Tesla And The Governments II: Swimming Against The Tide

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

Tesla turned in two profitable quarters. However this quarter, and likely this year are projected to show more losses.

Government policies affect Tesla’s fortunes in many ways. Many of these have moved or might move in ways that cause damage to Tesla.

Changes in Government policies can directly affect Tesla’s cash flow, can help or hinder sales, can sometimes help Tesla compete against ICE vehicles, and can help or hinder Tesla’s competition.

We look at only at government policies as they affect TSLA as an investment.  I am not discussing whether any of these policies are wise public policy or not.

This article is rather dry compared to many Tesla articles; I do believe the facts here are important to investors.

Since its debut, Tesla has received crucial help from government policies around the world. The ZEV and GHG credits in the US gave Tesla badly needed cash. The FIT credit to consumers in the US and various consumer incentives around the globe greatly benefited Tesla (indicated by the collapse of Tesla sales in places as diverse as Hong Kong and Denmark when incentives stopped). Now the net effects of government policies seem to be turning negative for Tesla in many different ways all over the world.

Government policies affecting BEVs and BEV companies are extremely variable around the world. We will look at the US, the EU, Scandinavia, and China.

The US: While many of Tesla’s critics say that its main business is milking the government for subsidies, this is not true. Most of Tesla’s money comes from selling cars and raising capital. However, government support is still critical for Tesla. In its most successful quarter (Q3, 2018) Government mandated transfers provided 60% of Tesla’s net income, since these are pure profit and flow through to the bottom line.

GHG credits: These are payments that are mandated by the federal EPA. Companies that do not meet the federal gas consumption guidelines are required to buy credits from companies whose vehicles are more gas efficient. While it is hard to get solid information on these, the value to Tesla was was $315.2 million in 2018, or about $1,283 per vehicle.

ZEV credits: these are very similar to GHG but done by California and 10 other states under an administrative waiver from EPA under the Clean Air Act. Tesla does not give information on how many of these it has “in the bank” and what price it gets. In 2018 it received $103.4 million for ZEVs or about $420 per vehicle sold.

Total GHG + ZEV = about $1700 per car.

There are two important problems for Tesla with GHG and ZEV.

1) These credits only apply to cars sold in the US. Europe has no corresponding credits. This means a $1700 loss to the bottom line for every Tesla sold in Europe. With its recent price cuts and the fierce EV competition in Europe, this is a profit and cash flow loss that Tesla can ill afford. The vaunted exports to Europe may not be as lucrative as many hope.

2) Political risk: ZEV credits are under threat. The EPA has formally proposed abolishing ZEVs and does not need authorization from Congress to do so. This would mean an abrupt end to future ZEV payments and any ZEV credits that Tesla has stashed away would immediately become worthless. The EPA plan will be challenged in court, but California’s success is very uncertain. And GHG credits are threatened as well. The market for GHG credits depends on auto companies failing to meet mileage standards. These standards were scheduled to become increasingly severe over the next decade, which would lead to more demand for credits. The Trump Administration has proposed stopping the escalation of mileage standards, which would lead to a marked reduction in GHG credit demand and price. Once again, this does not require authorization by Congress. This would directly hurt Tesla’s net income.

FIT credits: These are for up to $7500 and go to the purchaser of a BEV, not to Tesla itself. They do increase demand for BEV products. However Tesla has now sold >200,000 BEVs and is losing this credit by the end of 2019. This will diminish its ability to compete with ICE vehicles. This also affects Tesla car prices, which reduces both revenue and the bottom line.

On Jan 1, Tesla announced “we are taking steps to partially absorb the reduction of the federal EV tax credit. Starting today, we are reducing the price of of the Models S, Model X and Model 3 in the US by $2,000.” More seriously, other BEV companies will keep the FIT credit, which will give them a $7500 price advantage in their competition with Tesla in the US.

“Government bailout”: Some on SA mention a possible government bail out if Tesla gets in serious trouble. The precedent for this was the GM bail out, begun by President Bush and then wound up by President Obama. While this resulted in saved jobs for at GM and its suppliers and a leaner more successful GM, it also required new management at GM and a packaged bankruptcy that wiped out the shareholders and bondholders. A government bailout is not something Elon Musk or Tesla shareholders would like one bit.

EUROPE:

Tariffs: the EU has a 10% tariff on auto imports from the US. This has two effects. 1) Tesla is less competitive against European brands. While the Model 3 is doing well right now with pent up demand, a 10% price disadvantage can take a long term toll. 2) the price of a Tesla in the EU may suggest high margins, but 10% of the price goes to the EU tariffs. This is $5,000 on a $50,000 Model 3 that does not flow through to either Tesla’s revenue or especially to net income. It is not trivial.

