Tesla And The Governments

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About: Tesla, Inc. (TSLA)
by: Guy Whitehead

Summary

Tesla just turned in a brilliant quarter. However, future success is far from guaranteed.

Government policies could make the difference between global success or bankruptcy for Tesla or niche status which would destroy the value of the stock.

We look at government policies including company subsidies, customer subsidies, and tariffs around to world to assess their effects on Tesla. Often the effects of government policies on Tesla have.

This article only looks at government policies as they affect TSLA as a financial investment.  I am not discussing whether or not these policies are wise public policy or not.

Since its founding, Tesla has had a major and increasing relationship with governments.

Direct Payments to Tesla. These are government mandated transfers from some auto companies to others based on fuel consumption and greenhouse gases.

SInce its founding, they have contributed about $1.4 billion to Tesla’s revenue and net income (see here).

They were significant in the third quarter, providing 60% of Tesla’s net income since they are pure profit.

These were very important to Tesla in its successful Q3 2018. On page 41 of the 10Q report, “an increase of $169.4 million in sales of regulatory credits to $189.5 million in the three months ended September 30, 2018 as compared to the prior period. ZEV credits sales were $52.3 million and non-ZEV regulatory credits sales were $137.2 million in the three months ended September 30, 2018, compared to $0.6 million ZEV credit sales and $19.5 million in non-ZEV regulatory credit sales in the three months ended September 30, 2017.“

ZEV:

California and a coalition of 9 other states mandated ZEV credits which require Internal Combustion Engine manufacturers selling in those states to buy credits from EV manufacturers. These have directly contributed hundreds of millions to Tesla’s bank account and were crucial to its survival.

Some bullish investors believe that the fact that Tesla is generating more ZEV credits with its increasing sales means that Tesla’s income from ZEV credits will increase. However, the price has been dropping and while the theoretical value of a ZEV credit is $5,000, the market value has been less than a third that. Supply and demand suggests that the price of ZEV credits will drop further and may actually reach zero. The marginal price of ZEV credits beyond the number that ICE manufacturers are required to buy is zero.

Many shorts expected Tesla to sell up to $300 million of ZEV in the third quarter in a desperate attempt to produce a profit. In fact, Tesla succeeded terrifically on other fronts by actually making money by selling cars and cutting costs and did not need to sell any ZEV credits, although it certainly buffed the numbers. However, Tesla did sell $52 million in credits, all to Toyota. They likely did this because Tesla sees ZEV credits as a wasting asset. In California, the ZEV credit balance this year Increased from 468,000 to 815,000--an increase of 74%. Tesla only accounted for 45,000 of the 347,000 increase (source).

Bottom line: a ZEV glut is developing. This quarter Tesla didn’t really need the income. But if things get difficult in coming years, that ZEV income likely won’t be available.

In addition, both the Trump administration and Congress have been considering eliminating the states right loophole that enables some states to establish ZEV programs. If that happens, the door will be permanently closed on that source of income for Tesla.

GHG credits (Federal Green House Gas Credits)

These are rather similar to ZEV credits except that they are run by the federal government. Historically, they have provided Tesla with revenues ranging from 28% to 33% of its direct subsidy income. However, in the recent Q3 report, the contribution of GHG credits shot up to 72% at $137.2 million. The reason for this is completely unclear. It is possible that Tesla fears that the Trump administration might end this program and is unloading the credits while it can, but this is just speculation. The 10Q is completely opaque on all of this.

Bottom line: the ZEV and GHG subsidies provided $189.5 million of Tesla’s 3Q net income of $311 million, or 60%. And both subsidies are likely at political risk.

Subsidies to EV buyers:

Many states and nations have subsidized the purchase of electric vehicles, increasing the demand for Tesla’s products. Changes in these tax policies have sometimes had a a drastic effect on Tesla sales; Tesla sales in Hong Kong dropped almost 100% after Hong Kong changed its tax code. There are no uniform policies across the globe on BEV sales, and the policies often change. Therefore, we will look at important markets around the world.

US: The Federal government has a tax credit for BEV buyers of $7500. It phases out after a company sells BEV 200,000 vehicles. Tesla reached this milestone July 1, 2018 and the phaseout begins January 1, 2019. Manufacturers such as BMW, Volvo, Jaguar, and Hyundai which are just ramping up BEV sales will still be offering their customers the tax credit, and will have a strong competitive price advantage as a result.

California should probably be listed as a separate country. It has subsidies for electric vehicles. Unlike the federal subsidy, California subsidies do not phase out with time and unlike the feds, California subsidies have income caps to avoid the criticism that the state is subsidizing virtue signaling toys for the rich. On 29 March 2016, California added income-based caps to its rebate system. The income-base caps went into effect on 1 November 2016. Residents will not be eligible for rebates if their gross annual income exceeds US$150,000 for single tax filers, US $204,000 for head of household filers and US$300,000 for joint filers. The standard tax credits (on eligible cars) are $1,500 for plug-in hybrids, and $2,500 for all-electrics. (Source.)

Colorado has the highest state tax credit at $5000. Many other states have tax incentives as well (source).

Hong Kong: the story of Hong Kong shows just how important changes in government support can be for Tesla. Hong Kong has a vehicle Registration Tax which effectively doubles the price of every car sold in Hong Kong. For awhile, it was waived for BEVs, halving the consumer cost of a BEV. In the first quarter of 2017, Tesla sold 3,700 Models S and X. Then the tax break ended and in the next three quarters, S and X sales dropped to 32. a drop of more than 99%. Now there are some new tax breaks but Lyton Kam, chief of the Tesla Hong Kong Club, describes them as “a drop of water in the desert” and does not expect increased BEV sales. see Harbour Times, March 3 2018.)

