Tesla: Weak Model 3 Demand In Europe And China May Widen Losses In 2019

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About: Tesla, Inc. (TSLA), Includes: DDAIF, NIO
by: Motorhead
Summary

Tesla's Model 3 sales appear to have peaked out in the US, but the company is counting on Europe & China to pick up the slack in 2019.

But European orders for the Model 3 are only at 17,044 units currently, despite having invited non-reservation holders 3 weeks after configurations started on December 7th.

In China, auto demand is weak and competition from NIO is stiff. Tesla has dropped its Model 3 price three times, yet only has several hundred orders.

The cash-cow Model S is in the 7th year of its cycle and Tesla can't afford a full-model change. Volume and prices should fall, adding to the pricing pressures from the Model 3.

Tesla could approach Musk's stated target of 350,000 to 500,000 Model 3s this year if it launches the $35,000 variant immediately. Otherwise, the Model 3 volumes will miss. But at $35,000, Tesla will likely lose money on the Model 3, causing wider losses than last year.

European Orders for Model 3 Look Weak

This Tesla Motor Club website (click "orders per country" here) has been tracking European orders for the Model 3 since reservation holders were invited for configuration on December 15th last year (see here). At that time, Tesla (TSLA) sales reps in Europe were saying that new orders for the rear-wheel-drive (RWD) Model 3 would arrive this summer, at the earliest, while the all-wheel drive (AWD) version could take up to a year.

As of January 4th, there were only 13,773 orders for the Model 3 in Europe and Tesla opened up configuration to any non-reservation holders (here). Over a month has passed since then and current reservations are still only around 17,044 units, which is 13% below the US average monthly sales rate of 19,610 during the 2H of 2018.

This is an extraordinarily weak start for Model 3 sales in Europe when one considers that it took 12 months for non-reservation holders in the US to be invited to buy the Model 3. It is even starker when one considers that the European luxury car market is over 1.5x the size of that in the US, implying even higher Model 3 orders than seen in the US. According to Automotive News data (here, but data is paywall blocked), the US luxury car market in 2018 came to 2.1m units, while data I compiled from ACEA (here) and Marklines (here; paywall blocked) show that 2018 luxury car sales in Europe came to 3.3m units.

Pre-orders for the high-end Model 3 in the US were approximately 26,139 units (cumulative deliveries from launch in July 2017 through June 2018). After non-reservation holders were allowed to place orders last July, the Model 3 sold 117,659 units in the 2H of 2018. The fact that orders in Europe have only risen by 3,243 units since non-reservation holders were invited to configure on January 4th points to potentially weak demand for the Model 3 in Europe. Competition from new rival EVs may be a factor behind the weak Model 3 orders.

The Audi (OTCPK:AUDVF) e-tron SUV hit the European markets this month and, as of December 7th last year, already had 20,000 orders, all with a €2,000 deposit (see here). During Q4 of 2018, Jaguar's new I-Pace SUV outsold Tesla's Models S and X, combined, in the Netherlands - Tesla's number two market after the US. It also sold 41% of combined Models S/X volumes in Norway (Tesla's third largest market) and 75% of combined volumes in the UK. In October, the I-Pace outsold Tesla in all of Europe (see Figure-1).

Figure-1: Jaguar I-Pace Gaining on Tesla's Models S/X in Europe

Figure-1: Jaguar I-Pace Gaining on Tesla

Source: TMC & Marklines

European Orders Foreshadow Stiff Competition Ahead For Tesla in US

Everyone knows that the Jaguar I-Pace, Audi e-tron, and Mercedes (OTCPK:DDAIF) EQS should heat up competition for Tesla when they hit the US market later this year, but it appears to be happening right now on their home turf in Europe and is adversely affecting Model 3 orders. This is why the Model 3 may not sell as much as Musk stated on the last earnings call, saying globally, demand was "maybe in the order of 350,000 to 500,000" (page 6 of Q4 earnings call transcript here).

