of new launches should give Tesla fierce competition. So far, not many electric car models have been able to challenge the company.

Regarding Tesla stock, I think that markets are pricing almost every known positive. However, we need to remember that the company still needs to produce and sell cars to make profits. While Tesla and Musk have gained experience battling production bottlenecks, we still need to adjust our valuation models for risks and challenges. After the recent surge in Tesla stock, I would be wary of buying it at these levels. It wouldn’t be a bad idea to take some profits off the table at this price point.

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