There are no ZEV or GHG credits in the EU at this time. Every Tesla that is sold in Europe fails to earn credits worth about $1700 per car in net income. Again: not trivial. The EU may start a GHG credit in 2021. Or not.

Other Policies on EVs: Germany: a 4000 Euro subsidy for private purchasers and a 3000 Euro subsidy for corporate purchasers. This only applies to cars costing less than 60,000 Euros; most model 3s would benefit. Some model 3s and all X and S would fail to get the subsidy. The Germans have been ruthless in the past when Tesla tried to game the system.

These subsidies are absolute amounts rather than percentages; this favors the lower priced competition since the subsidy is a bigger portion of the purchase price for cheaper cars.

Belgium has a subsidy of 4000 Euros for BEVs costing < 31,000 Euros and a subsidy on only 2,500 Euros for BEVs costing Euro 41,000 to 61,000 which would be Tesla’s typical price range. Once again, the subsidy to purchasers is stacked against Tesla.

Italy is planning to start a E5,000 subsidy for BEVs costing <50,000 Euros; This may affect the pricing power of higher end Model 3s already handicapped by shipping costs and the 10% tariffs.

France has introduced a hefty 6000 Euro subsidy to EV buyers with additional subsidies for low income purchasers. Again, these should affect BEV purchases more in the lower end of the BEV market rather than upscale Tesla.

The Netherlands is moving toward a more progressive subsidy system on BEVs after promoting the Model X, S, and Jag very heavily. Dutch voters rebelled against big subsidies to wealthy individuals and corporations. Tax breaks on EVs costing over $50,000 Euros have been sharply reduced. A proposed Euro 6000 subsidy starting in 2021 would provided a much bigger chunk of the purchase price for a Renault Zoe, for example, than for a Tesla. And European made cars have a 10% price advantage already from the tariff.

Norway is not part of the EU. Tariffs are waived on EVs. The main subsidies come through the VAT system. Since this is a percentage of the price, rather than absolute amount, it does not discriminate against higher end cars like Tesla.

Summary: the European policies are shifting against Tesla relative to its competitors. The EU tariffs give a 10% price advantage to European manufacturers. The lack of a Green House Gas credit / ZEV system means that Tesla loses about $1700 in net income on every car it sells in Europe relative to the US. Different European countries subsidize BEV consumers differently, but all except Norway have moved to systems that favor lower cost vehicles rather than Tesla.

CHINA: Chinese tariffs have gyrated wildly in the Trump trade war. Currently they are at 15%, which offers a significant competitive price advantage to companies that produce in China. At this time it is completely unclear what the tariffs will be long term. Tesla is working on a plant in Shanghai which might resolve the China tariff problem, but success on that plant is debatable. It is unlikely to make a major contribution before 2021 at the earliest, I believe.

Chinese NEV credits are modeled on California’s ZEV credit program. Longer range BEVs earn more credits, which is good for Tesla. However, it is unclear how much a NEV credit will be worth. Every major company operating in China is seriously entering the EV market there; therefore the number of ZEV credits earned may flood the market and erode the credit price. This would reduce income for Tesla, a pure BEV maker. This already seems to have happened with the ZEV and GHG credits in the US whose prices have declined.

Peking is also reducing incentives to its citizens to purchase EVs, since these cost the government a lot of money. Policy on this is chaotic.

Summary: Tesla, already financially precarious, is facing increasing challenges from government policies.

In the US, the demise of FIT credits will help competitors while handicapping Tesla sales. The decline and possible elimination of ZEV and GHG credits could eradicate the source of more than half of Tesla’s net income in its most profitable quarter.

In Europe, the 10% EU tariff is a handicap on Tesla sales and pricing power relative to its competitors. The lack of GHG/ZEV credits in Europe cuts about $1700 of Tesla’s net income on every vehicle sold in Europe rather than the US. European subsidies to EV consumers increasingly favor the less expensive manufacturers relative to a premium brand like Tesla.

While Tesla’s early European Model 3 sales have been good, Tesla is facing significant long term negative pressure from these government policies.

In China, Tesla currently faces a 15% tariff, which gives manufacturers in China a significant price advantage. It is unclear when, if ever, Tesla’s Shanghai plant will overcome this disadvantage. Subsidies to Chinese EV buyers, which have been significant, are being phased out and this will probably affect the higher priced EV producers like Tesla the most. Tesla logically should benefit from NEV credits, but is unclear whether these will actually have significant value.

While these changes in government policies are negative for Tesla, I do not believe that they alone are a short thesis for Tesla. They are pieces in the Tesla Mosaic. I hope that readers find this quick global summary useful.

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: This article is not intended as investment advice. All investors should do their own investment research before investing.