Shares of Tesla (NASDAQ: TSLA) rose 8% on Thursday to another overall high, driven in part by a major upgrade by car analyst Joseph Spak of RBC Capital Markets. The share rose higher on Friday. Spak raised its rating for Tesla shares to performance in the sector (the equivalent of ownership) of underperformance (the equivalent of sales). Meanwhile, he has more than doubled his price target to $ 700.
The analyst gave two main reasons for this heart change: Tesla’s ability to raise cheap capital and the expectations for growth over the next five years. However, no justification makes sense. Rather, it looks like another case of an analyst chasing Tesla shares, which has pulled far in the bubble area after rising more than 800% in the past year.
Tesla share performance. Data by YCharts.
Mixed expectations for growth
In conjunction with the upgrade, RBC has increased its estimate of Tesla’s 2025 delivery of vehicles to 1.7 million from a previous estimate of 1.3 million. However, the new estimate still implies a sharp slowdown in Tesla’s growth path over the next few years.
Tesla reported last weekend that it delivered 499,550 cars in 2020 – up 36% from a year earlier – despite a production shutdown of about two months at its main plant due to the COVID-19 pandemic. From a few months ago, Tesla has annually installed capacity to build 840,000 vehicles annually, with more capacity en route. During the company’s revenue for the third quarter, an analyst asked if that meant Tesla would likely deliver 2040 or more vehicles by 2021. Elon Musk agreed that this was a reasonable estimate.
Of 2040 deliveries in 2021, Spak’s 2025 delivery target involves a compound annual growth rate of 19% over the next four years. By comparison, Musk has targeted about 50% annual growth. So far, he has mostly scored the goal. At that growth rate, Tesla would supply about 4 million vehicles by 2025.
It would be one thing for Spak and his team to argue that Tesla shares are worth more than the rest of the automotive industry combined if they expect the company to grow at an annual rate of 40% to 50% in the foreseeable future. growth. But there is no plausible argument for giving Tesla shares such a high valuation based on RBC’s targets, implying that the EV pioneer in 2025 would still hold less than 3% of the market share globally, with growth now and then rapidly decrease.
Image source: Tesla.
A circular argument about valuation
The RBC analysts also noted that in 2020, Tesla could raise very cheap capital by selling shares. They view this low cost of capital as a major competitive advantage that justifies a high valuation of 2025 sales for Tesla shares. The reason is that Tesla will be able to use its shares to finance growth investments and acquisitions, rather than relying on internally generated cash flow.
However, this argument is clearly based on circular logic: Tesla has a high share price, and with the high share price it can raise cheap capital; therefore, Tesla deserves a high valuation.) If Tesla’s share for some reason – or no reason at all – fell by 75%, the argument would work the other way around. The sharp drop in Tesla’s share price would mean that the company could no longer raise such cheap capital, which justifies a low share price.
A warning sign for Tesla shares?
With aggressive assumptions about Tesla’s future market share, the profitability of EV production compared to traditional car manufacturing, and the potential of complementary business opportunities, Tesla’s high appreciation could possibly be justified. Following the recent rise of the stock, Tesla’s fully diluted market capitalization is approaching $ 1 trillion.
However, Spak and his team of RBC analysts expect Tesla’s growth to slow significantly in the coming years, based on their updated estimate of 1.7 million deliveries in 2025. The broker’s recommendation and price target therefore appear to be fundamental. Increasingly, analysts seem to be chasing Tesla’s share price and raising their targets, just because the stock has soared.
That logic can go from both sides. Tesla looks like a bubble stock rising due to sheer momentum and fear of missing it. When the bubble bursts, Tesla shares could drop dramatically. That setback could be exacerbated by a wave of subsequent downgrades by the same analysts who have been rushing to raise their price targets over the past few months.