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Morningstar | Tesla's Risk Profile Has Improved, Raising Fair Value Estimate to $231

We said in our May 20 note we would raise our Tesla fair value estimate if deliveries improve and at that time we were concerned about increased negative market sentiment over Tesla's financial health. Although we still stress to investors that Tesla has about $3 billion in recourse debt due between now and 2022, mostly in March 2021 and March 2022, we feel market sentiment has improved materially since early June. Tesla's only nonconvertible bond, due in 2025, has seen its effective yield fall by about 180 basis points to about 7.5% (5.3% coupon), the stock through July 2 has risen by 27% since bottoming out on June 3 at $176.99, and second-quarter deliveries announced July 2 were an all-time company record of 95,200. We think the risk environment for Tesla has improved so we are lowering our weighted average cost of capital to about 10.5%, from about 12%, which increases our fair value estimate to $231.

We never believed the Model 3 had a demand problem because the vehicle is too new and only launched internationally in 2019. The Model S sedan and Model X crossover have become less novel in the market over time and their combined second-quarter deliveries fell 21% year over year. Model 3 deliveries more than quadrupled year over year and rose sequentially by 52% to 77,550. Total deliveries rose 51% from a difficult first quarter and by 134% year over year. In a July 2 press release, Tesla also mentioned logistics efficiencies when delivering vehicles, and it will be interesting to see if these savings, along with CEO Elon Musk personally approving many expenses and the CFO approving all payments, will make enough of a difference to offset a likely negative mix shift toward more Model 3 sales. Tesla still needs to generate meaningful free cash flow to reduce, according to our calculations, its $8.6 billion recourse debt load, but volume growth in the second quarter is a step in the right direction.

Tesla's recourse debt due over the next few years includes $566 million in convertible bonds due in November 2019, $103 million of convertible bonds due in December 2020, $1.38 billion of convertible notes in March 2021, and $977.5 million of convertible notes in March 2022. These convertible notes have mostly strike prices of over $300 a share, so Tesla's stock will need to appreciate for it to avoid needing cash to meet these obligations.