Yesterday, Tesla Motors announced its first profit in the 10 year history of the company. To many fans, this is vindication for the idea of electric cars in general and for Tesla specifically. However, a number of seasoned market forecasters, investors, and publications have treated the announcement with cautious optimism. This, of course, has led many Tesla fans to denounce publications, like the Wall Street Journal, as biased or claim they are shills for big oil. Neither of these is the case and I will explain why.
Before I explain, however, let me make a few things clear. First, I like the Tesla Model S. It is a good car with great potential. It is, however, technology with limitations and I think it is important to acknowledge those limitations going forward and understand why major manufacturers have not pursued electric cars the way Tesla has. Fanboyism won’t due anyone any good as blind adherence to a personal bias has never helped the world out. With that int mind, I want to take a look at the numbers behind the Tesla financial report just released and attempt to understand what technical and financial factors make some investors leery of this company.
The Financial Report
Revenue – $562 million
Profit – $11 million
If revenue is looked at in detail, there are a few things that jump out at us. First, the company made about $7 million on development services. This basically means that they made money by developing tech for other companies, like Mercedes. This may be lucrative going forward, but for now is just a side show.
Next, the company delivered 4,900 vehicles, which is just below the 5,000 they will need to deliver each quarter to hit the 20,000 projection. They claim that demand in the U.S. alone is 15,000/yr and worldwide it is 30,000/yr. The question on everyone’s mind is whether this is sustainable demand or whether this will drop once the “rich” have their toys and few other buyers step up to purchase the $70,000+ vehicle. To put the 20,000 into perspective, it is half the number of Ford trucks produced in a month. On a yearly basis, that means Tesla has a demand that is 24 times lower than what would be the case for Ford trucks. Now, there is nothing wrong with selling niche vehicles, but the question is whether this niche will be enough to keep the company profitable for the long term. Many niche companies sell their cars for much more than the Tesla, which brings us to margin per car.
The claim is that Tesla gross margins are 17%, up from 8% in the previous quarter. The company claims that it can raise this to 25% from Q4 2013. The final balance of the margin depends on just how much the company can cut in terms of:
1. Wages – Up to now, Tesla has been paying overtime, double time, etc. as it ramps up production. This leads to a higher cost of production per vehicle. These costs should fall some as the company develops a production schedule.
2. R&D – This is down 23% from Q4 2012. The question is, how low can this stay as the company begins development of the model X? That car is purported to have an all-wheel-drive option, which is no easy engineering feet, especially for electric drive. R&D is expected to increase slightly.
3. ZEV Credit – This accounted for $68 million of revenue. That’s right, the ZEV credit is more than
ZEV Credits – $68 million six times the company’s profit for this quarter. This means that without government subsidy, Tesla would have lost money. We’ll get to the details of this fact in the next section, but Tesla claims the 25% margin is WITHOUT ZEV credit.
4. Loans – The 17% margin includes payment on the loan that Tesla received from the DOE. At least this one is predictable.
5. Selling, general and administrative expenses – These are expected to rise moderately with demand.
6. Supercharger Stations – Tesla needs these to make its cars viable. If the company continues to invest in these and provide “free” electricity, what impact will it have on the bottom line?
7. Demand – Longterm demand for a car that costs so much remains speculative. The new lease option will likely improve demand, but it is not clear how that will affect overall earnings. What is more, the long term reliability of the car has yet to be tested. The coming years will determine if range loss of only 25% over 10 years is reality or just marketing hype.
As you can see, there are a lot of unknowns in the equation here, which is why outlets like the Wall Street Journal are not as optimistic as fanboys would like. The fact is, measured optimism is warranted after the financial announcement. Unbridled enthusiasm is less warranted.
Despite Musk’s personal tirades against government involvement in personal business, Tesla has been the recipient of government aid in three distinct ways:
1. A $465 million loan from the DOE
2. A $7500 federal credit on every car, which drastically lowers price. This is a consumer credit. Loss of this would affect demand for the car, but not gross margin.
3. ZEV credits that could amount to as much as $35,000 per car. This quarter, they amounted to just under $14,000 per car, which is a lot of credit. Loss of this credit would directly impact gross margin.
Without the ZEV credit, Tesla would not have turned a profit this quarter (in fact it would have had a loss of ~$57 million) and this is the major reason that many investors are cautious regarding the earnings release. A separate article will be the place to debate the appropriateness of government credits, here we are exploring what it means for the future of Tesla.
The company claims that Q4 2013 gross margins of 25% can achieved without the ZEV credit, but it is hard to see how that is possible. Tesla has not elaborated on how this would occur, but insists it is possible. For the coming year, Tesla plans to focus on improve efficiency.
Despite the good news, Tesla remains one of the most shorted stocks on the market, suggesting it is highly vulnerable to volatility. Only the future will tell if Tesla can remain profitable going forward. At the very least, the company has given electric cars a nice boost into the mainstream.