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Tesla Inc (TSLA) reported strong Q3 operating and free cash flow margins on Oct. 23, even though revenues were down slightly. This has huge implications for Tesla's value going forward. As a result, TSLA stock could be worth over 21% more at $307 per share, even after Thursday's rise. This article will delve into this valuation.
TSLA stock was at $256.67 in midday trading on Thursday, Oct. 24, up over 18% from the day before. The market sees the company as able to produce strong profits going forward. This is despite having to spend higher amounts on capital expenditures.
Tesla's Strong Cash Flow
Tesla achieved an adjusted EBITDA (earnings before interest, taxes, depreciation, and amortization) margin of 18.5% in Q3. That was significantly higher than 14.4% in Q2, and 16.1% a year ago. So, despite revenue that fell 1.45% from the prior quarter, it was able to lower costs and squeeze out higher profits.
Moreover, its operating margins spiked as well. It rose from $3.6 billion last quarter to $6.255 billion in Q3. That represents almost 25% of its revenue (i.e., $6.255b/$25.182b = 24.84%).
That pushed its free cash flow (FCF) up to $2.74 billion in Q4 from $1.34 billion in the prior quarter. This was even after quarterly capex spending rose from $2.4 billion to $3.5 billion.
In other words, the company's strong cash flow overcame higher capex costs. As a result, its FCF margin rose to over 10% of sales (i.e., $2.74b/$25.182b = 10.9%).
This has huge implications for its FCF next year and Tesla stock's ongoing value.
Forecasting Free Flow
For example, analysts now project that next year Tesla's sales will rise to $116.3 billion (up 16.7% from $99.6 billion this year). Therefore, if Tesla can keep making 25% operating cash flow margins, it could generate almost $29 billion in operating cash flow (i.e., 0.248 x $116.3b = $28.84b).
Moreover, during this quarter's conference call, the CFO said that Tesla expects to spend over $11 billion in capex this year. So, if next year that rises slightly to $12 billion, its free cash flow could end up as $17 billion (i.e., $25 OCF - $12b capex).
In other words, its FCF margin could rise significantly from 10.9% this past quarter to almost 15% (i.e., $17b est FCF/$116.3b in 2025 sales = 14.6%).
That could push the value of TSLA stock even higher.
Target Price for TSLA Stock
For example, look at the company's trailing 12-month (TTM) FCF. It works out to $3.617 billion. Since its market value is now $812 billion, that means the market is willing to give the stock a TTM FCF yield of 0.44%.
But even if we use a 1.5% FCF yield the stock could rise significantly. For example, dividing $17b in forecast FCF next year by 1.5% results in a market cap estimate of $1,133 billion (i.e., $1.13 trillion). That is 39.6% higher than today's market cap.
Just to be conservative, let's use a 1.75% FCF yield metric. That is the same as multiplying forecast FCF by 57.1x (i.e., 1/0.0175). So $17b x 57.1x = market cap of $971 billion. That is 19.5% higher than today's market value.
In other words, TSLA stock could still be worth $306.72 per share (i.e., $256.67 x 1.195). That is even after Thursday's 18%+ stock price rise.
The bottom line is that Tesla's huge operating and free cash flow margins could bring good upside to TSLA stock over the next year.
On the date of publication, Mark R. Hake, CFA did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.
