Tesla's Q3 Could Be Beautiful, But The Stock Isn't Marriage Material

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About: Tesla, Inc. (TSLA)
by: UncleBrian Research

Summary

Tesla met its delivery guidance for production and deliveries in Q3. Making some reasonable assumptions, we can estimate that Tesla is poised to show 80% automotive revenue growth vs. Q2.

I also consider it likely Tesla beats guidance on Model 3 margins due to the mix of all-wheel drive (AWD) and Performance variants sold during the quarter.

Q3 and Q4 earnings may surprise in positive way, but is the revenue growth rate that supports the share price sustainable?

On October 2, Tesla (TSLA) announced its production and delivery numbers for the third quarter. Production and deliveries both were in line with guidance, which I consider bullish news, despite the herculean effort required to pull it off. In fact, based on my estimates of the likely mix of vehicles sold during the quarter, Tesla could show automotive revenues in excess of $6B, an 80% increase over Q2.

For a stock that trades on its growth multiple rather than profitability, I take this is as very bullish news, and would not be surprised to see a share price rise when Tesla reports its Q3 earnings.

Based on the VIN registrations, tracked by Bloomberg and @Model3Vins, with the data compiled by the incomparable chartist @TeslaCharts, we can see that the overwhelming majority of new VIN assignments in Q3 were AWD models.

With a base price of $55,000 for the AWD long-range battery, and $64,000 for the Performance model, it is safe to assume that the average selling price for Model 3s in Q3 will be somewhat higher than Q2. What that means in future quarters for Model 3 ASP remains to be seen, as some speculate Tesla has pulled forward demand for its highest-priced and highest margin models in an attempt to show strong Q3 numbers. But we are taking a bullish look at the numbers right now, so we’ll save that conversation for later.

Since we know the delivery numbers for Model 3, S, and X, we can begin to estimate what automotive revenue might look like for the quarter. If we assume an average selling price (NYSE:ASP) of $60,000 for Model 3, and $100,000 for Models S and X, we get the following basis for automotive revenue:

Units ASP Total Revenues
55,840 $60,000 $3,350,400,000
14,470 $100,000 $1,447,000,000
13,190 $100,000 $1,319,000,000
83,500 $6,116,400,000

Model 3 revenues alone in Q3 could approach total automotive revenue in Q2, with X & S sales contributing to revenue growth of over 80% compared to Q2 ($3.36B). Because of the higher margin Model 3s being sold more heavily in the quarter, it is also reasonable to assume Tesla can beat its guidance of 15% gross margins on the Model 3 and achieve closer to 20%.

Units ASP Total Revenues Margin Gross Margins Cost of Revenues
55,840 $60,000 $3,350,400,000 20% $670,080,000 $2,680,320,000
14,470 $100,000 $1,447,000,000 25% $361,750,000 $1,085,250,000
13,190 $100,000 $1,319,000,000 25% $329,750,000 $989,250,000
83,500 $6,116,400,000 22.26% $1,361,580,000 $4,754,820,000

ZEV credits are still a wildcard. There is strong evidence that the market for ZEV credits has softened, but we will assume for this model that Tesla is able to generate $200M in 100% margin ZEV credit revenue, bringing total automotive revenue to $6.3B, gross margins to 24.72%, and total automotive gross profit to $1.561B.

If we take Tesla’s guidance that operating costs will be flat compared with Q2, and we do the same for Services & Other, Energy Generation and Storage, and net interest expense, we have a Q3 income statement that looks something like this. All historical numbers come from Tesla’s own filings, available on its investor relations site.

Automotive Revenues

$6,316,400,000

Energy generation and storage

$374,408,000

Services and Other

$270,142,000

Total Revenues

$6,960,950,000

Automotive Cost of Revenues

$4,754,820,000

Energy Generation and storage

$330,273,000

Services and Other

$386,374,000

Total Cost of Revenues

$5,471,467,000

Gross Profit

$1,489,483,000

Research and Development

$386,129,000

SG&A

$750,759,000

Total Operating Expenses

$1,136,888,000

Interest Income

$5,064,000

Interest Expense

-$163,582,000

Net Profit

$194,077,000

Again, this model assumes Tesla’s guidance regarding operating costs is accurate and Model 3 ASP and margins surprise a bit to the upside. It also assumes $200M in regulatory credit revenue, which isn’t a given. But those assumptions come with some challenges.

Problems with the Model as Presented

There are definitely a few issues with these assumptions. First, if the ZEV credit market is truly as soft as has been reported, then the entire net profit for the quarter could be wiped out by that factor alone. If ASP for the Model 3 is $58,000, rather than $60,000, another $100M is gone. And if Tesla only achieves its guided margins of 15% on the Model 3, net profit takes $95M hit.

