In this series, I (Jin Choi) talk about my goal of reaching $1 million in my TFSA account by 2033. If you want to know what a TFSA is, I recommend you read my free book. In this article, I’ll also explain why I plan on increasing my bet against Tesla (Ticker: TSLA).
January Results: Down 1.6%
At the end of January, I had $49,268 in my TFSA account. Although this is up from the end of December, the January number includes my $5,500 contribution for the year 2018. Adjusting for the contribution, my account went down by 1.6% in January. By comparison, the Canadian stock market went up by 1.1% while the U.S. stock market went up by 3.5% in Canadian dollar terms. Therefore, my portfolio underperformed.
The majority of my portfolio consists of oil and gas stocks. In January, oil prices climbed yet again from $60.46/bbl to $64.73/bbl (in US dollars), but consistent with recent trends, my oil and gas stocks lost value again during the month.
While I understand the justification of lower prices for stocks with significant natural gas production, I don’t understand why my purer play oil stocks keep going down. To show you how extreme the situation is, take the example of Baytex Energy (Ticker: BTE), which I own.
As of the time of this writing, BTE is trading at the same price level that was last seen in February 2016, when oil was trading below $33/barrel. Baytex doesn’t produce meaningful quantities of gas, and half of its production is located in the US where Canadian pipeline constraints have no effect. It’s a truly head scratching situation.
Meanwhile, the oil market continues to be undersupplied. According to the latest IEA report, oil inventories fell by some 1.3 million barrels/day during the last 3 months of 2017. These drawdowns occurred despite rapidly increasing production in the US.
Oil prices have weakened in recent weeks as investors are becoming more fearful that US oil production will grow even more in the coming months. But unless oil demand suddenly craters, I think US oil production will have to grow by an amazing 2 million barrels/day this year to put the oil market back into balance. I’m unsure if that’s possible, and if it’s not, then oil prices should in theory stay elevated throughout the year.
But enough about oil. For the rest of this article, I wanted to update my thoughts on Tesla, which I began to bet against in January 2017.
When I initially bet against Tesla, I considered it more or less a hobby. I did expect to make money on it, but I wasn’t confident enough about my decision or the timing to make a bigger bet. However as events have unfolded, my confidence in the decision has gone up, and I’ve decided to gradually add to my bet, thus making it a more serious endeavour.
Let’s talk about Tesla’s financial performance first. Over the past year and a half, Tesla’s profitability only went downhill. Tesla used to boast of having higher than industry level gross margins of over 20% (though some may argue that Tesla inflates their gross margins through accounting tricks). In the most recent months, however, Tesla’s reported gross margins took a severe hit and came down to 13% as the company lowered prices to juice sales. Tesla’s reported gross margins today are essentially on par with that of General Motors’.
Tesla’s net income nosedived as well. In the last three months of 2016, Tesla recorded a loss of $121 million. But during the same period in 2017, that loss has ballooned to $675 million, and many people expect the company to record even bigger losses this year.
Such big losses, even if they increase in the future, would not necessarily doom a company if it shows extraordinary growth. For example, Amazon’s losses went from $125 million in 1998 to over $1.4 billion in 2000. But during the same time, Amazon’s revenue went up from $610 million to $2.8 billion, a growth of more than 300%. The thinking is that losses are temporary, and that the company will start generating profits once they achieve necessary scale. Indeed, Amazon’s losses started to shrink after 2000, and the company turned profitable starting in 2003.
Unfortunately for Tesla, the kind of hypergrowth achieved by Amazon seems increasingly out of reach. For one, Tesla has attempted, but has so far failed to deliver, the kind of transformational product that makes or breaks a growth company.
Take solar roofs, for example. When first announced, the company promised that they would look great, cost less than traditional roofs and would start arriving in the summer of 2017. While the roofs do indeed look great, the costs are higher than if one had installed traditional solar panels instead, and the company is only just now starting to install the roofs.
