Investors in Tesla and Electric Vehicles Face a Crucial Moment

After a few years of rapid growth, the electric-vehicle industry, which gave rise to billion-dollar startups and propelled Tesla Inc.’s value to new heights, is now facing setbacks.

The central theme of this earnings season is the decline in demand for electric cars. The first was Tesla’s dismal earnings report last week, followed by scathing comments from General Motors Co, Mercedes-Benz Group AG, Honda Motor Co and car rental company Hertz Global Holdings Inc.

The change has been shocking for investors, as the valuation of most electric vehicle stocks assumes rapid growth in the industry. If this does not happen, stock prices will likely decline and many startups will not be able to rely on capital markets to finance their unprofitable ventures.

“People were always too aggressive about EV adoption,” said Craig Irwin, an analyst at Roth Capital Partners. “Now we have a market adjustment, a recalibration back to reality.”

While Tesla CEO Elon Musk blamed high interest rates, others pointed to demand. GM said it was rethinking the goals because electric car sales were slower than expected and Honda scrapped plans to develop low-cost electric cars with GM. Mercedes called the electric car price war “brutal” and unsustainable, and Hertz said it would slow the pace of purchases of these cars due to high repair costs.

Meanwhile, Wall Street analysts downgraded companies exposed to electric vehicles, such as lithium suppliers and charging station operators.

“Electric cars had a grace period of initial demand excitement, but that appears to be over,” said Nicholas Colas, founder of DataTrek Research.

Cracks appear

Warning signs appeared early this year when Tesla began aggressively cutting prices to try to support demand. This sparked a price war as other EV makers followed suit, eating into the profitability of some automakers and raising already steep losses for others.

But demand remained weak despite the lower prices, leading some to conclude that the “first adopter” consumer base may have been tapped. Then there are other obstacles, such as high interest rates and expensive car loans, still inconsistent charging networks and relatively fewer electric models.

Even the global political pressure for cleaner transportation options does not affect car companies.

“Consumers have the final say on where pricing should go,” Colas said. “If demand is already faltering, the margins will be tight from now on.”

Stocks have begun to reflect these concerns. Shares of Tesla have fallen 14% since reporting results on Oct. 18, and Rivian Automotive Inc. and Lucid Group Inc. have each retreated more than 10% since. The S&P 500 index fell by 4.4 percent in the same period. All are trading well below their record highs touched in late 2021 amid a broader bull market.

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Still, Tesla remains one of the most expensive stocks in the S&P 500, trading at about 56 times forward earnings, compared to mid- to high-single-digit multiples for General Motors and Ford Motor Co. Meanwhile, unprofitable startups Rivian, Lucid and the market’s newest gold, VinFast Auto Ltd., command market capitalizations larger than American Airlines Group Inc. So these stocks have room to fall further.

“For small manufacturers, it all depends on whether they can turn cash flow positive,” said Ivana Delevska, chief investment officer at Spear Invest. “For unprofitable companies, growth is important in terms of operational leverage, but the most important metric is cash flow.”

Rivian and Lucid both price their cars for less than what it costs to make them. Without economies of scale, they need capital to finance operations at a time when borrowing costs are high. Add in skyrocketing demand and it’s a lethal combination.

Tesla, with a market cap of $660 billion, also has a lot at stake. It’s already far bigger than any other automaker in the world, and its valuation leaves little room for error. And as demand for electric cars lags, the pressure on its self-driving software will intensify.

“Tesla’s efforts to get into truly autonomous vehicles are becoming much more important,” Datatrek’s Colas said. “Selling electric cars is becoming much more difficult.”