Tesla's Most Important Vehicle

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About: Tesla, Inc. (TSLA)
by: Empire Investments

Summary

The Sedan market is diminishing every year, while the SUV market continues to grow.

The Model Y is Tesla’s cheaper version of the Model X. It is an SUV with similar specs to the Model 3.

The Model Y is likely to surpass Model 3 sales within its first year of production.

Surprisingly, the Model 3 isn’t Tesla’s (TSLA) most important vehicle. Expected to start production in 2020, the Model Y is Tesla’s most important car. Sedans have seen lower sales every year, while SUV sales continue to increase. In 2017, there were 14.92 million compact cars sold worldwide, while 27.85 million SUVs were sold worldwide. This isn’t to say that the Model 3 is failing by any means, or that sedans aren’t a viable car market, but SUVs will generate more sales for Tesla. The Model 3 has been good for Tesla, but if an “affordable” electric sedan can have this much success, imagine the potential of an affordable electric SUV.

Manufacturing

It’s not much of a secret that the Model 3 had a lot of issues when first appearing on the assembly line, so what’s to stop that from happening to the Model Y? the Model Y will be practically the same car as the Model 3, with the same powertrain, motor, and practically everything else. However, a change in the amount of wiring needed in order to create the car has been greatly reduced by 95% with Tesla’s homemade “flex circuit”, going from 1,500 meters in the Model 3, to only 100 meters in the Model Y. Less wires allows for a higher level of automation in the assembly process, and therefore faster assembly. This means that Tesla will be able to create Model Ys even faster than Model 3s, right as they enter production. Tesla has also discussed how it has taken its time when creating assembly line plans for the Model Y, planning to reduce all the factors that lead to a slow and costly production ramp with the Model 3. All of these factors contribute to the guarantee that the Model Y will be made without an unnecessary cash burn and can become mass market quite quickly.

The location of the Model Y production is another concern that has been voiced by investors and analysts of Tesla. Musk confirmed in the first quarter earnings call that the Model Y won’t be manufactured in the Fremont factory, so the question is where. Tesla has already stated that they plan to manufacture Model 3s and Model Ys at the Shanghai Gigafactory after it is ready for completion in, supposedly, about two years. In addition, many speculate that it will be produced in the European Gigafactory, of which very little is known - including when it will begin construction, or where in Europe it will be. Both of these factories are, obviously, outside of America, and Musk also wants to produce the Model Y inside of America. This would mean that Tesla is looking into building at least another factory, even more likely another Gigafactory, in America. This new Gigafactory would also most likely produce the upcoming Tesla Semi and Roadster, as Gigafactory 1 has already been filled to its maximum capacity. The location of the new American Gigafactory is going to be released in either the third or fourth quarter earnings calls.

Model Y Financials

Musk has predicted that Model Y will exceed Model 3 production, eventually reaching a million Model Ys annually, but with less CapEx, than it cost to get Model 3 production to half a million annually, by a factor of two. This would lower their CapEx per unit produced from its current $8,000, the highest of all car manufacturers, to $2,000 for the Model Y, a lower number than most other manufacturers.

Tesla has been expected to break the $100 per kilowatt hour (kwh) by the end of the year for its battery cells; it would be the first company to do so. The cost of manufacturing cars will decrease dramatically. Since the Model Y will be using the same batteries as the Model 3, with around a 50 kwh battery for the base model and around a 75 kwh battery for the extended range.

Tesla hasn’t released any specifics on its cost per kwh since 2016 when it announced $190 per kwh; while not confirming any specifics since then, they have assured the public that it has gone down significantly since then. Audi (OTCPK:AUDVF) recently announced that they will be able to produce battery cells at $114 per kwh, which is still very impressive as the Chevy Bolt was previously the official lowest with $145 per kwh for their battery cells.

What we can gather from this is that, even if Tesla is currently producing at $114 per kph (which is unlikely), it would be saving $1,050 per car on extended range battery packs and $700 per car on the standard range packs once it hits $100 per kwh. These lower costs for battery production will be a great way for Tesla to further improve their operating margins. Tesla is looking to achieve a similar profit margin for both the Model 3 and Model Y, at around 14% per vehicle before the battery upgrades. When taking the projected average price of the Model 3 and Y of $42,000, the 14% profit margin would provide $5,880 on average per car, but then adding the battery savings with an estimated average of $650 for each battery, the total profit margin for each car is $6,530.

Since the Model Y is expected to have one million units produced every year, Tesla would achieve a $6.5 billion profit margin annually for the Model Y. This means that the Model Y would be contributing a $38.10 annual boost for Tesla’s EPS. The Model Y will have a significant effect on Tesla’s future valuation. By 2021, after the Model Y has been in production or over a year, Tesla could see a market cap of 75 billion, driven, in a large part, by the Model Y and Solar City. This market cap can be achieved through the high sales and profit margin of the Model Y; sales will be discussed further below.