Motorhead had been estimating that the Model X might be most hurt by the new SUVs from Jaguar, Audi, and Mercedes, but these new European electric SUVs may be pulling orders away from the Model 3 as well (I-Pace outselling Tesla in all of Europe last October; Audi e-tron orders already at 20,000 as of December vs. Model 3 orders of only 17,044 as now, etc.).

Figure-2 below shows the 3 new electric SUVs versus the Model X, which is more expensive than its rivals, but note that the current order book in Europe indicates the average Model 3 is priced at $72,000, which is also more expensive than the European new EVs. If the same happens in the US, Tesla could see much stiffer competition than it had been estimating. It is, after all, the first time Tesla faces true rivalry. The offerings from the Europeans are hardly as mundane as the Chevrolet Bolt or the Nissan (OTCPK:NSANY) Leaf up to now.

Figure-2: Electric SUV Prices & Performance Comparisons

Figure-2: Electric SUV Price & Performance Comparisons

Source: Company data, Insideevs, and Motortrend; Note: Model X tax credit is only $3,750 while other car makers' are $7,500

And as the Jaguar, Audi, and Benz ramp up their supply of rival EVs for European car buyers, Model 3 deliveries that have already arrived in Europe may not be eligible for delivery. There appear to be problems with Autopilot approval by European authorities (which is strange, as they were approved for the Models S/X in Europe), which has held up shipments of the Model 3 at Belgian ports. Details are in this excellent L.A. Times report here. Not only will this delay further shipments until authorization is received but it could also lead to huge rebates, as the Autopilot option is around $6,000 (nearly 10% of the European price), according to the L.A. Times. The European website tracking orders of the Model 3 in the EU shows that 77% of the 17,513 orders in Europe include the expensive Autopilot option (see "Diagrams" sheet in the website here).

China Model 3 Orders in the "Hundreds" Even After 3 Price Cuts

The auto market in China fell by 3% in 2018 - the first decline in over 2 decades - and in Q4 alone, plunged by 15% YoY. The Chinese economy has become very weak and the steep fall in luxury goods sales show how price-sensitive Chinese consumers have become (Tesla was no exception, as can be seen in Figure-3). The US-China trade war caused demand to get hit from Q2 last year, but a truce until March 2019 saw tariffs on cars imported from the US decline from 40% to 15% as of January 1st. Tesla has cut prices on its Models S & X twice in lieu of this, with an average drop of 22%.

Figure-3: Tesla Sales in China (Model S & X Combined)

Figure-3 Tesla Sales in China (Model S & X Combined)

Source: JL Warren Capital

Although configuration for the long-range AWD and Performance versions of the Model 3 were opened to Chinese consumers in November last year, the price had to be cut three times, and even as of January 23rd, orders for the Model 3 are said to only be in the "hundreds", according to JL Warren Capital, a Chinese industry advisory (homepage here).

In November, the AWD version was offered at 628,000 yuan ($91,000) but was then lowered by 7.6% to 580,000 ($84,000). This still didn't spur demand, so Tesla offered the mid-range RWD version of the Model 3 for 499,000 yuan ($72,424). This still didn't attract buyers, so Tesla has now lowered the price on the RWD mid-range by another 13% to 433,000 yuan ($64,222). All in all, the minimum price of the Model 3 in China has plunged by 31% from $91,000 last October to $64,222 last week. Given the steep added costs from import duties, VAT, and shipping, Tesla has little room to maneuver in terms of pricing. At its current price of 433,000 yuan ($64,222), the RWD Model 3 is probably just making as much as it does in the US.

But the new price cut to $64,222 may still be too expensive for Chinese consumers, as the weak economy has led them to become more penurious, driving would-be Model 3 buyers to a new Chinese EV start-up called NIO (NIO) - the "Tesla of China". For those not familiar with the NIO, this is a very insightful article with great video clips of its unique voice-command functions, etc. (here). NIO may not have the brand value that Tesla does, but it certainly has a flare, and it's much cheaper.