There is also the issue of the line item Tesla calls “Services and Other”. Watching this number over the last few years has been interesting, to say the least. The gross margin for this category has followed the following trend:

This dramatic falloff from essentially a break-even operation to one generating non-trivial losses has led some analysts to believe Tesla is placing costs that belong in automotive COGS, such as having service centers fix manufacturing defects, into the Services and Other segment. Regardless of the reason, the first half of 2018 has already exceeded the losses in all of 2017, which was a dramatic fall-off from the two prior years. If this segment is being used to house the costs of remediating manufacturing defects at the service centers, we can expect this loss area to accelerate in Q3 and Q4.

But the most difficult assumption to justify in the model is that Tesla’s operating costs will not increase, despite a doubling of delivery volume and 80% increase in automotive revenue. To date, Tesla has shown a remarkable inability to gain significant operating leverage in the Sales, General, and Administrative expense portion of the income statement.

If we assume SG&A holds steady in Q3 compared with Q2 per management guidance, we would expect an SG&A per vehicle sold number of $8991. However, the number has hovered consistently between $18,000 and $24,000 in every period since 2014, despite a 5-6x increase in delivery volume over that same period.

At this point, I do need to remind readers that this metric is not perfect in a vacuum, because the SG&A costs in 2017 spiked due to additional costs from the now absorbed SolarCity. The relative improvement between FY2017 and 1H2018 is significantly impacted by the 9% workforce reduction announced earlier in the year, and the combining of Tesla Motors and Tesla Energy sales personnel: the “synergies” that Elon Musk promised as justification for the merger.

Period

SG&A/Vehicle

FY2014

$19,070

FY2015

$18,233

FY2016

$18,800

FY2017

$24,038

1H2018

$20,321

What is remarkable is how range-bound this number is, despite increasing production and delivery scale. FY2016 had nearly 2x the delivery volume of FY2014, but nearly identical costs per vehicle. If we break out 1H2018 into its respective quarters, Q2 2018 saw SG&A per vehicle of $18,428. The 40,740 deliveries in that quarter extrapolate to an annual run rate of over 160,000 vehicles/year, but the SG&A per vehicle is nearly identical to 2015, which saw 50,580 deliveries.

If we generously assume that Tesla can break this range-bound pattern and get its per delivery SG&A costs to $12,000, this represents an overall SG&A cost increase of only ~33%, despite the doubling of unit volume. Now our income statement looks a little different, even with all the other generous assumptions

Automotive Revenues

$6,316,400,000

Energy generation and storage

$374,408,000

Services and Other

$270,142,000

Total Revenues

$6,960,950,000

Automotive Cost of Revenues

$4,754,820,000

Energy Generation and storage

$330,273,000

Services and Other

$386,374,000

Total Cost of Revenues

$5,471,467,000

Gross Profit

$1,489,483,000

Research and Development

$386,129,000

SG&A

$1,002,000,000

Total Operating Expenses

$1,388,129,000

Interest Income

$5,064,000

Interest Expense

-$163,582,000

Net Profit

-$57,164,000

And, if we further assume this number stays closer to its historical range at $16,000/vehicle:

Automotive Revenues

$6,316,400,000

Energy generation and storage

$374,408,000

Services and Other

270,142,000

Total Revenues

$6,960,950,000

Automotive Cost of Revenues

$4,754,820,000

Energy Generation and storage

$330,273,000

Services and Other

$386,374,000

Total Cost of Revenues

$5,471,467,000

Gross Profit

$1,489,483,000

Research and Development

$386,129,000

SG&A

$1,336,000,000

Total Operating Expenses

$1,722,129,000

Interest Income

5,064,000

Interest Expense

-$163,582,000

Net Profit

-$391,164,000

Despite not being the profitable quarter Musk was targeting, compared to the $717M loss in Q2, even this outcome would mark significant improvement. It would certainly be a rare reversal in the accelerating quarterly loss trend as captured here by chartist extraordinaire @TeslaCharts.

I consider all of these potential outcomes somewhat bullish in the near-term for TSLA stock. Possible profits, or at least decreasing losses on increasing production and delivery volume, along with strong revenue growth, could all be catalysts to push the stock higher.

Long-Term Implications

We know that Tesla was pulling out all the stops to try to make this quarter profitable, because Elon Musk told us as much. What I have attempted to show is that even if Tesla didn’t quite make it to profitability, it almost certainly showed significant improvement over prior quarters. However, as referenced in @TeslaCharts’ graph above, this has happened before, and the results in future quarters were ugly, to say the least.

Returning to the earlier point that Tesla will almost certainly show an increased ASP and margin improvement on the Model 3, we have to wonder how long that trend can last. All Model 3s currently being sold are long-range battery models starting at $49,000, $55,000, or $64,000 without options. What is impossible to know, because Tesla is intentionally opaque regarding the matter, is how many long-range North American reservations are remaining.

Toward the end of September, Tesla began registering “European” VINs (vehicle identification numbers), so it is possible we will see international Model 3 deliveries begin in Q4. Should that happen, it is likely that Tesla will continue selling its highest-priced and highest-margin Model 3 variants in the near-term. This may allow Tesla to avoid the type of losses experienced in previous quarters, and possibly even achieve something close to profitability in Q4.