Perhaps because of the costs, I don’t see much enthusiasm for the roofs, either from potential customers or from Tesla’s management. For example, CEO Elon Musk didn’t give it a single mention during the latest investor conference call.
Tesla’s Model 3, on the other hand, still gets plenty of mention during conference calls, but for all the wrong reasons. After promising to produce 5,000 of those vehicles per week by the end of 2017, they have pushed that timeline to the summer of this year. As of the time of this writing, they appear to be only producing 1,000 Model 3s a week. This production number matters because unless the company can produce and sell massive quantities of Model 3s, the company will never generate any profits on them.
But even if Tesla solves its production hurdles, there are real question marks over whether the company can sell the vehicles. Up until now, Tesla’s US customers could count on $7,500 in tax subsidies to reduce the price of the cars. But those subsidies are set to disappear over the next couple of years. At the same time, a flood of new electric vehicles from competitors will start to arrive, and the prices of those vehicles will benefit from the subsidies.
In the meanwhile, the sales growth of Tesla’s older lineup of cars appears to be coming to a halt. In 2017, Tesla delivered about 100,000 Models S and X. In their latest letter to shareholders, management said they expect to deliver a similar numbers of those cars in 2018.
Tesla’s Cash Needs
Without that hugely successful product, Tesla’s revenues won’t likely grow very quickly in the next two years, and its losses will probably continue to mount. At the same time, in order to grow quickly in the future, the company will have to invest a lot of money into building new products, such as the recently revealed Semi and an additional factory in China.
Now, let’s summarize what all this means for Tesla’s cash needs in 2018. Assuming the company continues to lose $700 million every three months, and assuming the company invests slightly more than last year as planned, the company will need to raise some $7 billion in cash this year. Note that although the company did have $3.5 billion in cash at the end of 2017, it’ll have to use that cash to pay suppliers (to whom they owe $2.4 billion) and maintain operations.
So how does Tesla plan on raising all that money? In recent months, the company has preferred to borrow money instead of issuing shares. For example, it raised $1.8 billion by issuing bonds in the summer of 2017, and it recently raised $550 million in asset backed securities earlier this year.
However, I’m not sure how much more debt Tesla could raise in the future. Tesla’s bonds are already rated junk, so any new bonds the company issues will come with very high interest rates. Perhaps they could borrow a bit more at reasonable rates by pledging their assets as collateral, but I think the company is running out of such suitable assets.
If the company can’t, or doesn’t want to borrow additional money, then it’ll have to raise money by issuing more shares, and here we come to my main reason for increasing my bet against Tesla. I have long held that the stock prices are not based on rational valuations, but are rather determined by the supply and demand for stocks rooted in part by irrational emotions. If demand outstrips supply, prices go up, and vice versa.
For years, Tesla garnered a cult-like following among some investors. They witnessed Elon Musks’s genuinely amazing achievements, such as having rockets land back on earth, and figured that Musk can and will solve any difficulties that Tesla ever faces. These investors acted on their belief by buying Tesla stock whenever they could, increasing demand for Tesla’s stock. At the same time, Tesla’s preference for issuing debt meant that the supply of Tesla stock didn’t increase very quickly. Demand outstripped supply, and prices rose.
But that supply-demand balance could shift significantly in the coming months. Tesla’s new stock issuances will increase the supply, but continuing disappointment over the launch of the Model 3 could erode investors’ demand for them. This combination should in theory cause Tesla’s stock price to dive, and that’s why I’m choosing to add to my bets against Tesla now.
That said, I don’t think there is a 100% guarantee that my plan will work. The scenario I fear most is that a significant foreign investor might choose to jump in when Tesla’s stock starts to go down. I have no doubt that such an investment would prove to be unwise for that foreign investor. But as with real estate prices in Vancouver, these investors can keep an investment overvalued for very long periods of time.
Given the risks I just outlined, I won’t bet heavily enough against Tesla to the point that it would spell financial ruin if Tesla’s stock price went up. But at the same time, I feel enough conviction on the bet that I will gradually increase its size.