Why One Analyst Thinks Tesla’s Margins Are Too Good to Be True

Deliveries are usually a big deal for Tesla stock, and its fourth-quarter deliveries should be reported in the first days of the new year. Delivery estimates, overall, are moving higher—even among bearish analysts.

Cowen analyst Jeffery Osborne recently raised his fourth-quarter delivery estimate to 181,500 from 156,500. He rates shares Hold and has a $380 price target, far below where the stock trades.

RBC analyst Joseph Spak is a little more bearish, rating shares the equivalent of Sell with a $339 price target. He recently raised his fourth-quarter delivery estimate to 176,000 from 162,000.

GLJ‘s Johnson is one of the biggest Tesla bears on Wall Street. He rates shares Sell and has a $40 price target, which values Tesla stock at roughly what

Ford Motor

(F) stock is worth. GLJ is an independent research firm founded in 2019. Johnson has 10 years’ experience as an equity research analyst.

Johnson has given Tesla stock a Sell rating since the third quarter of 2019, when he picked up coverage of the company. Johnson covers a range of solar and material stocks as well as Tesla. He rates nine of the 15 stocks under his coverage Sell, six Buy, and none Hold.

Using only Buy and Hold ratings is a little unusual. The average analyst rating-combination for a stock in the

Dow Jones Industrial Average

is currently 57% Buy, 36% Hold, and 7% Sell.

Despite his bearishness, Johnson expects Tesla to deliver about 185,000 vehicles in the fourth quarter. His earlier estimate was 174,000. Wall Street analysts expect, on average, the figure to be roughly 176,000 vehicles.

Stronger delivery performance isn’t enough for Johnson to change his view on the stock. He questioned the quality of Tesla reporting in his Tuesday research report, comparing the reporting of Tesla’s profit margins to a notorious Ponzi scheme.

“The tell tale sign of Bernie Madoff’s deception was impossibly consistent returns,” Johnson wrote in a email to clients reviewing deliveries. “With a number of acute price cuts for [Tesla] cars this year across various geographies, yet margins that continue to rise, we see similarities between [Tesla’s] reported margins and Madoff’s returns.”

Bernie Madoff fabricated the returns of his investors for years in what amounted to a Ponzi scheme discovered in 2008.

Price cuts are helping spur demand, one apparent reason Johnson has increased his delivery estimate. But lower prices, says Johnson, should result in lower profit margins.

One mitigating factor on Tesla margins, however, is falling costs. Costs are dropping as the company produces more cars from its lower-cost plant in China, according to the company.

“We are also seeing benefits from the continuing upward trend of locally built and delivered cars, which has increased from under 50% at the beginning of last year to over 70% most recently,” said Tesla Chief Financial Officer Zachary Kirkhorn on the company’s recent third-quarter earnings conference all.

CEO Elon Musk has also addressed the price cuts recently, saying it’s important to continue to reduce vehicle prices. “I do not think we lack for desire for our product, but we do lack for affordability,” Musk said on the same conference call.

Tesla produced operating profit margins of about 9% in the third quarter, and analysts expect margins to improve in the fourth quarter. Reported profit margins include regulatory credit sales, which some analysts back out, believing zero-emission credit sales—earned by selling a higher than average percentage of zero emission cars to auto makers selling too few zero emission cars—won’t last forever.

But while credit sales boost profits, Tesla’s higher-than-average share-based compensation hurts profits. Share-based compensation is higher at Tesla because of the way Musk is compensated and because Tesla stock has been so strong recently, making stock options very valuable. Both numbers—regulatory credits and stock-based compensation—should be normalized when comparing Tesla’s profits to those of other auto makers.

Backing out both numbers actually improves operating profit margins reported in the third quarter of 2020.

Despite falling costs, Johnson tells Barron’s he believes that lower prices should still result in lower margins, saying aggressive accounting for car warranties and software sales is part of the reason Tesla can produce consistent profit margins.

This isn’t the first time Tesla has been accused of aggressive accounting. Hedge-fund manager and Tesla bear David Einhorn questioned Tesla’s accounts receivable at the end of 2019. Tesla’s outstanding accounts receivable as a percentage of sales are lower than those of auto industry peers and have been relatively stable for the past few quarters. Tesla is also a little different from other auto makers because it essentially owns its dealer network.

Musk called Einhorn’s accusations false in a November 2019 letter.

Others on Wall Street have questioned Tesla’s warranty accruals. Last year, Roth Capital analyst Craig Irwin cut his rating on Tesla stock to Sell from Hold, arguing that lower warranty accruals boosted profit margins.

Warranty accruals are the amount Tesla sets aside to fix cars. Reserving less money to fix cars can mean higher profit margins. That can be a problem if the warranty assumptions are too low. But Barron’s found that Tesla warranty assumptions appear to be in line with the rest of the auto industry.

The debate about Tesla accounting will continue among bears even after deliveries are reported. Margins won’t be disclosed in early January. Investors will have to wait until earnings are reported weeks later.

If Tesla delivers the 185,000 cars Johnson predicts, Tesla will have delivered more than 500,000 vehicles in 2020, something Tesla targeted before the pandemic.

For 2021, Wall Street expects Tesla to deliver 794,000 vehicles.

Tesla stock is up 2.8%, at $684.71, in recent trading. The

S&P 500

is up 0.3%.

Write to Al Root at [email protected]