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What to expect from Tesla's Q3 earnings

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Colin Rusch - Oppenheimer Senior Analyst joins Yahoo Finance’s On The Move panel to preview Tesla’s third-quarter earnings report.

Video Transcript

ADAM SHAPIRO: Shares right now are up about 2% as we await Tesla earnings in after the bell today. We want to bring in Colin Rusch, Oppenheimer Senior Analyst, to talk about what we should expect, and one thing that's forefront is we know what's going on with deliveries. Will they hit the 500,000 threshold this year with vehicles, do you think?

COLIN RUSCH: You know, there's a very good chance, and I'm not sure it's super important that they hit the 500,000 number exactly. What they need to demonstrate is that they're continuing to move forward with the production ramp, and I think we are going to get good news on that front. I think the more important number that we're looking for is really gross margins, because it's going to translate into operating cash flow for us.

And so we're watching that automotive gross margin number x credits, which the Street is expecting about 20%, which is a little over 150 basis points quarter over quarter. We think that number could be closer to 22, 23%. And as we look at the company ramping into higher volumes, you know, those sorts of numbers have a pretty meaningful translation. The top running cash flow, just to put that in perspective, that's an incremental for every hundred basis points, but about $90 to $100 million a quarter in operating cash on that gross margin [INAUDIBLE].

RICK NEWMAN: Hey, Colin. Rick Newman here. One of the things that did not happen for Tesla this year that disappointed investors in Tesla was that it did not get included in the S&P 500 index. The index committee at S&P did not say why. They don't have to say why, but there are some guessing that maybe it has to do with the way they measure profitability or the fact that some of their profits don't come from selling cars, it comes from the sale of regulatory credits. Did that cause you any concern, and do you feel-- do you have your own questions about Tesla's numbers in that regard?

COLIN RUSCH: Yeah, I really don't. And you know, we've been covering the company for almost a decade at this point and been able to validate what they're reporting back to the Street. At the end of the day, you know, cash is a real number, and we always look at manufacturing companies like this on a basis of cash on cash returns over time. And so, you know, seeing that cash flow number, you know, move in a positive way I think is very important for us, particularly as a scale. You know, one of the things that I think will happen is if we're right on this cash flow number, that they consistently generate free cash flow, you're going to see the debt get re-rated by other agencies and then you start to think about the inclusion in some of those indexes still being a possibility. But you know, this company's been controversial. They're made with any number of things that wanted that inclusion process consideration, but accounting was not one of them, in my opinion.

JULIE HYMAN: Hey, Colin, the stock is up more than 400% this year. And according to your price target, you think it still has a little bit of room to go, although not another magnitude of move upward. As an analyst, how do you even calculate that number, right? Because the price earnings ratio doesn't make-- I mean, that's just an insane number, like it's not a real number. Do you do price to cash flow as you've been discussing, or what's the calculation?

COLIN RUSCH: You know, I would need to take a step back from that question and about valuation in this market. With the 10 year trading at, you know, 60 to 70 basis points, you know, dramatically lower than anything we've seen, you know, with the debt markets. You know, understanding what the right multiple to put on growth is incredibly difficult, and we're seeing that across our coverage universe and across the market right now. And I think it's getting negotiated at this point. So you know, taking historical examples I think has been challenging.

What we try to do is look out to future, you know, for future earnings power in terms of the concrete numbers that we feel to get our heads wrapped around, and then put a multiple of, you know, earnings on that as we look at that earnings leverage. So you know, for a high growth company that has optionality around a very defensible market position on both EVs and autonomous vehicles at the back half of this decade and is continuing to show that it can disrupt a very large market, if we continue to think of a 40 times multiple is about right on this earnings number, and then what we're doing is going out to '24-'25 and just counting back. But it's a hard challenge for everybody, I think, with this company and the broader market right now.

ADAM SHAPIRO: So if I'm an average investor listening to what you've just said about the potential for Tesla, it sounds as if you're also saying they're going to be able to swat away competition from established car manufacturers who are going into electric, even perhaps new startups. I mean, we've got General Motors announcing they're all electric Hummer earlier, so it seems to me that what you're saying to those investors.

COLIN RUSCH: Yeah, I mean, so there's a couple of things that are going on here. So you know, on the technology side, we think this technology's a lot harder than people have given it credit for. There's been a bear case floating around for years about Tesla not be able to make these vehicles. But as we've, you know, seen other OEMs try to do full EVs and ramp, you know, kind of from a clean sheet of paper, we've seen a lot of trouble, right? I mean, these OEMs have not able to deliver vehicles. The second thing, you know, that we're seeing as the specs on this, these companies coming out, part of what happened last year was Porsche came out with a new model that was full EV, and the range was incredibly disappointing on the take hand.

And so you know, the power electronics design, being able to look at the battery performance and then optimize, you know, chemical energy within those batteries into compulsion on the vehicle is a very complex problem, and integrating all of that with, you know, with software that actually functions to serve all the different systems within the vehicle is, you know, proving to be incredibly difficult for the OEMs. And that's what we're looking at. We're looking at actual products that can be produced in a cost effective way that can actually perform to the standards that customers want, and we're not seeing anything out there right now that really gives us pause around Tesla's technology position.

ADAM SHAPIRO: All right, we want to thank you for joining us, Colin Rusch, Oppenheimer Senior Analyst, talking about Tesla. We're always watching Tesla here, so we appreciate that. And again, Tesla reporting after the bell.