Tesla Has Its Price Target Cut by Morgan Stanley. It’s a ‘WACC’ Problem. – Barron’s

Written by Amanda

Tesla is expected to deliver 270,000 cars this quarter.

Xiaolu Chu/Getty Images

Morgan Stanley analyst Adam Jonas cut his Tesla price target Wednesday afternoon. He’s still a Bull, with a Buy-rating. And his target price only dropped $100, moving from $1,300 to $1,200.

It doesn’t seem like all that big a deal. Still, his report helps investor understand how the minds of Wall Street analysts work. The price decline is entirely because of an increase in the weighted average cost of capital—the cost companies pay to finance their business. It has nothing to do with how many cars Tesla is selling—or not selling.

The report updated key numbers before Tesla reports them. Tesla (ticker: TSLA) should report its second-quarter delivery figures next week—around July 2. A few weeks later, earnings for the quarter will be due.

The second quarter has been wild, with production delays due to Covid-19 wreaking havoc on operations. Jonas cut his second-quarter delivery estimate to 270,000 units from 316,000 units.

Lower deliveries will result in lower gross profit margins. Jonas now projects margins, excluding regulatory credits, will come in at 24.6% instead of his prior estimate of 25.8%.

None of those cuts affected the price target, though. That was driven by the weighted average cost of capital rising.

“Target to $1,200 from $1,300 on WACC increase to 9.0% [versus] 8.5% previously,” wrote Jonas. The 0.5% “increase in WACC….accounts for approximately 100% of the price target decline.”

WACC sounds like a term from business school. It is. Essentially, a WACC takes into account a company’s cost of debt and cost of equity. The WACC is used in things like discounted cash flows that help analysts and investors value stocks.

The cost of debt is easy enough to understand. Companies pay interest rates on bonds and to lenders. The rate is the cost. The cost of equity is a little more difficult to fathom. It’s essentially the return shareholders deem acceptable for any stock. A cost of equity is influenced by things such as stock volatility and government bond yields.

Government bond yields represent the risk-free return. Investors can buy Treasuries and know they will get their money back. (The government can print dollars.) A stock, which is risky, should always earn a nice spread over U.S. Treasury bonds.

Jonas wrote WACC increased because of the “higher risk free rate.” Government bonds are yielding more, so stocks have to return more. And better returns mean paying lower prices for the same business.

This is all very academic. But it is how analysts adjust models for things such as rising rates as well as unusual situations.

Tesla stock didn’t seem to be affected greatly by the midday price target cut. Tesla stock finished down 0.4% on the day, at $708.26 a share. The S&P 500 and Dow Jones Industrial Average dropped 0.1% and 0.2% after spending much of Wednesday in the green.

The average analyst price target for Tesla stock was down to about $910 after Jonas’ cut. It declined to about $907 early Friday after Credit Suisse analyst Dan Levy cut his price target to $1,000 a share from $1,125. Levy cited the same reason as Jonas in his report: “A higher discount rate.”

The average analyst target price peaked at almost $1,000 a share back in April, shortly after first-quarter results were released.

Tesla shares were up 0.8% in premarket trading Friday to about $710.55 a piece.

Write to Al Root at allen.root@dowjones.com

Source: barrons.com

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Hi there, I am Amanda and I work as an editor at impactinvesting.ai;  if you are interested in my services, please reach me at amanda.impactinvesting.ai