Tesla's (TSLA) Model Y is years away, but we have to talk about it now. Why? Because it's rapidly becoming Tesla's next hope for achieving profitability.
As you most vividly recall, Tesla's strategy was to have the Roadster (2008-2012) profits pay for the Model S (2012-current), whose profits would pay for the Model Y (2015-current), whose profits would pay for the Model 3 (2017-current).
Well, none of that happened. There were no profits for the Roadster, Model S or Model X. None of those models paid for anything - other than enabling Tesla to issue more shares and take on $9.4 billion worth of long-term debt as of December 31, 2017. Capital raises paid for essentially everything. And in 4Q 2017, Tesla's interest cost had swollen to $4,884 per car sold - up from $4,481 in the prior quarter.
What the Roadster, Model S and Model X had in common is that they were all relatively expensive vehicles. To be sure, the Model S and X were less than the Roadster, but the cheapest Model S now starts at $74,500 (perhaps not including the $1,200 destination fee).
The Model 3 changes all of that in a meaningful way. Currently, the cheapest Model 3 being delivered is $50,000. including destination fee. On the horizon just before 2018 draws to a close, will be the $36,000 version.
However, in Tesla's 4Q 2017 earnings report last week (here), it guided to a third consecutive quarter of negative gross margin for the Model 3: "We are expecting a negative Model 3 gross margin in Q1…" That's despite hitting a run-rate of 2,500 vehicles per week for the Model 3, which would be higher than for the Model S and Model X combined.
If Tesla can't get to positive Model 3 gross margin at that production level, can it ever? This can of course be debated, and I discussed my take on this in detail on December 26: here.
Bulls will of course argue that March 31, 2018, is the precise inflection point at which Tesla goes from negative gross margin to magically breaking into positive territory. Fine. I'm not going to argue that Tesla can't ever get to positive Model 3 gross margin. In fact, I think it's likely that it does, whether in 2Q 2018 or later. The question is only how soon, and to what degree. Management has guided to 25% Model 3 gross margin and suggested that this will be achieved in 2Q 2018. I'll take the other side of that bet, but we'll find out some time around August 1, when 2Q is reported.
This brings us to the Model Y.
With the Model 3's profitability - or even ability to achieve any positive gross margin, ever - in doubt, it should come as no surprise that on the 4Q conference call last week, Tesla's management tried to turn the focus to the Model Y.
We learned from the 4Q 2017 conference call that:
We would see the Model Y in concept form 3-6 months from now.
We would learn the manufacturing plans/location of the Model Y 3-6 months from now.
Tesla hopes to make 1 million Model Y units per year.
Here are three things where I agree with Tesla and its stock bulls:
Yes, we will see the Model Y in concept form 3-6 months from now.
Yes, the product is real and it will look absolutely great!
Yes, Tesla will likely announce manufacturing plans for the Model Y.
However, that still leaves us with two essential questions that we sure would like to know some time before that magic moment Tesla has promised us for 3-6 months from now - an eternity in the stock market:
Where will the Model Y be made?
How soon can proper volume production be underway, post beta testing?
In terms of Model Y factory location, the company has been very clear about the fact that the Fremont, California, factory is fully occupied with Model 3 growth, and therefore cannot be used for Model Y. That leaves us with a few possibilities:
Use space inside the existing Tesla site near Reno, Nevada.
Use space inside the existing Tesla site near Buffalo, New York.
Build a new factory in the U.S.
Build a new factory in Europe.
Build a new factory in China.
For a moment, I'm going to leave aside assuming too much specifically about Tesla's talk on the conference call about making 1 million Model Y units per year. Such talk leaves automotive industry watchers baffled, because it would mean that such a facility - let alone making only one vehicle - would be the largest in the world.
To wit, the largest automotive factory in the world is considered to be Volkswagen's (OTCPK:VLKAY) Wolfsburg plant, which has been in operation since around the time of World War II. It makes approximately 920,000 cars per year, including Golf, Tiguan and Touran.
Mazda's (OTCPK:MZDAY) four factories, located in two clusters, in the broader Hiroshima-Hofu area in Japan, have a combined capacity of some 960,000 cars per year (4 x 240,000). They all make a long list of vehicles - essentially Mazda's entire product line.
The largest car factory in the U.S. is Nissan's (OTCPK:NSANY) plant in Smyrna, Tennessee. It produces approximately 640,000 cars per year - and six models at that, not just one. So that's an average of just over 100,000 per model, under one roof - Altima, LEAF, XC60, Pathfinder, Rogue and Maxima.
