Tesla May Be At A Significant Battery Cost Disadvantage

|
About: Tesla, Inc. (TSLA), Includes: GM, LGCEY, LGCLF, PCRFF, PCRFY
by: EnerTuition
Summary

Replacement battery pricing from GM indicates that GM battery costs may be significantly below that of Tesla.

With Gigafactory ramp and absorption overhead, and with China CATL getting aggressive, we predict Tesla cost disadvantage will increase over time.

Forget about cost advantage, Tesla may not even be competitive in the battery space going ahead.

As GM's (NYSE:GM) Chevy Bolt volumes start ramping, the car is becoming more widely available. GM now expects that the Bolt will be available across the US by August of this year, about a month ahead of its planned schedule. This is good news for GM as Tesla (NASDAQ:TSLA) is generating an enormous amount of hype around its supposed Model 3 introduction in July.

CEO Elon Musk has repeatedly guided investors to about 1,000 units a week in production starting July and ramping by about 1,000 units per week in each subsequent month and getting to 5,000 units per week by the end of the year. However, the status of the manufacturing facilities indicates that no volume production is possible for the next several months. At best, we expect Tesla to hand build tens of cars a week at launch in July. This prototype build may keep the myth of Model 3 production going but will cost Tesla several tens of thousands of dollars extra for each incremental unit. To cut the losses, Tesla will likely sell the most highly appointed cars at the beginning.

Given Tesla is planning on phasing in AWD models several months after introduction, we suspect that initial Model 3 builds will sport 75 kWh batteries, Enhanced Auto Pilot, premium paint, and some high end interior trims. This configuration could push up the Model 3 price at launch in the $45,000 to $50,000 region.

A slow Model 3 ramp would be good news for GM. By making the Bolt widely available across the country around Model 3 launch, the company can cash in on the excitement around Model 3. For some Model 3 reservation holders, the slow Model 3 ramp, the likely sticker shock, potentially high insurance premiums, and the impracticality of the vehicle may make the Bolt an attractive alternative.

As GM ramps the Bolt, the company is also starting to make replacement parts for the Bolt available to its dealers. One such replacement part that GM made available is the Bolt's 60 kWh battery. As can be seen in this article at Green Car Reports, Chevy Bolt replacement battery is listed at $15,734.29.

Because of the long battery warranty that comes with the vehicle, very few outside of insurance companies are likely to pay for these replacement batteries for many years to come. Nevertheless, the price provides a good insight in to the likely cost of Bolt batteries.

In this case, note that GM's wholesale price to dealers is likely to be well below the advertised retail price. For example, a GM parts retailer has put the part for sale at $11,674.84. If we assume that this retailer is making a meager 5% to 10% margin on this part, GM is likely wholesaling the part for no more than $11,000.

Typically, replacement parts are high margin business to brand names as the demand is largely captive and is at low volumes. Margins in the 25% range are common. A 25% margin would mean that the battery cost to GM is around $8,250. If we err on the conservative side (a case in Tesla's favor) and assume that GM is only making a 10%, that would put the cost of the battery to GM at $9,900. While margins higher or lower than this range is possible, for rest of the analysis, we will assume that GM's battery cost is in the range of $8,250 to $9,900.

Note that the Bolt batteries are rated at 60 kWh even though their actual capacity is likely to be higher by about 5% or possibly more. Nevertheless, for this article, we will assume the battery size to be 60 kWh. This battery size implies that GM's battery pack cost is in the range of $138 to $165 per kWh.

This is a stunning range and well below any analyst prognostications we have seen to date. While the low end of the range appears somewhat unrealistic given the last GM disclosed cell costs of $130 per kWh, the high end of the range certainly appears to be reasonable. (For reference, we have modeled GM's battery costs at $170 per kWh). To err in favor of Tesla, we would estimate that GM's pack level costs are closer to the high end of the range at $160 per kWh.

What does this mean to Tesla?

Not very good news, we believe. Part of the Tesla myth is built around its supposed battery cost advantage.

The last known official number on Tesla battery costs comes from Jeff Evanston, VP of Investor Relations, and is supposed to be under $190 per kWh as of April 2016.

Could Tesla battery costs have decreased dramatically since April 2016?

Given Tesla's long-term procurement contract with Panasonic (OTCPK:PCRFY) (OTCPK:PCRFF), a modest 5% or 10% reduction is possible in the last 12 months or so, but a steeper cost reduction appears unlikely. Especially considering that Tesla has single sourced its batteries with Panasonic and considering that Tesla's Model S and Model X volumes have come below expectations (although we do not know if they are below contractual commitments to Panasonic).

A 5% to 10% cost reduction would put Tesla battery cost in the neighborhood of $170 to $180 per kWh at the pack level. This implies that Tesla may be paying about $10 to $20 per kWh more for its batteries than GM. This would also explain why LG Chem (OTC:LGCEY) (OTC:LGCLF) has been racking up design wins in the EV space ahead of Panasonic. Tesla's cost disadvantage is not just against GM but is likely to extend to its peer group.

While we have long suspected that LG Chem has a superior cost structure over Panasonic, this is the first time that we are able to crystallize this advantage with information available in the public domain.

Looking ahead, the next 12 months are likely to be challenging for Tesla as the Reno Gigafactory ramp will likely increase the company's per kWh costs due to Model 3 ramp issues. Note that this is happening at a time when the industry is continuing to drive battery costs down. CATL from China appears to be very aggressive in gaining market share and it would not surprise us if CATL has already started or will start pricing its batteries below LG Chem.

Based on the above analysis, assuming 60 kWh batteries, we estimate that Model 3 will be burdened by about $600 to $1,200 in 2017 and the burden is likely to grow in 2018. Tesla will likely see improvement in battery cost trends once the Gigafactory fully ramps in 2019 but by that point in time the battery industry will be even more commoditized driving out the margins in the battery business.

In addition to higher battery costs, we estimate that Tesla also will face significant headwinds due to higher material costs, labor costs, and warranty costs than its peers.

Overall, we see Tesla's cost disadvantage per unit compared to its peer group to be about $5,000 a unit in 2018. This translates to over an effective 10% hit to Tesla at the gross margin level compared to its peers. Given this steep headwind, we are increasingly skeptical of Tesla competitiveness in the BEV space.

Forget about being a leader, we are skeptical that Tesla can even compete in the space. We predict that Tesla's Reno Gigafactory will not be cost competitive with its Asian counterparts and may need massive additional subsidies from government to survive.

Our View: Sell short.

Before it is here, it is on the Renewable Energy Insights subscriber platform. For timely and in-depth research and analysis of solar, wind, and battery industry stocks and developing news, please consider subscribing to our Renewable Energy Insights platform.

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.

Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.