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Zacks Investment Ideas feature highlights: Tesla and Apple

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For Immediate Release

Chicago, IL – May 18, 2018 – Today, Zacks Investment Ideas feature highlights Features: Tesla (TSLA) and Apple (AAPL).

What Lies Ahead for Tesla, part 6 – Update

In April, we did a five part series on Tesla, focusing on product offerings, competition and news about the stock.

(Read the original articles here>>)

Since that series, it’s been a month full of news on Tesla, so it seems appropriate to update our readers with a recap of what’s happened since our last report and provide some context for understanding what might be coming in the near future.

Q1 Earnings and that Infamous Conference Call

Two weeks ago, Tesla reported first quarter results that were slightly better than analyst expectations.  Accompanied by an optimistic letter from CEO Elon Musk and CFO Deepak Ahuja, the company seemed to confirm that they were on their way to producing 5,000 Model 3 cars/week – a goal that was originally set for the end of 2017.

Upon the release of the report, Tesla stock rallied in the after-hours session, at one point gaining about 3%.

Then the conference call started. At first, Musk seemed playful and optimistic, detailing some of the production woes that had hampered the model 3 and explaining how the company had solved them. The investor letter stated and Musk reiterated that there would be a total of 10 days in Q2 in which Model 3 production would be shut down – including the 5 days that were already lost to a shutdown in April.

Once, the Q&A session commenced however, the mood on the call changed markedly. Musk began to refuse to answer quantitative financial questions from some analysts, calling them “boring” and “boneheaded.” He instead directed the staff to “go to YouTube,” - meaning Gali Russell, a retail investor who runs a YouTube channel about investing.

He also told the investing public at large that if they didn’t like volatility, they shouldn’t buy Tesla stock.

Investors concluded that Musk either didn’t know the answer to questions about gross margins in the Model 3, or more likely, didn’t want to answer them.  Musk explained after the call that the analysts he cut off represented the sell-side and were formulating a short thesis. He even tweeted “Oh and uh short burn of the century coming soon.” Unfortunately for Tesla stock, the damage was done and heavy selling erased the initial gains after the report and sent the stock down to $280, 6% lower than the day’s close.

Although they made for great news in the following days, in the end, the earnings report and conference call didn’t really provide investors with any more information than that which was already known or predicted beforehand. The takeaway - Tesla is working hard but struggling to increase production.

Analyst and Investor Sentiment

The investment community continues to be significantly divided on the prospects for Tesla, with several large investors positioned on both the long and short side of the trade. Notable short seller Jim Chanos of Kynikos Associates has been short Tesla for years and has appeared in numerous television and print interviews, often describing Tesla as “worthless.” On the other hand, billionaire investor Ron Baron said in an interview on CNBC on Monday that he has been long Tesla since 2014 and expects the investment to “make 20 times our money” over the long term. Baron’s typical holding period is 10 years or more.

Both money managers have a position in the stock and obviously have an incentive to present their rationale publicly.

George Soros, who rarely discusses his trades publicly, recently bought $35M worth of Tesla convertible notes in the first quarter, according to an SEC filing. These bonds can be converted to common shares. Little else in known however about whether the purchase is part of a larger trade or is hedged with options or other instruments.

The analyst community is similarly split on the prospects for Tesla. Romit Shah of Nomura Securities believes Tesla’s $52B market cap will double to $100M within two years and that Tesla will have 10% market share in the global luxury automobile market by 2022. His price target is $420/share.

Adam Jonas of Morgan Stanley, formerly extremely bullish onTesla, lowered his rating to equal weight from overweight this week and reiterated his $305 price target this week, focusing on competitive pressures he believes Tesla will face.

Goldman Sachs analyst David Tamberrino recently reiterated his “sell” rating on Tesla and maintains a price target of $190, expecting that the Model 3 - even if it can be produced in large numbers - will compress margins across Tesla’s entire product line.

Few companies have such a wide range of supporters and detractors as Tesla. It’s the most widely shorted stock in the world, with nearly 40 million shares sold short, but also boasts a stable of dedicated longs whose reluctance to sell has fueled several short-covering rallies in the recent past. Unfortunately for investors, there are so many varying opinions on Tesla that watching the behavior of traders and reading the analyst research provides little help in determining the direction of Tesla.

Executive Departures and “Flattening” the Management Structure

Perhaps the most potentially disturbing development is the exodus of some key Tesla executives, most recently Matthew Schwall, Tesla’s liaison to the NTSB, who left to join Alphabet’s self-driving vehicle unit Waymo, and Chief of engineering Doug Field, who has taken a leave of absence to spend time with family.

