Tesla In China: Cleaning Up The Smoggy Skies

Apr.15.14 | About: Tesla Motors (TSLA)

Summary

Tesla goes on sale in China this month with a price point comparable to competing luxury models such as Mercedes, BMW and Lexus.

I see demand from high-end car buyers and the expected partnership with Sinopec to be near-term drivers for the demand in China.

Long-term drivers are continued expansion of charging stations and JV with local auto maker or component supplier to attract a broader customer base.

Tesla (NASDAQ:TSLA) goes on sale in China this month. The Model S will be priced at RMB734K, similar to its U.S. price after factoring in shipping and taxes.

U.S. price ($)

81,070

Shipping and handling

3,600

Customs duties & taxes

19,000

VAT

17,700

USD:RMB

6.05

China price (RMB)

734,000 (~USD121,370)

Source: Company data

Click to enlarge

Contrary to the company's view that the Model S is priced lesser than its competitors, I see Tesla's price point places it within the luxury vehicle segment that includes Mercedes, BMW (OTCPK:BAMXF) and the Lexus models.

Model

Tesla

Model S

Mercedes

E400L

BMW

535i

Audi

A5 S5

Lexus

GS350

Price (RMB'K)

734

779

703

728

780

Click to enlarge

According to Veronica Wu, VP of Tesla's China operation, Tesla expects China to contribute 30-35% of the company's global sale for 2014. (Link) Moreover, Elon Musk said that Tesla sales in China could be equal to that in the U.S. as early as next year, which means that Tesla expects to sell 7,000 - 8,000 units in China in the second half of this year and 25,000 units next year.

While the delivery goal seems rather aggressive given that Tesla has yet to build up its charging stations in China, I expect 4,000 - 5,000 units a more realistic target for second half of this year with demand coming mostly from Tier 1 cities (i.e. Beijing, Shanghai, Guangzhou and Shenzhen). As Tesla gradually expands it charging station network across the Tier 1 cities and the established Tier 2 cities, I expect 2015 shipment to reach 30,000 units by the end of 2015, driven by favorable government incentives and increased brand awareness. The real upside is when Tesla begins to form a JV with a local OEM to produce the Model S locally, which could make the model S even more affordable by as much as 20%, thereby driving demand from entry-level luxury car buyers.

Cleaning up China's smoggy skies

I believe that Tesla can be a success in China given its market positioning as a unique high-end luxury vehicle, with fuel/operational efficiency and favorable government support.

As the first luxury EV entering China, I expect the Model S to enjoy a high degree of novelty effect. Moreover, the model's performance capability (0 to 60MPH in 5.4 seconds) and horsepower (>302hp) will attract high-end car buyers and automotive enthusiasts. Operational efficiency will also be a key selling point as Tesla's charging station will be free to use, compared with an average luxury car buyer who will spend approximately RMB11K/year on gasoline cost (assuming 27mpg and RMB8/liter gas price). Finally, air pollution in China's major cities have been entering a critical level where average PM2.5 index in Beijing and Shanghai have reached above 120, a level considered unhealthy to the human body. As a long-term resident here in Shanghai, I can contest that walking out with a pollution mask is sometimes necessary to avoid harmful pollutants entering the body.

The government has been keen on combating pollution with "Beautiful China" movement, and encouraging renewable power sources such as solar and wind. While the effort will result in incremental improvement to China's air quality, I think it is critical for the government to promote the mass commercialization of EV and hybrid vehicles in China in order to see an immediate impact to cleaner air.

The current obstacle towards full-scale EV commercialization is the lack of charging stations across China. However, according to media sources (Link), Tesla is in talk with the China Petroleum & Chemical Corp. (NYSE:SNP), known as Sinopec, to build charging facilities. The initial networks will be in Beijing, Shanghai, Hangzhou, Guangzhou, Shenzhen and Chengdu, and I expect further expansion by year-end as the initial network gains traction. A partnership with Sinopec is important to Tesla as it needs the backing of a stated-owned enterprise to fully realize the potential of a nationwide charging station network. From Sinopec's perspective, the company gains valuable insight on building and managing a top tier charging station network, which is an incremental positive to the future development of China's EV initiative.

Although the demand from high-end car buyers and favorable government policies will support Tesla's growth in China, I see the biggest growth driver being Tesla forming a JV with a competent local partner to co-produce a range of EVs from high-end to low-end. The locally produced Tesla models could be priced at 20% discount to the current price, which could drive future demand from entry-level luxury car buyers.

I expect a JV to be formed by year-end or early next year once China sales begin to take off and charging stations begin to be more established. Although no word on who the potential partner may be, I expect that Tesla will pick a state-owned local automaker such as First Automotive Group and Dongfeng Automobile (OTCPK:DNFGY) so the JV can easily navigate China's complex regulatory system. Or Tesla may choose Tianjin Lishen Battery as its partner given the fact that government policy requires foreign car makers that engage in local production to work with a local battery maker. By partnering with Tianjin Lishen, Tesla can secure the critical supply for its batteries.

Bottom line, I expect China to be a key driver for Tesla's future revenue and earnings growth driven by demand from the high-end car buyers and favorable government policies. The expansion of network charging stations is no slam dunk on the fate of Tesla in China but is certainly a key positive as it shows that Tesla could replicate its business model in China and that the Chinese government is serious about cleaning up the pollution in the country.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.