Is it still worth buying Tesla on dips despite declining profits and Cybertruck production difficulties?

In the past few weeks, as concerns about interest rates have gradually eased, the market has resumed its upward trend. Most tech stocks and growth stocks have soared (such as Microsoft (MSFT.US) hitting a new all-time high), but electric vehicle stocks, especially Tesla (TSLA.US), have remained stagnant in this market rebound.

Since reaching a new high for the year of over $290 in July, Tesla's stock price has fallen more than 25%. Many investors are wondering if now is the time to buy on the dip.

In fact, Tesla's long-term prospects remain promising, and many of the unfavorable factors the company is currently facing are temporary. Now may be a good time to increase holdings in Tesla, as from a long-term perspective, Tesla still has many catalysts for growth that can help the stock overcome its current slump.

Gross margin issue is temporary

Critics who hold a negative view of Tesla often raise the following criticisms: competition from other automakers (both traditional automakers and electric vehicle competitors like Rivian (RIVN.US)), the risk brought by Musk - he is always distracted by too many business projects, and the high valuation.

However, the key reason for Tesla's recent stock price decline lies in its latest gross margin data, which shows a decline in profitability in the third quarter. Tesla's gross margin in the third quarter dropped to 17.9%, a YoY decrease of 719 basis points and a MoM decrease of 30 basis points. This is the result of Tesla's decision this year to lower the prices of its entry-level Model 3 and Y to stimulate demand.

Although some analysts may now argue that there is no better time to buy Tesla than now, with the federal tax credits for electric vehicles open to Tesla again, coupled with the automaker's price reduction measures. In addition, the long delivery waiting period has also ended (during the pandemic, potential buyers may have had to wait for months to receive their custom Tesla orders; dealer inventory has also remained low).

However, there is a macro fact here, that weak demand is a major symptom of the macro environment. Unlike previous economic recessions, this recession has had a greater impact on the income of the middle and upper classes, as companies have generally laid off employees, especially in the tech industry. In addition to the suffocating car loan interest rates, it is not difficult to see why a slight price reduction from Tesla may not entice potential buyers.

However, price reductions will not become the norm for Tesla. In one of Tesla's most important markets, China, the company recently raised prices again after lowering them earlier this year - of course, this is to cope with rising costs, but it undoubtedly indicates that the company has enough confidence in the demand in the Chinese market.

Furthermore, while achieving economies of scale, Tesla also has a long-term gross margin advantage. In addition, with the significant drop in lithium prices (the core component of electric vehicle batteries) and the advancement of Tesla's technology, the unit cost will also decrease.

Overall, Tesla's ideal price may stabilize at a level that consumers are accustomed to. Over time, the increase in production and the natural decline in battery prices should help Tesla recover to its gross margin level in 2022 (or even higher).

Don't forget about business beyond cars

In the case of declining gross margins, many short sellers underestimate Tesla's high valuation, clearly overlooking the company's other businesses. As most consumers know, Tesla is also involved in many other businesses, including solar energy and robotics. However, one of the most promising avenues for additional profitability is the establishment of its Supercharger network.

As of the end of the third quarter, the company only had about 5,600 Supercharger stations across the United States. Investors should also note that earlier this year, the company opened up its Supercharger network to non-Tesla electric vehicles.

Betting on Tesla is not just betting on the ability of this automaker to challenge Detroit's automotive giants, but also betting on the entire electric vehicle industry, California's commitment to phasing out gasoline vehicle sales by 2030, the tendency of other states/countries to enact similar regulations, and the general awareness of modern consumers regarding fossil fuel prices and their harm.

Currently, Tesla's "Services and Other" business revenue accounts for less than 10% of total revenue, but its YoY growth rate has reached an astonishing 32% - directly related to the company's decision to open up the charging network to other electric vehicles. Meanwhile, as shown in the chart above, the business has just started generating substantial gross profit earlier this year.

The new car factor is another significant opportunity for Tesla. One of the reasons for the recent decline in Tesla's stock price is Musk's seemingly pessimistic attitude towards progress in this area. Musk stated during the third-quarter earnings conference call:

"Cybertruck, I know a lot of people are excited about Cybertruck. I am too. I have driven this car. It's a fantastic product. But what I want to emphasize is that there will be significant challenges in achieving mass production of Cybertruck and making it cash flow positive. This is normal because when you have a product with a lot of new technologies or any new vehicle project, especially a unique and advanced product like Cybertruck, you will encounter proportional issues with the new things you are trying to solve on a large scale. So, I just want to lower expectations for Cybertruck. It's a great product, but financially, I don't know, maybe it will take a year to 18 months to become a significant positive cash flow contributor. I wish there was a different way, but this is my best guess. The demand has exceeded expectations. We have over a million people who have pre-ordered this vehicle. So, it's not a demand problem, but we have to manufacture it, and we need to manufacture it at a price that people can afford, which is very challenging."

Therefore, investors should once again focus on the long term when it comes to Musk's comments. The backlog/orders in the truck sector is an indicator to watch, and the enterprise application of heavy-duty trucks is another favorable factor for investors to consider. In the past month, the partnership between Rivian and Amazon (AMZN.US) has encountered issues, which is one of the main reasons for the decline in the stock price of this Tesla competitor. Imagine Tesla taking over the retail and logistics industry with autonomous delivery trucks. It is not impossible because Tesla already has leading experience and reputation in this field.

Valuation and Key Points

In terms of valuation, according to relevant statistics, the market has a wide range of profit expectations for Tesla. Wall Street analysts expect the company's earnings per share for the fiscal year 2024 to be between $2.27 and $5.85. The market generally expects earnings per share to be $3.85 (a 28% increase YoY, compared to this year's expectation of $3.00), which would make Tesla's earnings per share unable to recover to the level of the fiscal year 2022 (the company's best year ever with earnings per share of $4.07). The market generally believes that the company's revenue will increase by 22% YoY to $112.1 billion. Contrary to the general expectation of earnings per share, Tesla's price-to-earnings ratio is 56 times, which many bears point out is unreasonable in an environment with interest rates exceeding 5%. However, Tesla somewhat deviates from traditional valuation thinking because the company has so many growth catalysts - economies of scale from increasing car production, the growth of the Supercharger network, and Tesla's first-mover advantage in terms of space, new vehicles, and corporate entry into the market, not to mention solar/energy and robotics technology. While there is indeed a risk of short-term profit decline, investors can remain optimistic about Tesla in the long run.