Volkswagen's plant in Mexico is of similar size to Nissan's Smyrna, Tennessee, plant. It also produces a long list of models, from Golf to Jetta, Beetle and Tiguan, among others.
From that standpoint, when Tesla says it will build one million cars under one roof - let alone a single model constituting the whole number - the listener's antennas and filters should perk up and question whether any of this is remotely realistic.
But leaving that one-million annual volume aside, where would this production occur? I'm asking and answering this not assuming one million cars per year, but just as well in the context of a regular automotive plant, which is typically operated around 240,000 units per line, per year, using the maximum amount of overtime. That's 200,000 per year normally, plus 40,000 with overtime.
What Tesla may be saying is that it will put four of those plants side-by-side, conceptually under one roof. It does not matter for the purposes of the conclusion of this article whether Tesla does any particular version of this. It could build only one of these, up to four side-by-side, or spread out four of these between locations in the U.S., Europe and Asia. So let's not get hung up over those details, even though they are interesting to discuss, and to be put in context when compared with other automotive factories around the world.
With that in mind, let's discuss the basic alternative of Tesla doing this inside one of its own facilities, or whether to build a greenfield site.
Inside the Nevada Gigafactory
Located a little bit outside Reno, Nevada, the Tesla Gigafactory remains under construction while it is plagued by Panasonic's battery cell production, and Tesla's own module and pack assembly issues. Surely these production issues will be resolved soon enough.
The benefit of Tesla's Nevada site is a combination of taxpayer incentives and its sheer size. Tesla gets subsidized electricity (which is why you don't see the factory roof filled with solar panels - otherwise a natural in the Nevada desert) and the buildable square footage of this site is about as large as any building on Earth.
Simply put, there's the sheer size - and taxpayer incentives - to fit an automotive factory on that site, size-wise. Let's not argue at this point whether it's for a 240,000 a year unit production or 960,000. Many of the considerations below are the same either way.
The downside of the Nevada site comes down to two issues:
The closest automotive factory of any significance is Tesla's own Fremont factory, followed by other company factories in Mexico, San Antonio, Dallas and Kansas City. We are talking about distances that range from 550 miles to 1,550 miles away from Reno, Nevada. Basically, building cars in Reno would be almost a little bit like building cars in Australia. Ford (NYSE:F) and GM (NYSE:GM) just closed down their Australian operations after the better part of a century making cars there.
It is not impossible for Tesla to build the Model Y in Reno, Nevada. It could be done, and I would not bet against it. But just ask yourselves: Why aren't other automakers building their new automotive assembly plants in the middle of the Northern Nevada desert and mountains? What do they know that Tesla doesn't? Again, this is not impossible, and it could be part of Tesla's future Model Y.
Northern Nevada is a fine place to live. However, for what it's worth, it does not have a huge pool of available and experienced automotive labor. Of course, it's possible for people to move there, and for Tesla to recruit from the nearest defunct Sears (NASDAQ:SHLD) and Macy's (NYSE:M), as well as from the unemployment ranks. In fact, it would be a good thing in the long run, at least for Northern Nevada's economy.
However, it is also a difficult thing for Tesla to accomplish, especially in the short-to-medium run. Does Tesla want to stake its Model Y future on finding this much of the right kind of labor in this location?
Building a new site: U.S., Europe and/or Asia
The most obvious way for Tesla to proceed with the Model Y would be to build one or more greenfield plants in the U.S., Europe and/or Asia. Perhaps instead of building all of these million units per year under one roof, it will spread out these factories across multiple continents, each making nearly a quarter million.
Let's take the U.S. as the prime example. There are three brand-new large automotive factories under construction in the U.S. right now, in various stages:
Volvo (OTCPK:GELYF) in South Carolina (will make the S60 and XC90).
Mercedes (OTCPK:DDAIF) in South Carolina (will make Sprinter work vans).
Toyota (TM) and Mazda in Alabama (will make Corolla and a Mazda SUV).
So how long does it take from announcement until proper volume production of a new vehicle in an all-new greenfield plant? Well, the answer to that question depends more than a little bit on when that announcement is made in the process. Has the company figured out the supply chain? Has the company negotiated with the state about incentives and building permits, including environmental permits? Those things could take many months, or even a couple of years in some instances.
Let's take the example of the new joint Toyota-Mazda plant in Alabama. It was announced on January 10, 2018: here.
