Despite vague assurances to the contrary, Tesla's 2015 Q4 earnings release made very clear that the Model X hasn't really entered mass production. This calls into question Tesla's (NASDAQ:TSLA) guidance for 2016 and production expectations. Tesla investors should be very worried.
Source: Tesla Motors
Model X Dissembling
Even more alarming than miserable financial performance of Tesla for the December quarter, was the dissembling regarding Model X production. In the investor letter Tesla revealed that it had delivered just 206 Model X vehicles for the entire quarter, despite claiming that it had "started volume production." Those with a background in manufacturing will recognize that this isn't mass production. This is hand production.
But wait, it gets worse. In January, Tesla allows that this massive production output was "limited for a period of time." My reading is that production was shut down yet again in order to install fixes that hopefully would get the car into true mass production.
During the conference call, Tesla management allowed that in retrospect, Model X should have been approached differently, with fewer new features and technologies.
In retrospect, it would have been a better decision to do fewer things with the first version of Model X, and then roll in the capabilities and features on new technologies over time, in subsequent years. So I do think that there was some hubris there with the Model X.
So the net result, however, is that I think the Model X is an amazing car. I honestly think it's probably the best - I mean, I think it's the best car ever. I'm not sure anyone's going to make a car like this again. I'm not sure Tesla would make a car like this again.
Is Tesla even making the car now? According to Jeffrey Straubel, CTO, the production challenges in Q4 "have really been largely overcome today." Largely is not completely, and such qualifiers kept cropping up repeatedly.
I've seen this phenomenon before in engineering. A design for a particular system will get committed to, and then when it doesn't work out, the band-aids come out, because by this time it's too late for anything else.
According to Tesla, seals around the massive front windshield had to reworked by hand until the seal could be redesigned. And of course, we now know courtesy of the Wall Street Journal that Tesla had to drop its German supplier of the falcon wing doors last May and find a new one. This led to a lawsuit by Tesla against the supplier, Hoerbiger Automotive Comfort Systems.
Supposedly, the doors are no longer a production bottleneck. That doesn't mean they actually work as advertised. During the conference call, Tesla received a pointed question about why there haven't been any reviews of the Model X by the major automotive magazines. The response is that Tesla has been deliberately trying to "suppress demand" due to the fact that it couldn't supply that demand. I suppose that's plausible. I'll believe that the doors work when the cars are finally reviewed, which Tesla management indicated would be available "next month." Don't hold your breath on that one.
Financial Happy Talk
Long-time Tesla critic and SA contributor Anton Wahlman has termed Tesla's contrived financial metrics as "Happy Talk." I think it's an apt description, unfortunately. The centerpiece of Tesla's shareholder letter is this graph that claims that "Cash Flow from Core Operations" jumped appreciably in Q4.
I've looked at how Tesla calculates this interesting non-GAAP metric, which is shown on page 15 of the shareholder letter. The key improvement between Q3 and Q4 is cash flow used in operations, which went from $203.3 million to just $29.85 million in Q4. Tesla does not provide any detail for how the cash flow used in operations was arrived at. As far as I can tell, it appears to be simply wrong. If anyone has any additional insight into this, please contact me and share your thoughts.
Apart from this non-GAAP metric, Tesla's financial situation shows little improvement. While total revenue continues to grow nicely y/y by 25% to $1.117 billion, operating loss increased even faster, by nearly 250% y/y to $260.3 million. Even folding in the gross profit deferred due to lease accounting of $124.2 million doesn't help all that much. GAAP loss per car in Q4 stood at $18,331.
Gigafactory and Model 3
During the conference call, Tesla management more or less confirmed my take on the Gigafactory. Musk confirmed my take on the Nevada incentives, that they are proportional to activity at the plant. The full $1.3 billion in tax incentives would be for the plant producing about $100 billion in revenue.
I was also interested to hear any information concerning the final planned size of the Gigafactory. Musk did state that it will eventually be the largest footprint building in the world. So clearly, there are plans for expansion beyond the current size, but Musk didn't specify when the building would reach that size.
I believe that this goal is considerably further away than 2020, and assumes a larger production capacity than the planned target of 50 gigawatt-hours of packs in 2020. Based on the analysis that I discussed in the Gigafactory article, I continue to expect that the factory is right-sized for Tesla's near-term (3-5 year) needs.
Obviously, there's a lot of uncertainty including areas such as battery cell design, how much capacity will be needed by Tesla Energy and Model 3 production, and the relative ease with which the factory can be expanded. Bottom line is that concerns about sizing of the Gigafactory have been red herrings in my view.
For the Model 3 unveiling on March 31, I expect we'll see a working, drivable pre-production prototype that will look very close to the final version. Given that Tesla seems to have learned from the Model X experience, I consider the plan for Model 3 deliveries to begin in late 2017 to be reasonable.
Tesla was also asked about possible competition from the Chevy Bolt. Tesla management confirmed my take on the Bolt, that Model 3 will be aiming for a much higher market segment. Specifically, the Model 3 was compared to the Audi A4. The positioning of the Model 3 as a premium compact car along with the Model S as a premium sedan is exactly what I expected.
Tesla's sales performance against premium sedans in the U.S. and worldwide confirms that the key appeal of the car is its superior user experience, as I have long maintained. For this reason, declining fuel prices haven't really affected sales. Buyers of the Model S aren't concerned with saving money on gas. This will be true of the Model 3 as well.
Tesla's projections of being cash flow positive and profitable (non-GAAP) for 2016 appear to be predicated on achieving high rates of Model X production. Despite the Q4 financial performance, the projected financial performance may be achievable if the production goal can be met.
If Model X really can get into mass production, then Tesla has a chance. If we see further delays for the Model X, then I wouldn't want to be a holder of Tesla under any circumstances. Presumably, we'll know in the next month or so (by virtue of reviews of the X) whether the production problems have been solved.
Tesla has always had something of the nature of a value-based investment, similar to SolarCity (SCTY). You're buying the stock as much to promote the values of automotive electrification as to make money on the stock. Giving Tesla the benefit of the doubt on Model X production, I still rate the stock a hold. But if Model X production falters, this will change to a sell.
Disclosure: I/we 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.