Tesla: Threats Multiply In China (Rating Downgrade) (NASDAQ:TSLA) -LSB

Background

It doesn’t take much from Tesla, Inc. (NASDAQ:TSLA) for the company to make headline news — every day, readers are algorithmically bombarded with new information about the company and its mercurial CEO, Elon Musk. Check out some titles from just the last few weeks:

• Tesla added in its terms and conditions that Cybertruck buyers can be sued if they sold the vehicle in the first year of ownership (the company later removed this from the terms and conditions).
• A side by side video of Cybertruck and Rivian (RIVN) The off-road R1T seemed to show that the Cybertruck had a tougher time with things.
• The company sold the limited edition CyberBeer on a CyberStein for $150. The drink does not take good comments.
• General Motors (GM) quietly bought the only North American gigacasting production specialist.

Whether bull or bear, there is a dizzying amount of information being thrown around companies every day, and it can be difficult to distinguish the noise from the signal.

However, there have been some developments that we think should be on investors’ radar.

Let’s dive in.

Connection with China

It’s no secret that China is arguably the biggest growth market in the world for Tesla. The company has invested countless time and money to make Tesla a distinctive brand domestically, and with good reason: Chinese consumers have been among the fastest adopters of EVs in the world (so much so that traditional ICE companies have been was caught flat-footed with the pace of transition).

China has also become a material part of Tesla’s financial statement. In the most recent quarter, sales in China for Tesla totaled $5.02 billion, or roughly 21% of overall sales. Those numbers were a disappointment — in the same quarter last year, the company posted $5.13 billion in Chinese sales.

The back-to-back sales in the country are perhaps not surprising when you consider that Tesla has faced stiff competition in the country, none more so than BYD Company Limited (OTCPK: I WILL). The company just announced it The Sea Lion line of mid-size SUVswhich is poised to take a stab at market share for Tesla’s Model Y.

BYD and its founder have found massive support, including from the Oracle of Omaha himself, Warren Buffett (the legendary investor who sold shares recently but still holds a great position in the company).

Readers should also not forget the fact that there are a number of other startups, including NIO Inc.NIO), competing for a large share of the market, and Tesla’s supremacy in the country is far from assured. Factor in the ever-changing attitudes of the Chinese government toward American business in the country, and the calculus changes again.

It was obvious, then, that just a few days ago a new entrant to the Chinese EV market made waves: smartphone maker Xiaomi (OTCPK: XIACF)(OTCPK: XIACY) received approval of control by the Chinese government for its SU7 EV. Shipments are targeted for February 2024.

Readers unfamiliar with Xiaomi should know that this is no ordinary smartphone manufacturer – it recently passed Apple (AAPL) as the world’s second-largest smartphone maker, and the resilience of its ecosystem has led some to call the company the “Apple of China.”

Some history for those unfamiliar – Xiaomi has a history of achieving what it sets out to do. In 2017 the company made a great investment in India with a view to gaining a strategic foothold. By 2022, the company was one of the high end smartphone brands in the country, for a while holding the first place. The company is also in the midst of transitioning from being a value-based brand to making more premium offerings, with a priority

According to for Bloomberg:

The Xiaomi-branded EV is a critical link in the company’s plan to create “a versatile ecosystem” for its customers. It has already upgraded the operating system for smartphones and other home devices to include EV in the future so that users can control all kinds of Xiaomi products on a unified platform.

The competitive threat posed to Tesla by the dual launch of the Xiaomi and BYD Sea Lion offering is hard to overstate. While Tesla recently made price cuts in Model X and Model S in China, the Model Y was, for most of the vehicle’s iterations, frugal. The introduction of new competition is unlikely to make the market any easier to navigate.

Numbers

The story of margin compression at Tesla isn’t new, but it’s true.

Rather than moving up and to the right, margins have been steadily compressed on a quarter-over-quarter basis for the past five years. Operating margin most recently fell by 21%, and net income by 26%.

Perhaps more interesting, however, is the fact that gross margin has been able to tread water. It’s not exactly a success story, however, as Tesla bulls have long claimed that the company’s innovative manufacturing techniques would allow it to produce its vehicles more and more cheaply.

Things have also not been too rosy on the earnings front. After 11 consecutive quarters of outperforming estimates, the company has faltered recently, missing four of the last five consensus estimates. The latest quarter marked Tesla’s worst ever loss with a nearly $800 million gap between analysts’ expectations and quarterly results.

Despite these mistakes, the stock is up 90% year-to-date. The bulls, of course, point to this as a victory. Bears see a stock with a lot of excess air left in it.

To prove this, bears will point to Tesla’s valuation on a forward basis still being extremely high. On a forward basis, the stock trades at a whopping 64x earnings and 27x EV/EBITDA. For context, combined Apple and Microsoft’s forward P/E (MSFT) are 61x, and Tesla’s forward EV/EBITDA is only slightly less than the combined figure of these two companies of 43x.

After all

Tesla has done a lot to prove its naysayers wrong in the past — when the bears expected it to go bankrupt, it thrived. When investors thought they were going to burn money forever, he became profitable. However, we think it has been true for some time that the company no longer enjoys a privileged position in its most important growth market, and new entrants in this area will only make the going tougher. With a high valuation, we think the road ahead could be quite difficult for Tesla, Inc. shareholders.

Editor’s Note: This article discusses one or more securities that are not traded on a major U.S. stock exchange. Please be aware of the risks associated with these stocks.