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Tesla: Top Analyst Says Sell TSLA Ahead of Earnings

Tesla Inc (TSLA) shares are rallying right now. After the controversial company revealed record delivery numbers for its Model 3 vehicle, prices climbed over 15% to $258. However, the stock is still down 22% on a year-to-date basis. So where does that leave investors ahead of the crucial July 24 earnings date? Luckily top Needham analyst Rajvindra Gill has set out his views on the matter in a just-released report.

This is a stock that divides investors like no other. And here we can see both sides of the argument, as the five-star analyst sets out both the bull and bear case for Tesla. That involves covering a number of key questions, including whether Tesla can meet its FY19 delivery target of 360-400k vehicles. But which side will win the battle? Let's take a closer look now:

The Tesla Bull case

Bulls scored a victory after Tesla reported a record-breaking 95,200 deliveries for Q2. They now believe the company can deliver over 200,000 vehicles in 2H19 and hit its annual target. “Although many bulls acknowledge that Tesla has exhausted a large portion of high-end demand in North America, they believe that the global market opportunity for the Model 3, particularly in China and Europe, can offset any weakness in North America” notes Gill.

Fans of the stock argue that Tesla will be able to improve gross margins through manufacturing efficiencies, including lowering battery pack costs. Similarly, they argue that Tesla will be able to slash logistical expenses once it ramps production of Model 3s in Gigafactory 3 in China. TSLA expects to do this in 2020- and the initial production target is 250,000 vehicles a year.

As for the question of competition, bulls are likely to focus on the company’s full self-driving computer (FSD). “Due to the large size of its fleet, Tesla has had the unique opportunity of using billions of road miles driven (rather than simulation miles) to train its neural networks” says Gill. As a result, many bulls view Tesla's edge in neural network training as a key differentiating factor of its FSD technology.

The Tesla Bear Case

Bears believe the Q2 delivery figures paint an overly optimistic demand picture. They argue that the key contributing factors to the high delivery figures in 2Q were customers accelerating purchases due to the decline of the U.S. federal tax credit from $3,750 per vehicle to $1,875 after June 30.

What’s more, TSLA has enacted aggressive price cuts for the Model S/X, and Model 3 and cut lease pricing. Consequently, bears are skeptical of Tesla's ability to meet its 360-400k delivery target for 2019 and expect the company to face demand challenges for its vehicles in the coming years.

Another major concern shared by bears is Tesla's gross margin. Even though the margin has historically been low, it has recently come under additional pressure from declining sales of higher-margin Model S/X (25-30%), a lower mix within Model 3 (release of $35k standard battery), and aggressive pricing.

Similarly, Tesla's ability to sustain long-term profitability raises significant questions. For example, even in quarters when Tesla has delivered strong deliveries, it is expected by the Street to post a sizable loss. “In Q2, Tesla's bottom-line is expected to have been significantly impacted by multiple factors, including price cuts, leasing costs, and costs associated with geographic expansion” Gill tells investors.

Lastly, bears argue that Tesla's lead in ADAS/autonomy is relatively small and is quickly declining. Beginning in 2020, many believe that L2 vehicles from other OEMs (Toyota, GM, Ford) will reach the mass-market and offer similar capabilities, including adaptive cruise control, lane departure warning, etc.

Where does Gill fall?

The analyst firmly states: “We are in the bear camp.” He notes that the FY19 target of 360-400k units implies nearly 140% 2H vs 1H snapback. That works out at an average of 100k deliveries over the next two quarters. “To meet these aggressive targets, we anticipate further price cuts and aggressive leasing plans” Gill tells investors. He has a Sell rating on the stock- after downgrading Tesla from Hold all the way back in July 2018.

Furthermore, he expects gross and net profit margins to remain ongoing issues for the automaker. “We believe the automaker will continue to take steps to boost its deliveries at the expense of its bottom line. Thus, we are projecting negative earnings throughout 2019, and limited earnings power in FY20” says Gill.

And what’s most worrying is the troubling long-term outlook described by the analyst: “Although Tesla's FSD technology is currently the leading self-driving system in a mass-market vehicle, we believe Tesla's lead in ADAS/autonomy will diminish over time.”

He projects mass market vehicles will offer similar and potentially even superior ADAS/autonomous capabilities to market in '20/'21 (e.g. inclusion of driver monitoring). And this increased competitive environment would further hurt TSLA's margins. “Level 2 Advanced ("L2A") vehicles will become ubiquitous over the next several years, diminishing Tesla's competitive advantage in ADAS” says Gill.

According to various company estimates, Level 2+ vehicles, with advanced driving capability will reach 35 million cars by 2025, while Level 3/4 could read 5 million cars and Robotaxis 1 million cars. Specifically, both Toyota and Volvo are using Nvidia's DRIVE AP2X featuring AutoPilot, which offers similar capability. These vehicles are set for deployment in 2020.

Word on the Street

Overall analysts remain highly divided on Tesla’s outlook. Over the last three months the stock has received 9 buy ratings, 5 hold ratings, and no less than 12 sell ratings. Meanwhile we can also see the divergence in price targets- from $500 on the high-end to just $140 on the low-end. The average analyst price target of $263 indicates upside potential of only 2%.