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2020 and 2021 brought a flurry of investment into electric vehicles (EVs) as virtually every major legacy automaker implemented new programs centered around lowering emissions and improving sustainability.
But in 2022, the landscape of the auto industry, including EVs, was heavily impacted by rising interest rates, inflation, supply chain issues, and an increasingly crowded list of competitors.
Many legacy automakers now find themselves overextended just as consumer spending is taking a hit. in time for a decrease in consumer spending. The consumer car market is cyclical and heavily influenced by rising interest rates, which make it more expensive to finance a car. Given that most cars are purchased with debt, this is a big headwind for the auto industry going forward. Pair that headwind with the fact that it could take years for many of these legacy automakers to have profitable EV lines (not to mention reliable battery production and supply chains), and it’s a one-two punch of slowing growth and compressed margins.
As bad as the short-term outlook is, though, it could benefit Tesla (TSLA 1.12%) more than any other automaker. In hindsight, the company’s valuation got way ahead of itself, but now that Tesla stock is down 72% year to date (down 42% in the last month alone), the once-hypergrowth stock is starting to look like a good value. Here’s why Tesla is my top EV stock to buy in 2023.
Image source: Getty Images.
Rising interest rates are leading to a supply/demand imbalance that is pressuring automakers to implement discounts. Tesla offered a $7,500 discount in December and since Tesla is notorious for not offering discounts, the move was likely perceived by some as a sign of weakening demand.
As demand shrinks, automakers will likely face more pressure to cut prices. Expect margins to come down across the board next year.
TSLA Operating Margin (TTM) data by YCharts
A big advantage for Tesla is that it has the second-highest operating margin of the 10 major automakers (second only to Ferrari, which has far lower delivery volumes). High margins give Tesla a coveted cushion to handle margin compression relatively better than its competitors.
Not only is Tesla a much more profitable business than its competitors, but it also has an impeccable balance sheet. Tesla has total net long-term debt of negative $18.7 billion — meaning it has more cash, cash equivalents, and marketable securities than debt. The only other major automakers with negative total net long-term debt positions are Chinese automaker BYD and BMW.
Company
Market Cap
Total Net Long-
Term Debt
Debt to Capital
Financial Debt to Equity
Tesla
$355.8 billion
($18.7 billion)
5.7%
0
Toyota Motor
$183 billion
$143.9 billion
51.5%
1.1
Volkswagen
$76.3 billion
$110.9 billion
48.9%
1.8
BYD
$70.6 billion
($3.3 billion)
19.0%
0.05
Mercedes-Benz Group
$69.3 billion
$56.9 billion
49.9%
1.4
BMW
$58.2 billion
($29.4 billion)
0.0%
0
General Motors
$46.2 billion
$82.3 billion
63.3%
2.3
Ford Motor
$44 billion
$88.2 billion
75.3%
2.8
Ferrari
$38.4 billion
$1.4 billion
54.2%
0.08
Honda Motor
$37.9 billion
$28.3 billion
41.7%
1.5
Data source: YCharts. Data as of Dec. 28, 2022.
As you can see in the table above, many of the major automakers have practically as much net debt or even more net debt than their entire market cap, which leads to high debt-to-capital and financial-debt-to-equity numbers. Toyota, Volkswagen, Mercedes-Benz Group, GM, Ford, and Honda rely heavily on debt to run their businesses.
Rising interest rates are a two-fold problem for these companies. They increase the cost of capital, thereby making it more expensive to operate, and rising interest rates make it more expensive for customers to finance new cars. Tesla’s cash position gives it a unique advantage over its competitors in any environment. But that edge is enhanced in a period of rising interest rates.
For years, Tesla had a nosebleed valuation that could only be justified with hypergrowth. The last four years have been transformational for Tesla. The company is still growing at a rapid pace, but it is now highly profitable, has a high operating margin, and generates gobs of free cash flow (FCF) so that it can avoid taking on too much debt.
Tesla’s crashing stock price, paired with its profitably, gives the company its least expensive valuation ever. As you can see in the chart below, revenue and net income have risen and the price-to-free-cash-flow and price-to-earnings ratios have dropped.
TSLA Revenue (TTM) data by YCharts
The company’s forward price-to-earnings ratio — based on estimated earnings — of 27.3 isn’t just low by Tesla’s standards. It’s in the ballpark of many large, stodgy, low-growth consumer staples companies.
TSLA PE Ratio (Forward) data by YCharts
Tesla’s margins are likely to erode if supply keeps outpacing demand. Its forward P/E ratio could rise if profits fall for any of several reasons — such as lower production out of China due to COVID-19-induced issues, leadership risk related to Elon Musk’s involvement with Twitter and the subsequent impact on the Tesla brand, and any number of unforeseen risks.
However, Tesla stands out as a far better buy than any of its competitors because it has room for margins to come down and still be highly profitable, it has the balance sheet strength to weather a downturn, and it has already built out a global and highly efficient EV procurement, production, and delivery network that is better than that of any other company.
Tesla stock isn’t dirt cheap but the stock’s sell-off and the company’s fundamentals make now the most attractive time to buy the stock since its initial public offering in June 2010.
Tesla has transformed itself into a mature and highly profitable company. The timing of a slowdown in the auto industry couldn’t be worse for Tesla’s competitors, but it’s not such a worry for Tesla. If a slowdown had happened two or three years ago, Tesla would have been in dire straits, but now that the company is consistently FCF positive, it is well-positioned to handle an industry-wide downturn and even take market share.
Add it all up, and now is a great time for long-term investors to consider adding Tesla stock to a diversified portfolio.
Daniel Foelber has positions in Tesla and has the following options: long January 2025 $300 calls on Tesla and short January 2025 $310 calls on Tesla. The Motley Fool has positions in and recommends BYD, Tesla, Volkswagen Ag, and Walmart. The Motley Fool recommends Bayerische Motoren Werke Aktiengesellschaft and recommends the following options: long January 2024 $47.50 calls on Coca-Cola. The Motley Fool has a disclosure policy.
*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.
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