Denmark had significant tax subsidies for EVs but cut them back in 2016. In 2015 4762 EVs were sold in Denmark, declining 913 in 2017 (source).

Norway, leads the world in adoption of EVs due to its progressive policies, wealth, and abundance of hydroelectric power. Tax breaks effectively cut the price of a BEV in half. However, as EVs have established a strong footing there, Norwegians are starting to talk about scaling back the incentives. Also, Tesla is facing increasing competition in a market that may become saturated. The Nissan Leaf dominates sales in Norway but it will be interesting to see how the Model 3 does when it arrives. The Leaf will be substantially cheaper than the Model 3.

China: the largest EV market in the world, with purchases of of EVs about 3X those in the US . Tesla has had some sales there of the S and X as a high prestige model to the ruling class but Tesla has had only about 5% of EV sales in China. Going forward, Tesla faces increasing obstacles. Earlier this year, Tesla faced a 25% tariff which was due to to drop to 15%. However, the Chinese increased the tariff to 40% in retaliation for President Trump ramping up tariffs on Chinese goods. Tesla’s competitors from non-US countries now face the low 15% tariff instead of 40%. Elecktrek reported this July that Tesla increased prices on the S and X by over $22,000 to $37,500 due to “new trade war tariffs”. In short, new Chinese trade policies are significantly damaging Tesla. Empire Investments reported on SA on October 15 on Tesla’s plans to build a Shanghai plant to work around these challenges. I am less optimistic that this will be a great success. In any case, the China enterprise is an attempt to jump new hurdles to just get back to more level competition in China--competition with a large and robust domestic Chinese EV industry (source).

Germany: Bloomberg reports that sales of electric vehicles in Germany rose 64% in the first half of 2018, while sale of Tesla Models S and X dropped by one third. Government policy may be partly responsible. Germany subsidizes electric vehicles that cost less than 60,000 euros, and demanded the return of 4,000 euro subsidies on 800 Tesla cars, stating that these luxury cars were not covered under the program. 2018 (January to September) Germany: Best-Selling Electric Car ...https://www.best-selling-cars.com/germany/2018-germany-best-selling-electric-car-br...

German Tesla Drivers Told to Return $4,650 Electric Subsidy ...https://www.bloomberg.com/news/articles/2018-07-18/german-tesla-drivers-told-to-re...

Netherlands: Has recently been a terrific market for Tesla. The Model S sells better in the Netherlands than in Norway. Due to tax breaks, It has outdistanced less expensive cars like the Nissan Leaf and VW E-Golf. Electrek notes that cars like the Models S and X costing more than 50,000 Euros, which are popular company cars, have been getting a tax break worth up to 19,000 Euros over five years. This will end in January 2019, creating a rush in sales before then followed by a collapse for the S and X. The current ASP of the Model 3 is elevated enough that it may face an already saturated high end market in the Netherlands (source).

Europe: subsidies vary from country to country. However it should be noted that in July 2018 Models S and X combined were in 5th place behind the Nissan Leaf, Renault Zoe, BMW i3 and VW E-Golf. A subsidy can be a bigger percentage of the price of a less expensive car and this may be a factor (source).

Canada: a big market for Tesla. A new government in Ontario, the most populous and wealthiest province, recently eliminated the $14,000 subsidy for BEV buyers. A blatant attempt to discriminate against Tesla buyers during the phase out failed in the courts. Nevertheless, the $14,000 tax credit is ending. There has actually been a surge in BEV sales due to the fact that BEVs ordered by July 11 for delivery by September 10 get the tax credit and customers were rushing to get the discount. After the tax credit ends, expect a collapse in BEV (and Tesla) sales in Ontario, similar to the end of tax credits in Hong Kong and Denmark (source). Note: Quebec and British Columbia still have BEV subsidies in place.

Future Checkpoints for Investors:

Canada: Do Tesla sales drop dramatically in Q4? There was a huge buying rush in Q3 to beat the end of subsidies in Ontario.

US: Does the phase out of the FIT credit for Tesla reduce Tesla sales in the US? Since most of its competitors will still offer the full FIT credit, do their market shares increase?

Will Tesla be able to earn any income from ZEV credits in 2019? If not, it could be a negative $200 million or more in annual earnings.

Norway: Will there be any change in Norway’s aggressive subsidies for BEV cars? How would the details affect Tesla?

Netherlands: does the anticipated collapse of Model S and Model X sales in first quarter 2019 materialize? Can the Model 3 get traction without major subsidies?

Germany: Tesla will only get subsidies on its mid to lower end Model 3s. How will their sales do in 2019? Will margins be affected by the product mix?

Europe: The Model S and Model X did not compete very effectively against other BEVs (outside of the Netherlands, which heavily subsidized luxury cars).

The Model 3 price tag will still be high relative to the lower cost sales leaders in Europe.

Tax breaks to consumers tend to be a bigger percentage of purchase price for cheaper cars. It will be interesting how the M3 does.

China: Fascinating and complex. The Chinese government has been subsidizing BEV purchases although that seems to be declining. The Tesla Shanghai gigafactory will not come on line for a couple of years at least. In the meantime, President Trump’s trade conflict with China means that Tesla faces brutal 40% tariffs in China. This makes competition with the numerous Chinese producers difficult. It is also means Tesla is now paying a much higher tariff in China than do European and Japanese competitors like BMW, Volvo, Toyota, and Nissan whose countries are not involved in the Trump China trade war. Tesla sales in China should be closely watched.

I hope that this article gives investors a practical framework for analyzing and following government policies around the world as they affect Tesla.

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: I am short TSLA via a small number of Jan 2020 puts.