Tesla's Q2 Report: Sell The News

With the hype surrounding Tesla's (NASDAQ:TSLA) second quarter earnings release, it seemed hard to see the stock racing any higher. Going into the report, retail, sell-side, and buy-side expectations seemed calibrated around a GAAP profit, and inclusion into the S&P 500. Anything other than this would have been disastrous for the stock. This was reflected in options pricing going into earnings. The implied move in the stock was among the highest of companies reporting earnings, standing at ~15% in either direction. If you think about it, with all the hype and increased expectations surrounding the report, a blowout of astronomical proportions would've been required to get that 15% move to the upside. Combined with the insane run-up and being technically overbought, a bit of a pullback was overdue.

While S&P 500 index inclusion is not a direct fundamental catalyst right now, it could be a catalyst for the stock (in the short-term) and for the fundamentals of the business (in the long-term). What do I mean by this?

Well, considering that Tesla reported a GAAP profit of $0.50/share in the Q2 report, the company has become eligible for S&P 500 index inclusion. This inclusion will increase institutional ownership of the stock. When the company is plugged into the S&P 500, index funds and mutual funds will be forced to enter a position in Tesla. A lot of these funds are buy-and-hold investors, not traders. Thus, a large portion of Tesla's float will be bought up by massive institutional holders. Because these managers hardly alter their positions, a large portion of the float will not be traded as frequently. This will likely lead to decreased volatility, which would lower Tesla's cost of capital. Though Tesla is firmly cash flow positive, and already has $8.6 billion in cash, one final massive capital raise could allow them too supercharge (no pun intended) their expansion plans. Think about it, Tesla is still set to expand Fremont factory, the Nevada Gigafactory, Gigafactory Shanghai, Gigafactory Texas, and Gigafactory Berlin. The last of those two factories will be the largest of Tesla's factories. The creation of these plants, and the ramp to full capacity production would be benefited immensely by a large capital raise.

By being included into the S&P 500 index, not only will Tesla gain a prestige by being an S&P 500 component, certain investors will likely be forced to buy Tesla stock in order to get exposure to the S&P 500 index as a whole. Increased buying pressure from large institutional investors will likely lead to higher stock in the short-term, and a less volatile one in the long-term. Lower volatility leads to a lower cost of capital, making large scale equity-based (or convertible) capital raises easier to pull off.

To be clear, at the beginning of 2018, I was a bear on Tesla stock. In my view, anybody who compared Tesla to Apple (NASDAQ:AAPL) or Amazon (NASDAQ:AMZN) was insane. But now, with Tesla's execution on their fundamentals, my mind has been changed. I believe Tesla combines certain attributes of both Amazon and Apple. I don't say this lightly.

Tesla is very reminiscent of Apple in one key respect:

Battery electric vehicles are the new disruptive technology, as smartphones were the new disruptive technology. That being said, smartphones were around in before Apple entered the market. The same is true with BEVs. When Apple unveiled the iPhone, they disrupted the smartphone market. When Tesla launched a practical, attractive, and functional BEV, they disrupted the market. Both companies are on the cutting-edge of innovation (or at least Tesla is nowadays as Apple's innovation slows). Tesla leads in battery chemistry in both efficiency and cost, which helps reduce the COGS (cost of goods sold) and increase the range (i.e. the functionality) of the product. Tesla's blend of functionality with style is something every other "competing" automaker has failed to do. In this was, Teslas are disruptive technologies.

Second of all, Tesla has a strong brand. Think about it. Do people say they intend on buying an electric car, or do they plan on buying a Tesla? The latter right? Even the bears admit Tesla fans are devoted to the company, with a lot of bears believing Tesla is a cult. Tesla's brand is second to none, other than maybe Apple itself. A brand as strong as Tesla's, while an intangible asset, is an asset nonetheless.

Third, Tesla's products are simple, yet sleek. The same can be said about Apple's products, the iPhone in particular. One example of this is Tesla's interior. Try comparing the interior of a mostly buttonless Model 3, versus the complex overcrowded interior of a traditional luxury vehicle. Sometimes, simplicity is best, as we have seen with Apple.

With regards to Tesla's comparison with Amazon, the similarities are a little fewer and further between. The biggest one is scale: grow big fast. Amazon's multi-decade focus on reinvesting profits into scaling the business model has paid off in a huge way. Amazon famously expanded from a digital bookstore to a digital empire. Amazon's business has been a capital intense business, as has Tesla's. CEO Elon Musk confirmed on the last earnings call that the company will be barely profitable while they pass on profits to the customer (likely through price cuts and whatnot) to scale up market share. This is a very similar strategy to Amazon's in terms of reinvesting profits to grow market presence. The other thing that Tesla does (and will continue to do), is reduce prices on their vehicles. While bears continue to misinterpret this as a lack of demand for their product, it is quite the opposite. As Tesla becomes more efficient at producing vehicles, they find internal cost savings. "Normal" companies would use this opportunity to expand their margin profile and improve profitability. Tesla uses this opportunity to lower pricing, passing on the margin to consumers. This lower pricing leads to increased demand, improving Tesla's market share dynamics. We have seen AWS (Amazon's cloud division) employ a similar strategy in growing its customer base and revenue. The parallels are striking.

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As of right now, short interest in Tesla's stock stands at ~7.5% of the outstanding stock. As the stock sprints higher, the value of these short positions balloons, leading too a likely short squeeze. We have seen this play out over the last few months. The problem is, shorts continue to move the goalposts on the stock, something that I (ironically enough) claimed the bulls were doing when I was bearish myself. The argument has evolved:

One by one, Tesla has dismantled the bear case surrounding the stock, and the bears don't like it. So, rather than admitting they made the wrong call on the stock, they move the goalposts on it. Tesla's practice of just executing on their business model has done significant damage to the Tesla bears. Eventually, as Tesla continues to show profitability, bears will make the argument (the only valid one they have in my view) that Tesla's valuation is stretched. The problem is, the compare Tesla to an automaker rather than Amazon. As I have already talked about, Tesla has multiple striking parallels with the Amazon business model. Traditional analysis of Amazon versus other brick-and-mortar retailers would yield a far lower stock price than what Amazon trades at currently. The bears need to understand, Tesla is a disruptive force in the market that cannot be competed with, at least not yet. In addition, Tesla has other growth vertical in both energy and autonomy. Trying to value the stock on earnings, when management explicitly says they have no intention on earning more than the bare minimum, is not wise. Revenue is a better metric.

The clock is ticking on bears and disbelievers in the Tesla story. The company is executing, they are going to be admitted into the S&P 500, their business parallels big tech companies like Apple and Amazon, and bears continually move the goalposts. At a time when Tesla is called one of the greatest bubbles in the market, I would consider it the exact opposite. The recent dip in the stock is an opportunity to buy.

Disclosure: I am/we are long TSLA. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: This is not financial advice. I am not a financial advisor. Please do your own due diligence before initiating a position in any of the aforementioned securities.

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Tesla: An Opportunity To Buy The Dip - Seeking Alpha