Tesla's Model 3 Could Hit A Home Run In China

Summary

• Tesla Motors could hit a home run in China with the Model 3 as the vehicle is competitively priced not in just the EV segment, but also undercuts luxury vehicles.
• China has turned out to be the second-biggest market for Tesla for Model 3 pre-orders and this is not surprising considering the price point and the low booking price.
• Tesla is on track to set up a facility in China, which is a smart move as this will help it avoid import duties and also benefit from subsidies.
• Tesla has already proven with the Model S that it can eat into the full-size luxury sedan market, with sales outpacing the Mercedes S-Class in the U.S. last year.
• Mercedes owns 80% of the luxury car market in China, so Tesla’s Model 3 will allow it to gain share in this market due to lower pricing.

Toward the end of March Tesla Motors (NASDAQ:TSLA) unveiled its most affordable car so far, the Model 3. The company is offering a reservation for a down payment of roughly $1,000. As a result of the low booking amount for Tesla's most affordable car yet, the company has received almost 400,000 pre-orders.

The excitement is already evident with hundreds of Tesla fans across the U.S. and other key markets lining up outside dealerships even before the car was officially unveiled. This enthusiasm and the competitive pricing of the Model 3 helped Tesla achieve more than twice the pre-orders it expected. More specifically, Tesla's Model 3 seems to have struck a chord with the Chinese customers as China has turned out to be Tesla's second-biggest market in terms of pre-orders for the Model 3, even though the company did not reveal how many orders it has received from China.

So, what is it that has made the Model 3 click in China, and will the company turn this car into a success in the country? Let's find out.

How will the Model 3 fare in China's EV market?

Tesla has not been as successful in China as it has been in the U.S. The reason could be that Tesla's previous models have not been priced right so as to fall in the range of other electric vehicles that are on sale in China. For an electric car, the Model S and Model X have proved to be very expensive for most Chinese customers.

These two models start from a price of $70,000 to $80,000 and even go beyond the $100,000 mark. At such premium pricing, it is difficult to drive numbers in China even though the need for EVs in the nation is strong. At present, the short-range equipped and low-power cars are enough to serve the purpose of reducing air pollution in Chinese cities. That's why, even if a customer wanted to go electric in China, he or she preferred the cheaper and locally-made EVs such as the BYD Qin, which is priced at $23,000 right now.

The Warren Buffett-backed, Shenzhen-based automaker BYD dominates China's electric car market at the moment. It has an 18% share of China's new-energy vehicle market due to smart product development moves. For instance, BYD's new SUV that was unveiled at the Beijing show, known as the "Yuan," starts from 209,800 Yuan ($32,360) for the hybrid version.

However, with the introduction of Model 3, things are likely to change for the better for Tesla in China. It is priced at $35,000 for the basic model. So, Tesla has now become affordable for Chinese customers and will be in a much stronger position against the other EVs, which is why it has become the second-biggest market for the Model 3 after the U.S. in terms of pre-orders.

More importantly, Tesla is planning to produce the Model 3 for China in China itself. This will make the company eligible for local incentives in China and will thus remove the heavy import duty that it incurs on importing cars built in the U.S. The good part is that Tesla is already making progress on this front. Last week, Tesla President Jon McNeill visited China and commented that the company might build its next factory in China.

These comments are in line with what Elon Musk said earlier this year regarding securing a location and bringing a partner on board to start building a facility in China. Additionally, last month, it emerged that executives of the company have visited China to scout for locations in the Suzhou region. This is a smart move by Tesla as once it sets up the factory in China, the company will be able to bring down the price of its cars and make the Model 3 competitive.

Outpacing premium competition

There is another aspect to the Tesla Model 3. It is a complete car and not just a short-range EV. The Model 3 can be used for long distance journeys as well as for enthusiastic driving. It comes equipped with all the high-tech gadgets that are usually seen in the top selling luxury cars today. In that way, it is an entry-level luxury car too. So, it is necessary to consider the competition that it would provide to that class of cars in China.

The Model 3 is all set to compete against BMW 3 Series, the Audi A4, and the Mercedes C Class as far as features and performance is concerned. In fact, when we compare the price of these German luxury cars, the Model 3 looks like a better deal. According to Bloomberg, the Model 3 could make a mark in the entry-level luxury car class market. This is somewhat similar to what the Model S is doing in the full-size luxury car market in the U.S.

The following chart shows where the Model 3 is placed in terms of pricing when compared to the big three Germans and other luxury cars in the U.S.

Source: Bloomberg

As seen above, the Model 3 is cheaper than the BMW 3 Series and the Mercedes C-Class by almost 17%. The good thing is that Tesla has already proven itself by outselling the other full-sized luxury cars in the U.S. due to its relatively cheaper pricing. For instance, the Tesla Model S, which has an average price of $97,700, has overtaken the Mercedes S-Class, which costs an average of $106,400.

In 2014, the sales of the S-Class came in at 25,276 units and the Model S sold 18,480 units. In 2015, the Model S sold 26,566 units while the S-Class' sales dipped to 21,934 units. Thus, due to its cheaper pricing, Tesla can replicate the same success in the entry-level luxury sedan market. Moreover, once the company brings online its factory in China, it will be able to tap the same market in the country due to aggressive pricing, apart from the EV segment.

This is good news for Tesla's investors as the market for luxury cars in China is booming. For instance, China is the largest market for Mercedes across the globe and sales were up 24% in the recently-concluded quarter. In fact, it is estimated that sales of luxury vehicles in China will increase at a compound annual growth rate of 12% until 2020, which will be a tailwind for Tesla's Model 3 apart from the EV market's growth.

Conclusion

The Model 3 is priced very well and can help Tesla capture both the luxury entry-level sedan market and the EV market in China. In fact, in the luxury segment, it is one of the least expensive cars that makes it even more attractive. Thus, by all means, the Model 3 is going to give a tough time to the premium car makers in China, while a local manufacturing facility will help it receive the subsidies doled out to EVs in the country to make them more affordable.

Hence, Tesla could hit gold in China with the Model 3 as it is capable of taking down two targets with a single shot.

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.