A green Model S is appropriate, given that S margins will be seeing some green
Just recently, I published my article titled "The Same Low-Margin Tesla, Now For $6,500 Less." In that article, I described how the newly-launched Model S60 with the ability to upgrade later to 75kWh was a margin-destroying move for Tesla (NASDAQ:TSLA). And it was.
But, just 2 weeks later, Tesla has amended its hand. The Model S60 no longer has an option to "switch on" its 75kWh battery. Instead, there's a separate Model S75. This is a world of difference. The lack of an option to increase range later on forces the customer to do a worst-case analysis when initially choosing what model he's going to buy and live with. Under such a scenario, the adoption of the 75 version will be much, much higher than when the customer could choose later and fix any mistakes. We already know this because the adoption of the original S60 was pretty low.
This move, alone, was already a positive for Tesla for two reasons:
- First, because it saw its error and corrected it very quickly (2 weeks). This was faster than any other automaker would probably have fixed a similar mistake.
- Second, because fixing the error removes a margin-destroying error and creates a margin-improvement scenario.
It Gets Better For Tesla
It's not just that Tesla removed an obvious mistake and how fast it did so. It's also that there might be reason to believe Tesla stands on the verge of having visible margin improvement. You see, right after the Model S facelift, Tesla sold the 70 version with batteries that also had an option to "switch on" 75kWh of capacity. I believe this was not a coincidence.
Few will know, but while the 85 versions actually had well below 85kWh in battery capacity, the 70 versions had more than 70kWh in capacity. As such, it's possible and likely that the improvement from the nominal 70kWh to a 75kWh capacity was all due to a slight improvement in battery cell capacity. And furthermore, as Tesla gave it away by keeping the 75kWh capacity in the cars, this improvement likely came for free to Tesla (that is, Panasonic (OTCPK:PCRFY) is not charging more for the improved cells).
Thus, two things happened:
- With the facelift, Tesla increased prices by $1,500 for the Model S.
- And now, with the removal of the S60 mistake, Tesla put up a 75 option including an additional $3,000 for the extra 5kWh in capacity. Also, the movement from the 85D to the 90D versions was accompanied by a $3,000 price increase as well.
It's entirely possible, given these two developments, that Tesla will as a consequence enjoy something like a $4,000-$4,500 margin improvement for all Model S cars except the new S60. Tesla gives back $1,000 in the renewed referral program, but it still seems likely to keep $3,000-$3,500 in additional margin per Model S.
This margin improvement should start hitting during Q2 ($1,500 price increase; 90D), but be overshadowed by the lack of ZEV credits (it had $57 million during Q1) and Model X rework. By Q3, however, the margin improvement should be felt in its entirety. This margin improvement is the main reason I am going neutral on Tesla.
I'm going neutral because while Tesla's valuation makes no sense and its future remains challenged, it is too dangerous to sell short on valuation alone. A short seller also needs fundamental deterioration, and this margin improvement is the opposite of fundamental deterioration.
There are a couple of other effects to consider:
- The SolarCity merger is a clear negative, but the market is discounting that the deal might not go through.
- Tesla has an upcoming hype event on July 29, the opening of the Gigafactory. Often, these events lead speculators to buy ahead of them. When the event takes place, there's a sell the news reaction. But for now, we're ahead of the event, so this is a positive factor.
The Short Thesis Remains, But…
While I am going neutral on Tesla now, the overvaluation remains. Tesla is still likely to do badly as a stock over the long term. However:
- Selling short on valuation alone is too risky.
- Short-term fundamental deterioration is now unlikely, and margin improvement is likely.
- The short thesis is now entirely based on coming competition, but true competition will only arrive during late 2017/2018. That's too far away for it to influence most investors. A better timing will probably be had closer to that event.
- The Model 3 is still likely to be delayed but Tesla will only recognize as much at the last possible moment. Hence, this is also a 2017 catalyst.
- Tesla's rebate fee (the price of staying short) is again increasing, after a long while below 2%. This rate is now up to 9%/year.
I draw two main conclusions:
- Tesla is likely to show gross margin improvements by Q3 2016 at the latest, on account of price increases while enjoying stable to falling battery cell costs.
- It's my opinion that a neutral stance on Tesla is the best position for now given fundamental improvement and an upcoming hype event. Even if one wants to sell short Tesla, there are likely to be better prices available down the road (as long as the market stops falling, of course).
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.