Tesla: Overcoming Hubris

| About: Tesla, Inc. (TSLA)
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Summary

Tesla announced that it delivered 12,420 Model S and 2,400 Model X vehicles, well short of the 16,000 goal.

The shortfall in Model X deliveries was due to parts shortages, which it claims have been rectified.

Tesla has learned from Model X, and these lessons will be reflected in the Model 3 and Gigafactory.

In its 2016 Q1 deliveries announcement, Tesla (NASDAQ:TSLA) admitted to hubris in its expectations for Model X production. Despite the Model X shortfall, the admission was a good sign. Tesla's success as an automobile manufacturer may well depend on overcoming its hubris.

Kelty Image Source: Nikkei Technology

Turning the Model X Corner

Even Tesla bears, such as our own Montana Skeptic, were expecting Tesla to meet its delivery guidance, so I'm a little surprised that the bears haven't seized upon Tesla's stark admission concerning Model X production delays due to a shortage of critical parts:

The root causes of the parts shortages were: Tesla's hubris in adding far too much new technology to the Model X in version 1. . .

Tesla wouldn't say what parts were short, but did it really have to? It's obvious that the doors are still problematic. I found the 200/week Model X delivery rate encouraging nevertheless. This says that Tesla is at least out of the "hand production" stage and actually building Model X cars on its production line.

The announcement also stated that the parts problems had been solved and that production rate had ramped up dramatically towards the end of the quarter. We've heard that before, of course, but I think it's reasonable to expect that Tesla will continue to increase the production rate until it finally gets to the target 2000/week some time in Q2.

Model X production is absolutely critical to achieving Tesla's near-term financial goal of being cash flow positive this year. There's still risk. Tesla's Falcon Wing door supplier might decide that it can't make the doors profitably, forcing Tesla to either find another supplier or bring the work inside. This has already happened once, so it could happen again.

My assessment, based on the limited data, is that Tesla has turned the corner on Model X production. We'll probably hear more about that at Tesla's Q1 conference call. I'm sure analysts will want confirmation that the parts shortage has really been solved.

Model 3 Fervor

Tesla's delivery announcement was more or less completely overshadowed by the public interest in Model 3. Model 3 has exceeded my expectations in more ways than one. Tesla's Twitter announcement that it had over 325, 000 deposits for the Model 3 should lay to rest forever the myth of lack of demand for electric vehicles. There is demand for the right electric vehicle.

This is a point that SA contributor Anton Wahlman may have missed in his recent article. I always enjoy Wahlman's articles and recommend them to everyone, including Tesla bulls. Wahlman is the quintessential intelligent, articulate Tesla bear. In his article, Wahlman points out that Nissan (OTCPK:NSANY) also received a large number of deposits for the Leaf in 2010, and based on those deposits, expanded factory capacity to build 500,000 EVs per year. Wahlman was one of the depositors.

By the time Nissan started deliveries in 2011, many, including Wahlman were asking for their deposits back. Wahlman has a good point. There is a risk that many of those putting down a $1000 towards a Model 3 will change their minds.

But there are important differences. With its very limited range (~100 miles currently) and nothing equivalent to a Supercharger network, the Leaf wasn't a very practical car. Without a fundamental breakthrough in battery cost, Nissan was reduced to building a cheap car around an expensive battery pack. It was a terrible compromise that failed in the market place.

Tesla's vision for electric vehicles has always been bolder and more thoughtful. Rather than building a niche product that couldn't possibly replace the main family car, Tesla has gone for the family car sweet spot. Tesla, first and foremost, built an EV (in the Model S and X) that could be the principal family car. Even if not many families could afford Tesla's family cars.

With the Model 3, the economics swings dramatically in favor of much larger market demand. We should all have seen this coming, but I admit I didn't. Demand for the Model 3 is simply breathtaking. Now all Tesla has to do is deliver.

There's every indication, as I pointed out at the Model 3 unveiling, that Tesla has learned the lessons of the Model X. The Model 3 design is dramatically simpler and more straightforward. Model 3 has been designed to be producible and affordable.

Plenty More Hubris Where That Came From

Tesla's Gigafactory has always been, at the very least, enormously ambitious, if not an expression of hubris. Once again, I regard the scaled down size of the Gigafactory (in its current state) as a good sign that hubris is being reigned in. A good article by SA contributor Brian Morin featured his thoughts on a presentation by Kurt Kelty, Tesla's Director of Battery Technology.

This presentation was made recently at the International Battery Seminar and Exhibit. According to Morin, Kelty stated that cost reductions at the Gigafactory will stem from, among other things, a new form factor for the cells. Morin infers that the cells will still be cylindrical, but I don't concur on this point. As I've stated previously, I believe the economics of battery production clearly favor prismatic (rectangular) cells, and I believe that the "new form factor" is meant to confirm this. We'll see.

Kelty repeats the Tesla objective of a huge Gigafactory that will "be the second largest building in the world" by 2020, basically what we heard Musk say at the Model 3 unveiling. Frankly, I consider this more hubris. I really doubt it gets there by 2020, or even needs to in order to accommodate Tesla's production needs.

Investor Takeaway

Fortunately, I don't believe Tesla needs to produce 500,000 vehicles per year (or 35 GWh of battery packs) to be successful. If it did, I would have to rate Tesla a sell, because I don't think Tesla gets to 500,000 vehicles by 2020. Tesla will face increasing competition from traditional automakers, and this will probably serve to limit demand for Tesla's cars.

But the Model 3 deposits demonstrate that demand for the right EV is quite healthy, and I can easily see Tesla delivering 200,000 or more vehicles per year by 2020. This expectation is based on deliveries of Model S and X subsiding below 100,000 combined as Model 3 production ramps up. There will be some cannibalization.

With the Model 3 deposits, any near-term financial threat to Tesla has been removed. Unless Tesla falls on its sword with Model X production in some unforeseen way, I don't see a barrier to production of the Model 3. Tesla still has profitability and cost control issues. I don't see Model 3 profitability as a given.

I'm much more comfortable recommending Tesla as a hold, especially since the stock has recovered nicely from its February low. Has Tesla become a buy? There's certainly a reasonable case to be made that the stock is still overvalued, especially compared to the auto industry as a whole. The counter argument is that Tesla is a disruptive player that can't be evaluated by the yardstick of the conventional auto makers.

Maybe I'm behind the curve on this one and the Tesla bulls are absolutely right, but I'm going to hold off on a buy recommendation at least until after the Q1 earnings report.

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.

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