Production is to begin by 2021, according to the press release. Keep in mind that these are two of the most experienced automakers on Earth. They make a combined almost 12 million vehicles per year already, with manufacturing sites on all major continents. Each company has been international players for at least approximately 50 years. Their manufacturing skills are legendary.
In the case of Toyota (NYSE:TM) and Mazda, it will take them three years - from a January 2018 announcement until proper volume production by 2021 - to make this happen. And this is nearby another major Toyota facility which already has a well-developed supplier base.
In other words, in the case of this Toyota-Mazda factory in Alabama, all conditions for a swift factory start are present:
Established supply base (logistics).
Located very close to an existing automotive final assembly plant.
Tesla is at a disadvantage because it will be lacking anywhere from one to three of those factors.
And the clock is ticking! With Tesla announcing plans 3-6 months from now, working from the Toyota-Mazda analogy, wouldn't it be reasonable to assume that 2022 would be just as likely as 2021 for Tesla to get the Model Y off the ground in terms of volume production?
Back to the Gigafactory for a moment: Does this timeline change if Tesla decides to make the Model Y inside the Reno, NV, factory? Yes, it most likely does. It could speed the construction phase along perhaps as much as 12-18 months. We could be looking at initial beta-test production by the second quarter of 2020.
Why? Because the basic shell of the factory already is up and can be expanded quickly given the site preparation already in place.
In such a scenario, the Tesla Model Y could begin preproduction and beta testing by the middle of 2020. With most automakers taking 12-15 months to work out the kinks after that point, that still puts Tesla proper volume production well into 2021. That is, unless it wants to use its customers as beta testers. One would have thought that Tesla might have learned to avoid that by now.
Message to Tesla investors: Don't expect meaningful Model Y volumes until well into 2021, at best. And that's before taking into consideration that Tesla must raise the money necessary to finance such a new production capacity, to begin with.
Model Y competition: Yes, it will be available before the Model Y
With the Model Y not in serious volume production until 2021 at best, who will be the competitors arriving in U.S. showrooms before the Model Y? This is important because it would be unusual for Tesla to be the last to market with a new kind of electric vehicle.
After all, the Tesla Roadster (2008) had no peer when it entered the market. It still doesn't have one. The Model S was the first of its kind in 2012 - and it too still doesn't have a direct competitor. The Model X, 2015? Same thing there. The Model 3 was beaten to market by only one car, the Chevrolet (GM) Bolt EV, but generally speaking as of February 2018 the direct competitive landscape for the Model 3 remains benign.
With the Model Y (2021) that all changes. Here's the list as it exists today:
July 2018: Jaguar i-Pace
November 2018: Hyundai Kona EV
November 2018: Kia Niro EV
January 2019: Audi eTron
May 2019: Buick Crossover
June 2019: Volvo Crossover EV
August 2019: Mercedes EQC
October 2019: Audi eTron Sportback
November 2019: Mazda Crossover EV
April 2020: Ford Crossover/SUV EV
May 2020: BMW X3 EV
June 2020: Mercedes EQA
July 2020: Volvo/Polestar Crossover EV
August 2020: Volkswagen ID Crozz
September 2020: Maserati Crossover EV
October 2020: Nissan Crossover EV
November 2020: Cadillac Crossover EV
January 2021: Mercedes EQE
February 2021: Genesis Crossover EV
March 2021: Infiniti Crossover EV
In the interest of space and time, I will stop right there. That's a list of 20 more or less directly competitive vehicles, aimed straight at the Tesla Model Y and likely being in volume production before the Model Y. A fuller list, based on what we knew in September 2017, was published here. It should be obvious that this list keeps evolving as we find out new product plans almost every day.
The final Model Y-competitor list, by the middle of 2021, will be a lot longer. It will include more entries from the companies already mentioned, but also Honda (NYSE:HMC), Acura, Land Rover, Subaru, Mitsubishi (OTCPK:MMTOF) and others. I would be surprised if there were fewer than 30-40 competitive cars by the second quarter of 2021, all in the same general class as the Tesla Model Y.
Then what? Here's what: It won't matter if the Tesla Model Y is a most fantastic car. It certainly will be. The whole space will be so commoditized that hardly anyone will be making money. At a minimum, profit margins will be thin indeed. Input into your Tesla discounted cash flow analysis accordingly.
Disclosure: I am/we are short TSLA.
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.
Additional disclosure: At the time of submitting this article for publication, the author was short TSLA and long GM. However, positions can change at any time. The author regularly attends press conferences, new vehicle launches and equivalent, hosted by most major automakers.
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.