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Morningstar | Tesla's Balance Sheet Improves Cash Holdings to End 2018, Scale Potential Remains Attractive

Tesla reported a fourth quarter net profit of $139.5 million, less than the $311.5 million reported for third quarter, as guided by CEO Elon Musk in a recent 8-K filing announcing a 7% headcount reduction. After factoring in 2019 guidance of less capital expenditure than we were modeling ($2.5 billion versus $4 billion), and guidance of a less than 10% increase in operating expenses, less Model S and X volume in 2019 than we were modeling, and a higher share count, we see no reason to change our fair value estimate. We will revisit our valuation next month after incorporating the 10-K into our model, which could result in a modest increase to our fair value estimate.

Adjusted diluted EPS for the quarter of $1.93 missed consensus of $2.19 while revenue grew 5.9% from third quarter to $7.2 billion, slightly beating consensus. Fourth quarter deliveries more than tripled year over year to 90,966 and also rose 8.6% from third quarter. Compared with third quarter, Model S and X deliveries were about flat so Model 3 led the way and we expect it will continue to do so in 2019. Tesla guides for all vehicles delivered in 2019 of 360,000-400,000 whereas we had been modeling 450,000, but Musk made comments on the call suggesting the company can do better than 400,000. Musk also talked about the pickup truck possibly being unveiled this summer and guessed the standard range Model 3 of about 220 miles will be available mid-2019. Musk wisely constantly stressed that reducing costs and getting the Shanghai Gigafactory up and running this year are critical inputs to selling affordable vehicles at a profit. The China factory is guided to initially make 3,000 Model 3s a week.

We were pleased to see GAAP free cash flow of $909.6 million in the quarter, up from third quarter's $881 million. This cash flow enabled Tesla to finish 2018 with $3.7 billion in cash and we have no concerns about the company paying off its $920 million convertible bonds fully in cash in March.

The market after hours did not like the EPS miss nor the announcement at the end of the call of CFO Deepak Ahuja retiring in a few months. However, we think one quarter is not that important for a young company in growth mode for many years to come, as we expect Tesla will be. With the Model Y crossover on the Model 3 platform and sharing about 75% of its parts with the Model 3, and management expecting a less than 10% rise in operating expenses this year, we think Tesla has many opportunities to generate more scale. It still needs lots more money to build a double digit number of Gigafactories all over the world over time, so we still think there is much uncertainty to the story. That said, we think Tesla finished 2018 in good shape and has much to be optimistic about for the next few years if it can balance costs efficiencies with spending to launch many new exciting products, such as the Model Y at volume production in Nevada by the end of 2020. Musk sounded very positive on demand and said his best guess for global Model 3 demand annually is 700,000-800,000 units and 500,000 units if there is a recession. For now, Model 3 output in California is being sent to Europe and China as those markets get the vehicle this year. Lower priced Model 3s will be made in Shanghai while longer range and performance versions will keep being made in California for export to China.

Ahuja is retiring for the second time but Musk expects him to remain an advisor to Tesla for many years. He retired in 2015 but rejoined in 2017 following the departure of his successor, Jason Wheeler. The second retirement is not surprising to us given Ahuja, 56, had already come out of retirement. Tesla lured away then Seagate Technology CFO, David Morton, last August but he quit Tesla after about a month reportedly due to feeling his ideas were being ignored. We suspect Elon's going private Twitter debacle last August likely rattled Morton too. Given Morton's senior CFO tech experience at Seagate, we think he was likely to become CFO so Ahuja was probably looking to resume retirement. Nine-year Tesla finance veteran Zach Kirkhorn will become CFO. It remains to be seen if he is ready, but we like that he is a Tesla veteran with experience in launching many Tesla vehicles, all the way back to the first Roadster, so his Tesla learning curve may be less steep than an outsider such as Morton.