Because NIO produces its EVs in China, it enjoys government subsidies that reduce its MSRP by around 17%, which can amount to over $10,000 in some cases. Because of this, here are the main reasons why the Model 3 will most likely not fare well in China until it is locally produced there:

  1. The NIO ES8 (see spec comparisons in figure-4 and sales versus Tesla in figure-5) is a 7-seat SUV, with a starting price 13% below that of the RWD version of the Model 3, with faster charging and acceleration.
  2. The new NIO ES6 (already open for orders with a May/June delivery schedule) is a 5-seat SUV that is 31% cheaper than the RWD Model 3, with faster acceleration and longer range.
  3. NIO looks set to sell between 40,000 to 45,000 vehicles in China this year, which would be over 3x Tesla's 2018 China registrations of 13,456.
  4. Chinese consumers, more so than Americans, prefer large SUVs to mid-size sedans.

Figure-4: Tesla Model 3 Versus the NIO 6 & 8 - Value For Money

Figure-5: Tesla Model 3 Versus the NIO 6 & 8--Value For Money

Source: Company data

If you think the NIO looks funny compared to the slick Model 3, as Motorhead does, then take a look at figure-5, which shows monthly sales of the NIO ES8 versus combined Model S & X sales in China since NIO's launch in June 2018. In the 2H of 2018, the NIO ES8 outsold combined Models S/X volumes by 2.2x (11,248 units for NIO versus 5,086 units for Models S/X). While the Tesla Model 3 only has Chinese orders in the hundreds, NIO as of January 31st, had 11,000 orders for the ES6 and ES8, combined. Aside from its affordability, part of NIO's attraction to Chinese consumers seems to be its charging ease: not only does it have swappable battery packs, but for an annual fee of around $1,900, NIO's mobile charging unit will come and charge your car for you up to 15 times a month. No waiting in Supercharger stall lines.

Figure-5: NIO Overtaking Tesla in China Monthly Sales (Units)

Figure-4: NIO Overtaking Tesla in China

Source: JL Warren Capital & Marklines

On Tesla's recent earnings call, Musk said that global Model 3 sales this year might be "in the order of 350,000 to 500,000", indicating an overall sales increase of 2.4x to 3.4x that of 2018 levels. My hunch is that much of this was based on analyses of the Model 3's share of the US luxury sedan market in the $50,000-plus price range versus those in Europe and China. In fact, looking at Figure-6 below from Tesla's Q4 2018 Update Letter, it sure looks like it.

Figure-6: Tesla's Estimates of the Overseas Markets for the Model 3

Figure-6: Tesla

Source: Tesla

In figure-6, you can see how Tesla shows the Model 3 having captured roughly half of the US luxury car market last year and extrapolating that out to Europe and China's much larger markets. The problem is (1) the Model 3's high price and (2) real competition for the first time. Audi, Daimler, and Jaguar will harm the Model 3's prospects in Europe and the US, while the much cheaper, locally produced (and subsidized) NIO will take Model 3 share from Tesla in China. The only way out is for Tesla to produce the Model 3 locally in China. But this won't happen for a while, despite the accelerated push.

Expect Delays in Model 3 Production at New Shanghai Gigafactory

While Tesla continues to guide for start of Model 3 production at its new Shanghai Gigafactory by year-end, there has yet to be a car maker to go from "shovel in ground" to full production in 11 months' time. The industry record in China is Volkswagen's (OTCPK:VWAGY) plant in Northern China, which was completed last year and required only 23 months from ground-breaking to production. Toyota's (NYSE:TM) Alabama plant, which broke ground last November, won't be manufacturing cars there for another 26 months.

Tesla has literally just broken ground and, to see just what an early stage of construction it's in, this is a good article with a video link from electrek (here).

Figure-6 shows the auto plants that Volkswagen and Toyota built, with both the amount spent and time required until the first car rolled off the production line. Keep in mind that Volkswagen and Toyota are the world's two largest mass-producers of cars, with the best plant engineers. Geely's (OTCPK:GELYY) plans of building an EV plant with annual capacity of 250,000 vehicles leaked in August last year (here) and, at the time, was said to be running "by 2020".

