Image Source: Tesla
By Brian Nelson, CFA
With the 10-year Treasury rate reaching 5% in recent trading sessions, investors have been laser-focused on this benchmark rate that is commonly used as the foundation to estimate both the cost of debt and the cost of equity to discount future expected free cash flows within equity valuation models. We’re not going to prognosticate on the future direction of the 10-year Treasury rate, but we’re also not concerned about current rate levels either, given that our 10-year Treasury rate assumption within our discounted cash flow models is roughly ~4.3%, a level that we had maintained even when the 10-year Treasury rate was much lower years ago. Though it’s difficult to shift away from talking about the yield curve and macro data points these days, let’s nonetheless focus on two stocks that you should be watching.
The first is Tesla (TSLA). Elon Musk’s recent cautious comments on Cybertruck potential cash flow in the near term and the company’s disclosure regarding its future expected capital-expenditure plans have dampened excitement surrounding the stock. Tesla’s shares have still roughly doubled since the start of the year, as of this writing, however, so some sort of share-price pullback following its third-quarter report, released October 18, should have been expected. During the third quarter, Tesla generated $848 million in free cash flow and held ~$26.1 billion in cash versus debt of just ~$2.3 billion on the balance sheet, good for a very nice net cash position. From our perspective, Tesla remains a net-cash-rich, free-cash-flow generating, secular-growth powerhouse, and while we expect to make some changes to our valuation following the quarterly report, resulting in a downward fair value estimate adjustment, the firm continues to be a name for the radar.
On October 23, Chevron (CVX) announced that it had entered into an agreement to acquire Hess Corp. (HES) in an all-stock deal valued at ~$53 billion, or roughly $171 per share. Under the terms of the proposed transaction, shareholders of Hess will receive 1.025 shares of Chevron for each share of Hess they own. A Chevron-Hess tie-up should help extend the combined entity’s production outlook well into the next decade given the Stabroek block in Guyana and valuable Bakken assets. We’ll have more to say about the tie-up as more details come to light, but our initial take is that Chevron should be more focused on returning cash to shareholders within its existing portfolio and strengthening its balance sheet than wheeling and dealing at this time, especially since energy resource prices have bounced considerably the past 12-18 months. We’ll be taking a close look at our valuation model of Chevron following this news, but we don’t expect a material fair value estimate change at this time.
All told, Tesla’s third-quarter report could have been a lot better, and Elon Musk’s comments that they “have dug (their) own grave with the Cybertruck” weren’t reassuring. Nonetheless, the company continues to generate free cash flow, and its balance sheet remains pristine with a very nice net cash position. We won’t be adding shares of Tesla to any newsletter portfolio, but given the price drop in its equity during the past week, we think most of the bad news is already embedded in the stock. As for Chevron, the company was once a darling stock in the newsletter portfolios, but we’ve moved beyond this big winner in both the Best Ideas Newsletter portfolio and Dividend Growth Newsletter portfolio after the huge “gains” the past 12-18 months. Shares still yield an attractive 3.6%, however, and we’ll have more to say about its tie-up with Hess as more details come to light.
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Brian Nelson owns shares in SPY, SCHG, QQQ, DIA, VOT, BITO, RSP, and IWM. Valuentum owns SPY, SCHG, QQQ, VOO, and DIA. Brian Nelson’s household owns shares in HON, DIS, HAS, NKE, DIA, and RSP. Some of the other securities written about in this article may be included in Valuentum’s simulated newsletter portfolios. Contact Valuentum for more information about its editorial policies.
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