But the market for $50,000 vehicles is limited, and if Tesla wishes to continue its growth narrative and resulting stock valuation, the company will eventually have to produce the $35,000 variant. Musk believes that once Tesla achieves its target of 5k/week production, the company will be able to produce this variant and survive, though he acknowledged that was not possible until the production mark is achieved. And despite the “burst week” at the end of Q2, Tesla managed only 4100/week Model 3 production average in Q2 (53,249/13 weeks).

We can only guess (because Tesla won’t tell us) how many of the remaining Model 3 reservation holders are waiting for the $35k base model, but we can assume it is a sizable number, as it is the primary number Tesla has touted since it announced the Model 3 and presumably fueled demand for reservations. But even if Tesla is able to increase production and deliveries, while maintaining the high ASP due to international deliveries, the revenue growth is likely to stagnate somewhat in Q4.

Below is an income statement modeling 78k Model 3 deliveries (6000/week) at the same generous $60k ASP and 20% margins as this quarter’s projection. It also assumes Model S & X sales consistent with Q3 and the estimated ASP and margins. It adjusts the anticipated ZEV credit revenue to $50M, and assumes SG&A per vehicle sold at a generous $10k.

Automotive Revenues

$7,496,000,000

Energy generation and storage

$374,408,000

Services and Other

$270,142,000

Total Revenues

$8,140,550,000

Automotive Cost of Revenues

$5,818,500,000

Energy Generation and storage

$330,273,000

Services and Other

$386,374,000

Total Cost of Revenues

$6,535,147,000

Gross Profit

$1,605,403,000

Research and Development

$386,129,000

SG&A

$1,056,600,000

Total Operating Expenses

$1,442,729,000

Interest Income

$5,064,000

Interest Expense

-$163,582,000

Net Profit

$4,156,000

This model also results in slight profitability, albeit with some very generous assumptions, but the revenue growth slows considerably, and this is before Model 3 ASP begins its inevitable march downward. Again, Tesla’s stock trades on a valuation disconnected from profitability. The valuation comes from growth, and I anticipate growth is about to stagnate.

To make matters worse, if we assume the Fremont factory is ultimately capable of producing the 500,000 units/year that Tesla has targeted, and we assume operating leverage gets SG&A/vehicle costs down to $8,000 and Model 3 ASP drops to $50k but somehow maintains 20% margins, our income statement tops out at something like this.

Automotive Revenues

$7,816,000,000

Energy generation and storage

$374,408,000

Services and Other

$270,142,000

Total Revenues

$8,460,550,000

Automotive Cost of Revenues

$6,074,500,000

Energy Generation and storage

$330,273,000

Services and Other

$386,374,000

Total Cost of Revenues

$6,791,147,000

Gross Profit

$1,669,403,000

Research and Development

$386,129,000

SG&A

$1,021,280,000

Total Operating Expenses

$1,407,409,000

Interest Income

$5,064,000

Interest Expense

-$163,582,000

Net Profit

$103,476,000

These generous assumptions result in a model that is essentially as far as Tesla can go without additional factories.

Summary

What is clear is that Tesla isn’t going to be able to generate the type of profitability that would allow it to fund its own growth plans beyond 500,000/year. The rather optimistic models I used in this article don’t account for any increasing R&D expenses associated with developing the Model Y, Tesla Semi, Tesla Truck, or any other of Tesla’s ambitious plans.

Cash flow and profitability are certainly not the same thing, but the capital requirements to build new factories and deploy new products to continue demonstrating growth are going to be in the billions. Tesla is going to need to continue to raise capital, via equity or via debt (which it can ill afford), to keep the growth story going. The growth is already priced in, and the ability to access capital markets is not a given. If Tesla cannot continue to show growth, the share price will likely take a beating.

Because of its already inflated valuation, and sustained growth that isn’t guaranteed already priced in, I still don’t see Tesla as a good long-term investment. Aside from as a trading vehicle, the last four years have proven this supposition correct. Buy-and-hold investors from September 2014 ($286.04) to today, October 4, 2018 ($281.83) have achieved a -1.5% return over those four plus years. There are few places money could have been less well-placed during this raging bull market.

As a trading vehicle, I don’t pretend to offer advice on when to buy or sell the wild swings this stock can experience. Despite some short-term catalysts that I see as having the potential to move the share price higher, I maintain my bearish outlook on TSLA as a long-term investment.

I am not a financial advisor, and this article is not investment advice. It is merely my own musings based on my own research of Tesla and general interest in the story. Do your own due diligence and speak with an advisor before making any investment decision.

If you enjoyed this article, please don’t hesitate to click the “Like” button at the top of the comments section. You can also follow my occasional pontifications on Twitter @UncleBrianRsrch. For a more satirical (but still honest) take on Tesla, read my blog post here.

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.