Tesla (NASDAQ:NASDAQ:TSLA) reported strong deliveries last week. The company hinted to a Q3 profit driver in the delivery report earlier this month. Last night, a leaked email may have hinted to better margins in Q2 and may help confirm Q3 profits.
On Dec. 31, 2018 we wrote publicly about risk to Tesla shares. Since then the stock has dropped meaningfully.
Recently on June 5 we went to a Strong Buy Rating for subscribers (paywall).
Here's some of what we said back on June 5 when we went to Strong Buy from Neutral about a month ago when the stock was sub-$200:
"The stock has taken a huge hit. We got out of our last Strong Buy from 300-330s. I have $11 (See full model: paywall) in earnings for 2020 and think they can get a 45 PE. That gives us 150%+ upside. S&X and Model 3 gross margins can move up. That's the main driver to the model.
I also think that US demand dipped around the turn of the year with the loss of the rebate but with lower prices I would guess demand can bottom and pick back up.
...Also investors are playing Tesla for dead so I LOVE the risk/reward when I think things are fine.
My EPS are above the Street for the quarters and I have huge 12 month upside.
When we heard Elon Musk say the following at their shareholder meeting a week later we gained conviction in our call:
"We don't have a demand problem. Sales far exceeding production. Shot at record quarter. 90% of orders from new customers not reservation customers."
I've been listening to companies for over two decades. These are NOT comments you typically hear form a stock way down near its lows. I love that risk/reward.
Love It Or Hate It? We Care About Earnings
We also were bullish through part of 2018 profitably when we had earnings well above the Street. When Musk started talking about quarterly profits last year we did the work and thought it was realistic. That gave huge support for the stock.
But when we thought about the demand "pull forward" into Q4'2018 that was going to steal profits from Q1'2019, which it did.
So we exited ahead of that.
As for all our coverage, we feel the key is to focus on the earnings trajectory. Will they earn or not? Will they earn or not this quarter and next quarter? That's what matters because investors of course extrapolate this quarter and next quarter.
While everybody can make cases both bullish and bearish and get sold on those theories, I prefer to focus on earnings. I think by not focusing on earnings people can get too entrenched in a line of thinking and lose flexibility. Then when earnings beat or miss it's tough to change.
I prefer to predict and react to earnings which keeps me from being a permabull or permabear on anything.
The thing about earnings is they change all the time. Like stocks and markets I like to respect those changes. I have found it keeps you out of trouble. Defending a bad idea going against you where there's an earnings miss is not a good idea. Going against you and earnings missing, next. But the stock going for you and earnings beating, that's something good.
To bring a company's story all together I wrap up my work into one simple number - earnings. That's the decider. They're beating? We have big upside? Yes or no?
What are the trends and what's a company going to earn?
I don't love a company. I love their earnings. That keeps me flexible.
When a company shows me they have the ability to beat Street numbers and I can have a reasonable amount of stock price upside, I love it. If not I don't.
So when do I like Tesla, as long as they are sticking to the earnings script.
I think that's now again similar to when we liked the story last year for a nice run.
As a reminder, I stopped thinking that this was an earnings story at the turn of this calendar year, but when Musk started recently pumping the delivery targets near the lows I thought we were back in business.
Tesla's Delivery Report Hint To Margins
Here's what Tesla said when they reported deliveries earlier this month.
"In addition, we made significant progress streamlining our global logistics and delivery operations at higher volumes, enabling cost efficiencies and improvements to our working capital position."
Frankly though when looking at the potential for the coming Q2 earnings those comments could have been taken either way.
Listen to what Tesla said about maximizing profits on their last earnings call,
"So if we have to fully optimize for profitability in Q2, I think we can do it, but then we would be unable to unwind this crazy wave of deliveries and it also helps our working capital within the quarter to not have the wave."
The "wave" refers to delivering to different regions separately at different parts of the quarter which is inefficient but helps them manage quarterly.
If they were "unable to unwind" their "wave" delivery process they could gun it for profits in Q2. Obviously by their commentary in this month's delivery report they went the other way to fix the wave problem. They apparently made headway in fixing their wave delivery problem. That's why they said, "we made significant progress streamlining our global logistics and delivery."
If they made "significant" progress to fixing the wave issue, that means they did not "optimize for profitability in Q2."
At first blush the "efficiency" comments in their delivery report looked profit positive. But fixing their delivery issue is a headwind to Q2 profits.
So their commentary in their delivery report could have been read either way.
Very strong deliveries but profits could be in question.
But Yesterday's Email Leak Hints To Better Profits
Last night, Blooomberg reported on an email leak from Tesla's head of auto Jerome Guillen. In my speaking to Tesla, the company thinks Mr. Guillen is a star, maybe one of their most valuable employees.
People can read into what they want in email leaks, but since we know the deliveries, all that matters are margins and profits.
Here's what Mr. Guillen told employees in that email about Q2:
“....hit new records in all production lines for output and efficiency.”
That comment sounds much more clearly bullish about margins than their delivery report.
If they hit efficiency new highs it means they levered fixed expenses which can drive margins higher.
In their last earnings report the company said,
"We continue to target a 25% non-GAAP gross margin on Model S, Model X and Model 3, depending on variant mix and option take rates as our product offerings change."
Both S&X and Model 3 margins were about 20% in Q1. If Tesla sticks to the 25% goal that means margins should expand as we go through the year.
Resolving their wave delivery expense hurdles is one step to getting there. If they managed to do it profitably with "efficiency" "new highs" in Q2 that bodes well for future quarters.
That Takes Us To Q3 Profits
Here's what Tesla said on their Q1 earnings call about Q3 profits.
"The teams are working extremely hard and making terrific progress on improving the cost efficiency of the business without sacrificing growth and that in combination with the efficiencies from unwinding the wave, is where we feel we will be comfortable returning to a place of profitability in Q3 once all of those pieces are in place."
I think Tesla just hinted to that in last week's delivery release that they unwound the wave. If so we are preparing for profits in Q3.
The Street expects $.19 in EPS for Q3. We are nicely above the Street for the next couple of quarters.
Where Is The Street? Off-sides
Wall Street hates Tesla. Less than one-third of the sell siders are bullish. And the company just blew out deliveries. And the company may be about to blow out profits.
For modeling we're assuming about 10,000 leases this quarter. So we're assuming that although the delivery numbers were huge at 95,200, about 85,200 will matter specifically for this quarter. So be careful in doing the math.
Tesla's stock is way down and hated. The news is better. Profits have a good shot to beat and quarterly profits are back on in Q3. As production ramps globally they have a good shot at big profits in 2020.
Too many analysts and investors will have to shake off the cobwebs of getting too bearish. But I think good fundamentals and investors taking a fresh look can get this stock back to new highs.
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In my career working at Morgan Stanley, SAC, JLF and my own firm I've always been known to be a stock picker with the ability to uncover the big calls.
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