A potential issue would be financing the project, but again, Tesla will be able to dramatically cut the cost of production for the Model Y. In addition, a capital raise of $2 billion shouldn’t be too hard as long as Tesla remains on its current path. This capital raise should be more than sufficient to cover the CapEx required for the initial production of the Model Y. After Model Y starts production, the Model Y should be able to pay for itself within a year, with its $6.5 billion annual profit margin. Tesla and Musk have both discussed their confidence to create the Model Y at the lower cost many times due to the many design improvements and production changes.

Market Potential

The Model Y is a member of the global best-selling car class, that is continuing to grow. China, the world’s largest car market, has its streets dominated by SUVs. SUVs made up 41.6% of all vehicles sold last year in China. The United States, the world’s second largest car market, has a slightly lower number of 39.3% of their cars sold last year as SUVs. Their market share also continues to grow, with an average annual growth rate of about 15% since 2014 and a total growth rate of about 50% since 2014. This growth shows no signs of stopping. In 2017, there were 26.68 million SUVs sold. That number is expected to increase to 50.95 million SUVs by 2023 with compact and electric SUVs expected to lead the charge; the Model Y is both a compact SUV and an electric SUV.

Source: JATO

Many car manufacturers have noticed this trend and have begun focusing more on their SUVs than their sedans. This means that Tesla will have a lot of competition to face in the SUV market. This sparks the question of how Tesla will fair against the increased competition, but it seems as of now that it will do quite well. First of all, it’s electric which narrows the competition considerably and gives Tesla a leg up. For America, the cheapest SUV will be Volvo’s electric XC40, expected to be around $50,000. The other four electric SUVs expected to give Tesla a run for its money are the BMW IX3, Audi e-Tron, Jaguar I-Pace, and the Mercedes EQC, with prices of these vehicles, for the base model, ranging from $68,000 to $78,000. The Model Y is expected to have the same pricing as the Model 3, with a base price of $35,000. Out of all of the previously mentioned vehicles, the Model Y has the second lowest range, BMW IX3 has the lowest, but with a long range battery pack, it would be tied for first with the Volvo XC40, but would still be $6,000 cheaper. No matter how it stacks up, the Model Y is still cheaper than other electric SUVs and doesn’t compromise performance for it.

The Model 3 was the fourth best seller out of all sedans sold in US the during the third quarter and was the only Electric Vehicle (EV) in the top ten and the only American made car in the top five. This high market position is before the Model 3 has even begun selling $35,000 base Model 3. Even with the high price difference, four of the top five cars traded in for Teslas have a price range of $19,000 - $29,000 with the exception of the BMW 3 Series - starting at $45,000. This means that Tesla has already been successful without their mass market $35,000 car, even when compared to other sedans marketed as affordable; SUVs tend to be more expensive than sedans by around $5,000 for the affordable models. With these factors in mind, the Tesla Model Y should be able to become one of the top five best selling SUVs in America.

China is a whole different game. They have an incredible amount of manufacturers, and almost all of them make an EV of some kind. This is where Tesla might seem to have lost its advantage. The BAIC (OTC:BCCMY) EX - Series was China’s best selling SUV and car in general for 2017 and is priced at $30,000 USD. But, for $5,000 less, the car is sacrificing some performance with only 155 miles of range, compared to the base Model Y with 220 miles of range. The BAIC EX - Series also has a max speed of about 77.7 mph, while the Model Y will likely have a similar top speed as the Model 3 of 140 mph for the base version. And, although style is objective, there is no denying that the Model Y is more stylish than the BAIC EX - Series (as pictured below). In addition, because China has so many customers, the Model Y would be almost impossible to be lost in the crowd.

Source: ChinaMobile (BAIC EX - Series)

Source: Teslarati (Note that this is an artist’s rendering and Tesla hasn’t actually released any photos of the full vehicle. This rendering was created using existing Tesla cars, and what has been released by Tesla of the Model Y.)

Predicting the Model Y’s market position in China is much more difficult, because only the Model X and S have been sold in China so far and still at a significant disadvantage; Tesla vehicles face a 40% import tariff and aren’t eligible for the 15% off MSRP for EVs because they aren’t produced in China. Model 3s and Model Ys will be produced in Shanghai once the Gigafactory is complete (as mentioned above), so they won’t have this issue. However, making an accurate prediction of where the Model Y would place in the Chinese market is impossible because of the lack of data around the subject. All that can be said is that it should be able to perform well, as mentioned above, but how well can only be told with time.

Overall, the Model Y is Tesla’s most important vehicle because it should be its best selling vehicle in the future. With the booming SUV market, and the low price and high performance of the Model Y, it should be able to thrive in all markets across the globe. The potential of the Model Y in regards to profitability and its overwhelming ability to sell has not yet been fully realized by most analysts and investors meaning now, as Tesla’s stock has dipped, would be the best time to invest.

Disclosure: I am/we are long 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.