In any company, a certain amount of executive turnover is to be expected, but at this critical juncture in Tesla’s history – during which they are employing an “all hands on deck” strategy in manufacturing – it would be comforting for investors to see high-level players digging in the way Musk himself seems to be, rather than leaving for greener pastures.

Though Musk has promised, in his uniquely rose-colored lens way, to flatten the management structure, allowing all employees to make meaningful contributions toward efficiency in production processes, we will continue to monitor the makeup of the management team at Tesla. A clear and coherent strategy and a team talented and dedicated enough to pull it off is critical for a company at this stage of growth.

Crash Investigations

There have been four fatal accidents lately involving Tesla vehicles that are being investigated by the NTSB. Two involve Tesla’s “Autopilot” feature and the other two involve fires after the crash and the emergency crews’ responses to them.

These make for scary headlines, mostly because Tesla’s technology and materials are significantly different than other cars on the road, so investigations cast doubt on whether those advanced technologies will be proven safe.

In reality, the NTSB investigates thousands of accidents and expects to release the findings of 76 accident investigations just in the two-week period between May 23rd and June 5th. (Source: https://www.ntsb.gov/) These investigations are the reality of the transportation industry and the four recent Tesla crashes are a drop in the proverbial bucket. They make for sensational headlines – especially when they are accompanied by gruesome crash photos – but they are unlikely to derail Tesla’s progress into new technologies.

Keep in mind as well that Tesla is also subject to some selection bias in the reporting of accidents and investigations. Tesla has literally millions of miles of data showing that the Autopilot technology significantly improves the safety of its vehicles, but non-accidents don’t show up in the news because it’s impossible to know when or how often an accident was averted by the use of the technology. Years and years of real world experience may in fact show that in the long run, Tesla’s Autopilot does make cars safer to drive, but in the meantime, isolated incidents make for much more interesting news stories.

Unless Tesla accidents (and related financial liability) become some sort of epidemic – and they’refar from that now – it’s unlikely that this issue will be much of a factor in the company’s success or failure.

Model 3 Production

At the risk of using a tired cliché, this is where the rubber meets the road – literally.

After the initial shutdown in April, Model 3 production was reported to be close to 3,000 per week. Tesla is under no legal or regulatory obligation to report weekly production figures, but enterprising analysts have tracked the number of Vehicle Identification Numbers the company registers with the NHTSA as an indication of how many cars are actually rolling off the line. In late April, Tesla registered 5,000 new VINs, suggesting that production was once again on the upswing.

A leaked internal email from Musk to employees on May 15th said that they were very close to producing 500 Model 3s per day – an improvement over their previous best 2,270 in a week – and that they should expect to be making 6,000 cars/month by the end of June. Later the same day however, Telsa announced a second production shutdown of 6 days at the end of May. Though the shutdown was announced in the investor letter and some analysts took it as a positive sign that the company understood how to improve production numbers and was willing to take temporarily painful steps to solve the problems, investors still sold the stock off 3% for the day.

It is notable that although Tesla is currently only offering a premium version of the Model 3 that includes enhanced range and upgraded comfort and convenience features – and pushes the price well above the announced $35,000 sticker – reservations have not fallen off in any significant numbers, suggesting consumers are willing to pay a higher price and presumably support higher margins.

In the end, the immediate future for Tesla rests squarely on the shoulders of its ability to churn out Model 3s in larger numbers. Because hard data is not available, investors are left to investigate small details to discern whether they are making progress. Tesla is making a huge effort towards higher production numbers but no one outside the company really knows how it’s working on a day to day basis.

Investor Strategy

Although Tesla is one of the most notable and newsworthy companies in the equity universe and we’re likely to continue hearing about it often, it will probably be a month or two until we have any real data on when they will make money selling mass-market vehicles. The options markets are pricing in the chances of big moves in the near future with implied volatilities for put options expiring in June north of 50%.

(For comparison purposes, puts with a strike 10% below the current stock price in Apple with the time to expiration have implied volatilities in the low 20s.)

A sophisticated investor who is interested in being long Tesla for the long-term might want to consider selling puts with a strike price 10% below the current price that expire before the next earnings announcement, which is tentatively scheduled for August 1st.

This strategy allows us to take advantage of the rich option premiums, while becoming owners of the stock at a 10%+ discount to the current levels if the price declines in the interim.

(Read a recent "Know Your Options" article about put-selling strategy here>>)

Stay tuned for more Tesla developments as they occur.

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