Tesla silences the doubters

Proving it can be consistently profitable has reinvigorated the bulls, but what about that valuation?

Tesla (NASDAQ:TSLA) shares showed no signs of running out of road today after the electric car maker's first full year of profitability silenced doubters and cheered its army of followers in the UK.

Far and away the most popular US stock on the interactive investor platform, Tesla shares were slated to open 4% higher at around $1,600 this afternoon after the company's second-quarter results showed it continued to perform well in the face of Covid-19 disruption.

A surplus of $104 million meant Tesla achieved four consecutive quarters of profits for the first time, despite the closure of its Model Y production line in Fremont, California for almost half the period.

Sales were driven by strong demand in China, where the Model 3 constructed at Tesla's recently-opened factory in Shanghai is already the country's best-selling electric vehicle and firmly established as a rival to the BMW 3-Series and Mercedes C-class.

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Model Y production at Fremont recovered to full capacity by the end of the quarter, with new machinery expected to take the factory's annual output to 500,000 by the year-end. Tesla also confirmed it is on track to meet its target of 500,000 vehicle deliveries this year.

Last night's better-than-expected update showed that Tesla generated free cash flow of $418 million, compared with Wall Street's forecasts for a period of cash burn.

Praising this “outstanding” cash flow management, Morgan Stanley said increased China production had been a major boost for margins despite a weaker trend for the average selling price. The bank said:

“In our opinion, bears really would have to nit-pick at the release to construct a materially negative narrative here”.

Plenty of commentators have argued in recent weeks that the rise of more than 500% for shares since Tesla's surprise quarterly profit in October was unsustainable. Sceptics include our own technical analyst John Burford, who said last week that shares were now in bubble territory.

Critics point to the fact that Tesla's production in 2019 was still a mere 5% of German car giant Volkswagen (XETRA:VOW)10.97 million vehicles in 2019. And yet the company has overtaken VW and Japan’s Toyota (NYSE:TM) to become the world’s most valuable car maker and, at around $300 billion, is some five times the combined value of US giants Ford Motor (NYSE:F) and General Motors (NYSE:GM).

But with electric vehicle penetration still shy of 1% in the US and roughly 2% globally, there's plenty for Tesla and the rest to go for. The question longer-term is whether Tesla will be able to quadruple revenues by 2025 in order to justify an estimated forward price/earnings ratio that's far closer to that of Amazon (NASDAQ:AMZN), at almost 200, than Ford’s single-digit historical average.

Despite being impressed with last night's figures, Morgan Stanley remains underweight on the Nasdaq-listed stock. It cites longer-term concerns around the sustainability of profits in China and the threat of competition in electric and autonomous vehicles from the big tech firms such as Amazon and Alphabet (NASDAQ:GOOGL).

The bank's analysts added:

“We think the stock has run to a market capitalisation of $300 billion too quickly and has discounted years of growth. We see the risk/reward as tilted to the downside in the next 12 months.”

The rewards, however, have been plentiful so far for those UK investors with direct exposure to the shares or through the FTSE 100-listed  investment trust Scottish Mortgage (LSE:SMT), whose biggest single holding is Tesla with 11% of total assets.

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The success has also made founder and CEO Elon Musk one of the world's richest people, with his net worth of $74 billion reported last night to have briefly overtaken the wealth of Warren Buffett, the Berkshire Hathaway (NYSE:BRK.B) founder.

There's also speculation that Tesla could soon join the S&P 500, which is Wall Street's most closely watched benchmark. Its entry will depend on the next meeting of the index committee in September, when factors such as liquidity will be considered. At its current valuation, Tesla would be a similar size to JPMorgan Chase (NYSE:JPM) and Procter & Gamble (NYSE:PG) among the S&P 500's 12 biggest stocks.