It is highly doubtful that Tesla can produce its stated goal of 3,000 Model 3s/week by year-end unless it's a simple assembly of knock-down kits. But there could be penalties (taxes) by the Chinese government if a certain percentage of the Model 3 is not locally sourced, which is why it might require more time to get Shanghai Giga-3 fully running with a local supply chain. Funding should be available from local Chinese banks, but Tesla would need to come up with cash of its own up-front in order to receive financing.

Figure-7: Major Auto Plants' Capex & Time Required to Build

Figure-6: Major Auto Plants

Source: Tesla, Automotive News, China Automotive News, & Reuters

Model S Will Be An Additional Earnings Headwind in 2019

Tesla's Model S is now in its 7th year since launch and has managed to maintain over 50,000 units in annual sales for the past 4 years. There were undoubtedly extreme efforts made to keep sales levels over 50,000 units in the past two years, as it is Tesla's most profitable model, with an estimated gross margin of 26%.

Traditional automakers conduct full-model changes every four to five years, in order to renew interest and demand for a model. These changeovers are very expensive, however, and at an average cost of at least $300m, Tesla does not have the balance sheet to do this. Without any price cuts or full-model changes, Model S sales should fall by 22% YoY in 2019, which should present a drag of around $515m on profits, given its high profitability.

In Figure-7, I compare the rival Panamera by Porsche (OTCPK:POAHY) and its first model cycle before it was fully changed in 2017. As can be seen, in its 7th year since launch, Porsche's Panamera sales fell by 46% from its peak sales during its third year on the market.

Figure-8: Porsche Panamera Sales In Its First Model Cycle Versus Tesla's Model S in Current Model Cycle

Figure-7: Porsche Panamera Sales In First Model Cycle Versus Tesla

Source: Porsche, Tesla, & Marklines

Model 3 Prices Must Fall, But Can Tesla Remain Profitable?

The lukewarm reception to the Model 3 in Europe and China comes at a time when demand seems to have peaked in the US (see figure-8). According to InsideEvs (here), January Model 3 sales dropped to only 6,500 units, which is less than a third of the average monthly sales rate of 19,610 units seen in the 2H of 2018. To be sure, January is a seasonally slow month for car sales, but looking at Tesla's rivals, the month-on-month decline was much milder than that of the Model 3's drop of -76%: total sales at BMW were down -45% MoM, Daimler was -34%, and Audi was -37% MoM. There's no doubt that the Model 3 is a desirable car. It just seems to be over-priced given the competition coming out from Europe and China (and eventually in the US).

Figure-9: US Model 3 Sales Peak? (Share of $55,000+ Sedan Market)

Figure-8: US Model 3 Sales May Have Peaked Last Year

Source: Automotive News & Autoguide.com

Conclusions

  • European Model 3 demand appears weaker than the US at current prices of around $72,000, given only an initial pre-order book of just over 17,000 units. Rivals like Jaguar, Audi, and Daimler may be taking share away from the Model 3. This stiff competition could be replicated when these new European EVs hit the US markets later this year.
  • Given the weak European pre-orders, expect Model 3 price cuts in the near future after demand for the high-end variants has been exhausted.
  • Model 3 sales in China may be much weaker than expected. After 3 price-cuts, orders are just in the hundreds. If prices drop further, Tesla would make less money on its Chinese sales than in the US.
  • Localizing Model 3 production in China would vastly improve profitability, but this will take much longer than Tesla's target of year-end. No other car maker has built a fully functioning auto plant in just 11 months.
  • The cash-cow Model S, in the 7th year of its model cycle, should fall this year in the absence of a full-model change, which Tesla can't afford. This will be an added earnings headwind to the pricing pressure seen from the Model 3.
  • Overall, Tesla doesn't seem to have factored in competition from European and Chinese rivals this year. This should lead to either lower volumes or lower prices - both of which should lead to higher losses in 2019.

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.