Will The Slowdown In The U.S Auto Market Impact Tesla Stock?

Tesla Inc has been resistant to any slowdown in the auto market. TSLA stock continues to trade at sky-high valuation.

Earlier in the month, California-based electric car manufacturer Tesla Inc (NASDAQ:TSLA) surpassed Ford Motor Company (NYSE:F) and General Motors (NYSE:GM) to become the most valuable U.S car company. While the traditional auto manufacturers are getting hit by the slowdown in the U.S auto industry, there seems to be no impact on Tesla Inc. For the month of March, both Ford and General Motors reported a miss on deliveries. Ford Motor saw its deliveries fall by over 7% YoY in March while GM’s deliveries grew by just over 1%. In contrast, Tesla Inc reported 69% YoY increase in deliveries (albeit on much smaller base) handsomely beating analysts estimates. As a result, while Tesla stock has surged, shares of Ford Motor and GM took a hit. Over the past one month, shares of Tesla Inc have gained more than 20%, while GM and Ford have seen their shares fall by around 10% in the same period.

Source: Tesla Inc Stock Price Chart by uniquefinance.org

U.S auto industry is facing multiple headwinds.

The auto industry is facing multiple headwinds including rising sub-prime loans, declining resale value of used vehicle and saturation of the market. According to Deutsche Bank analysts Rod Lache, Mike Levine and Robert Salmon, the U.S auto market is facing triple threat “from rising rates, rising negative equity in vehicle loans and used vehicle-price deflation. This could lead to deteriorating affordability, delayed trade-in cycles, consumer shifts from new to used, diminishing credit availability and deteriorating mix/pricing”. While these have definitely impacted the shares of traditional carmakers like Ford and GM, the question is will these factors affect Tesla Inc stock price?

One of the biggest obstacles ahead of the U.S auto industry is the rising subprime loans. For a while now, analysts have been warning about the rising sub-prime loans in the auto industry. New York-based credit rating agency Fitch Ratings recently warned that the deterioration in US auto credit is expected to continue in 2017, particularly the subprime auto ABS portfolios. The rising interest rates will put further pressure on this segment leading to higher defaults and consequently higher repossession. The higher repossessions will add to the already rising inventory of used cars. According to J.D Power, Americans will return 3.36 million leased cars and trucks this year. The glut in the used car market had already forced Ford to cut $300 million from 2017 profit forecast of its leasing division. The rising tide of used cars will impact their re-sale value. Even GM has issued a similar warning. The prices of used cars in GM Financial’s leasing portfolio will decline about 7 percent this year.

However, the rising tide of used cars may not be a problem for Tesla Inc for now at least. Firstly, Tesla’s customers are from a relatively affluent segment. Around 78% of Model S buyers and 87% of Model X buyers have an annual income greater than $100,000. So the company is less likely to be hit by the sub-prime mortgage crisis. Secondly, Tesla cars have very high retention value. Also, according to a report by Autolist.com, a site for car purchases, used Tesla Inc’s Model S cars sell faster and for a higher premium compared with other luxury car models. The demand for Tesla models in the used car segment remains strong. Used Model S sells at 5% premium and takes 5% lesser time to sell than its peer group average.

Tesla Inc has a supply problem.

Then, there is the case of auto sales peaking in 2016. Fitch ratings estimates 2017 car sales to decline by 0.5 million to 17 million. Similar sentiments are echoed by traditional car makers such as Ford and GM. Both the companies have cut down on their production and investments. However, Tesla Inc has totally opposite problems. The company is not able to meet its demand. Tesla has over 400,000 pre-orders for its upcoming Model 3 cars. For comparison, Tesla Inc produced a little over 76,000 vehicles in 2016 and the most bullish analysts expect it to produce a little over 300,000 vehicles in 2018. Hence, Tesla Inc might actually remain unscathed from the coming slowdown.

Bearish arguments won’t impact Tesla Inc stock price.

The coming slowdown and the subprime auto crisis is unlikely to affect Tesla’s sales by much. But in spite of that, Tesla stock remains a risky bet. Given Tesla’s current production volume and the risks ahead, many analysts argue that Tesla stock is highly overvalued even if you take an optimistic view of the future. Recently, Barclays analyst Brian Johnson opined that Tesla Inc bulls are blind to the reality that the company faces several significant challenges. Tesla Inc stock is currently trading at 110X its 2018 earnings. Also, Tesla still requires a huge amount of cash and needs to deliver on its aggressive Model 3 targets. While there may be rational arguments to short Tesla Inc stock, as we pointed out in our previous coverage, it has proven to be a loss making strategy.  As Piper Jaffray’s analyst Alexander Potter put it “We sympathize with bears – but their (arguably rational) arguments probably won’t matter”. 

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