Tesla shares: China turmoil and geopolitical threats darken the outlook (TSLA)

Tesla (NASDAQ:TSLA) shares have been in a steady decline since the company reported its second-quarter earnings results a month ago. While we are currently seeing a slight rally in the share price, the company faces several hurdles that could prevent further appreciation in the coming weeks. Although Tesla has reported decent results and continues to ramp up production to meet its long-term goals, the ongoing price war in China coupled with worsening Sino-US relations could undermine the company’s growth story for the foreseeable future. As investors decide what to do with their shares in the company, this article highlights the main challenges Tesla already faces as it tries to diversify its supply chains to mitigate geopolitical risks.

The great diversification begins

Let’s start with the good news. latest earnings report for the second trimester presented that Tesla continues to increase its production and in the second quarter set a new record by producing and delivering 479,700 vehicles and 466,140 vehicles, respectively. At the same time, its revenue for the period rose 47.3% year-on-year to $24.93 billion and beat estimates by $200 million. The company also had $23.1 billion in cash reserves at the end of June, up 22% year-over-year, mainly thanks to the $1 billion in FCF it generated in the second quarter.

Other good news is that Tesla is poised to extend its lead in autonomous development in the coming quarters as it started recently. producer his supercomputer which bears the name of Dojo.

What’s more, the company has begun to actively mitigate geopolitical risks by diversifying its supply chain. Last month, the news broke that Tesla is planning to launch production of its cars in India, while in early August it was reported that the company has already started leasing office space in the country. On top of that, earlier this week Elon Musk himself accepted that he plans a trip to India next year, indicating that Tesla is genuinely interested in expanding its presence in the world’s most populous country.

At the same time, there are also signs that Tesla aims to build its largest Gigafactory yet with an annual capacity of 1 million vehicles in Mexico by 2025. Earlier this month, various popular media reported that Tesla had already hired its Chinese Suppliers will set up component plants for electric vehicles in Mexico.

All of those diversification efforts are certainly aimed at not only meeting growing demand for electric vehicles around the world, but also lessening Tesla’s exposure to China should a Sino-American confrontation enter a new and more dangerous phase. Those efforts still don’t fully solve Tesla’s problems, however.

Main obstacles to consider

Several major headwinds could undermine Tesla’s bullish case and prevent its shares from rising again anytime soon. The first of those obstacles is the relatively weak performance of the Chinese economy. Considering that China is the second largest market for Tesla, the company is likely to be negatively affected by the fact that the country is on the verge of deflation as their consumer confidence wanes due to the structural issues facing the economy.

Deflation coupled with the ongoing Chinese EV war have already altered Tesla’s margin story. In the second quarter, Tesla’s GAAP gross margin it was 18.2% versus 25% a year ago and below estimates of 18.7%. At the same time, its operating margin was 9.6%, up from 11.4% a quarter ago. Considering that Tesla recently once again cut prices of some of its models in China, there is a risk that margins will contract further in the coming months.

However, what is interesting is that despite these cuts, the company deliveries fell to record lows in July. While some of this is attributed to the redevelopment of the Shanghai Gigafactory, there is still a indication that the company will not reach its sales growth target by 2023.

On top of that, the company’s main competitor BYD (OTCPK:BYDDF) is also catching up and could pose a threat to Tesla’s dominance in the EV business for the foreseeable future. In addition to expanding its presence in China, BYD’s flagship SUV has recently outsold Tesla in Sweden, while the company’s global market share in the electric vehicle industry has risen to 16.2% from 21, 7% Tesla.

As for geopolitical risks, it’s obvious that Sino-US relations are likely to enter a new confrontational phase in the future, which could make it even more difficult for Tesla to achieve its goals. As well as getting their cars. forbidden In various public places in China, Tesla’s battery supply chain. keep going rely heavily on Chinese companies. Considering that China recently tax export controls on various materials needed to create semiconductors, while the Biden administration restricted investments in the Chinese tech sector, further confrontation could disrupt Tesla’s supply chains that depend on continued globalization to grow the business.

Whats Next?

Given all this, questions arise as to whether Tesla could continue to trade at a significant premium if its business is constantly at risk of being disrupted by outside forces. Its shares have already depreciated in recent weeks after entering overbought territory, but with a leading P/E and forward P/S of over 60x and ~7x, respectively, it can be argued that there is still more room to fall should additional negative news emerge.

Given the number of challenges Tesla currently faces, the street has already made a number of downward swings. reviews for the following quarter due to the difficult environment in which the company operates. Also, although my updated DCF model below showed that the company would continue to grow at a double-digit rate with a WACC of 8.8% and a 3% TGR, while its earnings would be slow to recover, it appears that Tesla stock is trading at a significant premium based solely on fundamentals.

The model shows that Tesla’s fair value is $131.44 per share, below the current market price.

looking for alpha quantitative The system also shows that Tesla is overvalued based solely on fundamentals, having given its shares a D- valuation rating and an overall Hold rating.

Despite this, that does not mean that Tesla would suddenly depreciate to those levels without negative news. Let’s not forget that Tesla is a growth stock that has been trading at excessive premiums for years thanks to the steady improvement in its top-line performance fueled by aggressive increases in cars sold. The street and my model show that the company’s revenue is expected to continue to grow at a double-digit rate for years to come. This could indicate that even if Tesla shares depreciate in the coming months, they would still trade at a decent premium to fundamentals if the company manages to adjust to the ongoing disruptions to its operations.

However, if geopolitical risks rise substantially in the coming months and Sino-US relations enter a confrontational new phase, then overvalued stocks of companies that rely on uninterrupted globalization, such as Tesla, will likely experience the most pain in such a situation. scenery. .

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