Tesla’s (TSLA) stock took a hit in pre-market trading this morning following a note from Goldman Sachs’ top analyst Patrick Archambault (see update below) downgrading Tesla to ‘Neutral’ and significantly cutting his price target from $240 to $185 due to what he sees as an “increased risk premium”.

Archambault wrote in the note that he expects a slower production ramp for the Model 3 than what Tesla is guiding. He adds that he prefers to be neutral on the stock because he sees Tesla’s record delivery numbers in Q3 as the last short-term potential catalyst for the stock.

Though he does expect Tesla to report a profit in Q3 of $0.28, which would be a first in 3 years, but CEO Elon Musk already hinted that it could be the case.

Here’s the summary of the note to clients:

Goldman Sachs downgrades Tesla Motors $TSLA to Neutral from Buy, PT $185:

We downgrade shares of Tesla Motors to Neutral from Buy and lower our 6-month price target to $185 from $240. Since we added TSLA to the Buy list on May 18, 2016, shares are up 0.1% vs. the S&P 500 +5.0% and our coverage +6.0%, as management’s deployment of capital for potential M&A has likely weighed on investor sentiment on the concept stock. We now see incremental risk to the business related to management’s deployment of capital for M&A, and further believe that any delay in the company’s timeline to launch its new Model 3 will be detrimental to shares. However, with solid 3Q16 deliveries and the potential downward catalyst of a missed Model 3 launch timeline out in 2H17, we prefer to be Neutral on shares.

Current view

We see room for downward estimate revision as volume ramps slower and spending grows quicker. While our 2016E EPS is ahead of the Street (-$0.59 vs. Street at -$0.93), our 2017 through 2019 EPS estimates are an average 48% below consensus. This is the result of our expectation of a slower ramp to the Model 3 launch and incremental SG&A spend as the company continues its heavy investment period, as well as from increasing R&D associated with the Model 3 and new products.

Pro-forma FCF and leverage a cause for concern. We believe the proposed combination of Tesla and SolarCity – two high growth, high cash burn businesses, creates a higher risk entity given the combined ongoing capital needs and higher net leverage that would potentially result. Our illustrative pro-forma analysis implies 2017E and 2018E FCF burn ranges of $2.4bn to $2.5bn and $1.3bn to $1.4bn with net leverage increasing to ranges of 6.6x to 6.9x and 3.5x to 3.6x, respectively, vs. legacy Tesla net leverage of 1.1x and 0.9x. Why are we not more negative? In the near-term we do see Tesla achieving a positive EPS result in 3Q16, mainly on strength of vehicle deliveries achieving half of the company’s 2H16 guidance. This puts our updated 3Q16 EPS estimate of $0.28 above consensus of $0.07. Additionally, we raise our estimates to fully incorporate the Tesla Energy business – driving a net positive increase to our 2016 through 2019 EPS estimates.

Valuation

We lower our 6-month price target for TSLA from $240 to $185 primarily as we increase the company specific risk premium within our discount rate being applied to both our probability weighted automotive valuation (which values the automotive company on its long-term potential) as well as our Tesla Energy valuation (see Exhibits 40 and 41 on pages 29 and 30) given incremental business risk from management’s capital deployment strategy, as illustrated by the announced Solar City deal.

Patrick Archambault is one of the best-ranked analysts on Tip Ranks: #385 out of 4,190 analysts with a 58% success rate and an average return of 14.3%. He has been covering TSLA for a long time, but his recommendations on the stock have been fairly conservative:

patrick-archambault-tsla-coverage

Update: we are told that David Tamberrino took over the Tesla coverage Goldman Sachs and issued the downgrade. But considering he was on Archambault’s team and that his history of TSLA coverage is fairly recent, it’s probably better to refer to Archambault’s coverage history on TSLA has seen on the chart above.

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