Vilas Capital 3Q18 Letter: Tesla’s Deep Troubles & Economic Outlook

Smart Money
  • Had a good quarter, rising 55.1% from 6/30/18 to 9/30/18
  • However, YTD return of 3.2% is below the index’s return of 10.6%
  • Top 10 holdings, in order of size, are Walgreens, Citigroup, the Tesla short, NMI Holdings, Barclays, Viacom, Honda, State Street, CVS, and McKesson

Tesla

  • The drama with Tesla will hopefully be over in coming months and years
  • We maintain that the company is in deep trouble, due to too much debt, too little cash, too many losses, too much spending on capital expenditures, too high labor costs in the Bay Area, too many finance employees quitting, too many defects, too few repair centers, too many lawsuits, too much incoming competition, too few remaining tax credits, and too many ethical issues that regulators will eventually find
  • It is only a matter of time before the walls come closing in on the company, regardless of the quantity of cars they sell this quarter or next
  • Honda made and sold about 1.3 million cars and 5.3 million motorcycles last quarter. Tesla made and sold about 83,000 cars. And the market is supposed to be impressed?
    • Tesla, despite its recent drop, still commands a far larger valuation than Honda when one takes into account Honda’s $18 billion in cash and Tesla’s $10 billion in debt
    • What makes it more absurd is that Honda earned over $9 billion last year while Tesla lost $2 billion
  • Pressure on Tesla has not come from critics, as the CEO laments, but rather from overly enthralled investors in the company’s stock
  • Shares have been driven to ludicrous levels by management statements designed to create excitement and hope that the planet will survive for our descendants because of the company’s activities. Living up to these massive expectations is really hard to do
  • When management teams realize that it is impossible, they start acting weird by pushing boundaries and stretching the truth. Seems to describe the current situation pretty well

Outlook

  • There are 3 times more shares hitting 52-week lows than 52-week highs. This is the highest this ratio has been since December of 1999
  • Setup is quite similar: The Fed is raising interest rates, value shares are left for dead, and the darlings are trading at enormous valuations that leave zero room for error
  • We would argue that the public and private darlings, in aggregate, are priced at such a high level that they will need to overtake expected GDP a decade from now to provide decent returns for shareholders. Will everyone eventually work for Amazon?
  • We think that the market is ignoring $20 bills laying all over the ground because the common wisdom is that picking them up is excessively risky. Stocks at 9x earnings with attractive long-term growth rates, dividends and share repurchases are not risky. Avoiding them in the name of being prudent seems to be what is foolish and, dare we say, reckless
  • It will take a recession to create another significant bear market. A normal 10-20% correction or two will likely happen but a deep drawdown requires significant declines in economic activity
  • Recessions are defined as GDP falling two quarters consecutively. GDP is comprised of consumer demand, government spending, corporate investment, and changes in trade. Roughly speaking, consumer demand is 70% of GDP, government is 20%, corporate spending is 10%, and trade is a wash
  • Consumers reduce spending when they become over leveraged or lose their jobs and increase spending when they feel wealthy, have solid job prospects and raises, and have manageable debt loads. Government spending almost never falls. Corporations invest, in aggregate, to provide products to satisfy consumer demand. Thus, the consumer is the lynchpin to the economy. Always has been, always will be
  • Household net worth is up roughly $40 trillion, or about 80%, from its level prior to the Financial Crisis. People spend when they have money in their accounts, which is sometimes called the wealth effect. Further, the unemployment rate, at 3.7%, is near a 50-year low and wage growth is starting to accelerate. And finally, the consumer’s debt to income ratio, defined as fixed payments as a % of income, is below past recessionary lows, not near bubble highs
  • Bottom line: the consumer is in fantastic shape
  • Over the last 40 years, the US has never entered a recession with consumer debt-to-income ratios this low

Vilas Capital 3Q18 Letter, October 2018

Image Source: Money Journals

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