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Tesla Inc (TSLA) released its second-quarter results late yesterday showing much lower profits. This has led to unusual activity in its call options today with heavy volume. It shows that some investors are bullish, buying calls.
What could be moving these investors? TSLA stock is down over $25 to $221.55, a drop of over 10% in mid-day trading. Nevertheless, large tranches of TSLA calls expiring in 2 days have been trading.
This can be seen in today's Barchart Unusual Stock Options Activity Report. It shows that 3 tranches of TSLA calls, all out-of-the-money (OTM), have traded for expiration on Friday, July 26.
For example, the $222.50 strike price calls, which are about $1.00 higher than the spot price (i.e., 0.45% out-of-the-money) are trading for $3.02 in the mid-price. That implies that any investor who buys these calls expects to see TSLA at $225.52 (i.e., $222.50 +$3.02) by the close on Friday.
In other words, despite the poor results and the 10% drop, these investors are banking on TSLA stock rebounding significantly. To just break even, the investor hopes TSLA stock will rise by $4 or so, or over 1.8% by the end of the week.
Why would they think that is a good bet? Let's look carefully at the actual results.
Tesla Results and Why Some Are Bullish
The good news is that Tesla's revenue rose 2% year-over-year (Y/Y) to $25.5 billion. This was its highest ever (vs. $24.9 billion last year). The market didn't like this, though, since the automotive sales component, the largest portion, was down 7% Y/Y. These figures can be seen on page 4 of the company's quarterly update deck.
Energy and services revenue, including sales of tax credits, made up the shortfall to lead to the overall 2% Y/Y gain. Moreover, the automotive revenue component rose on a Q/Q basis from $17.378 billion to $19.878 billion, a sequential 14.4% rise.
The market does not seem to want to recognize this automotive revenue Q/Q turnaround.
Moreover, the company made an operating profit of $1.6 billion. However, as pointed out above, this included $890 million in regulatory tax credits. That represented over half of the operating income. This could be another reason why the market was disappointed.
Nevertheless, the bottom line is that Tesla remains profitable and produces positive free cash flow (FCF). No other electric vehicle (EV) manufacturer can claim this status.
For example, it still generated $1.34 billion in free cash flow. This was after spending $2.27 billion in capital expenditures, including $0.6 billion related to AI. Its FCF margin was 5.25% (i.e., $1.34b/$25.5b revenue). That is a very healthy FCF margin and augurs well for the company's valuation going forward
The bottom line is that Tesla remains a truly viable and energized EV company with competitive products and operating profits. That could be why investors are still feeling bullish on TSLA stock.
What Could TSLA Stock Be Worth
One way to do this is to normalize its free cash flow. Let's assume that capex averages $10 billion for the next year. If Tesla can make 7.5% FCF margins on analysts' revenue forecasts of $117.6 billion in sales next year, FCF will hit $8.82 billion in 2025.
Therefore, if the market gives the stock a 1.0% FCF yield valuation, the market cap could rise to $882 billion. That is 14.7% higher than its present $769 billion market cap. In other words, TSLA stock could still be worth $254 per share (14.7% higher than today).
Moreover, analysts tend to agree. For example, AnaChart.com, a new sell-side analyst tracking service, shows that the average price target of 35 sell-side analysts is $250.66. That is over 13% higher than today's price.
The bottom line is that some investors are bullish enough on TSLA stock to buy near-term calls. This is a risky bet, however, since the expiration period is so close. The target price that I developed and that most analysts have is for 12 months out.
Therefore, be very careful about emulating these large bullish call option trades.
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.
