Gigafactory 3 has risen Phoenix-like out of a Shanghai industrial estate at an extraordinary pace that no-one seemed to predict. Once again, Tesla (NASDAQ:TSLA) has proved the doubters wrong.
The pace of construction and the tax breaks being offered give Tesla tremendous growth opportunities in China. The Chinese authorities are backing the company strongly in numerous ways. More than that, the Shanghai facility can be the base for profitable growth in the fast-growing auto markets of Asia.
Tesla's fulcrum for growth will increasingly be centred around the growth markets of Asia and the environmentally aware countries of Europe.
China should be the single biggest growth market for Tesla following the build-out of the Shanghai facility. The company has restructured its sales and marketing operations to have a "Greater China" operation out of Shanghai. This covers China, Hong Kong, Taiwan and Macau.
Elon Musk's visit in early September showed how close the ties are between Chinese decision makers and Tesla. Following his appearance with high profile Jack Ma at the World AI conference, Musk met with a range of the high and mighty. These included the Secretary of the Shanghai Municipal Party Committee, the Director of State Administration of Markets Supervision in Beijing, the Vice Minister of Industry & Informatisation in Beijing, and the Transport Minister in Beijing. Tesla has been exempted from the 10% sales tax. This exemption is normally applied to domestic auto companies. It applies not only to the Model 3 being built in Shanghai, but to the full range of products.
The Model "S" and "X" may still get adversely affected by further import duties if the Trump administration's protectionist policies continue. It is ironic that the U.S. administration rails against U.S. companies that build plants overseas. They then introduce policies that encourage companies to do just that.
In previous articles I've pointed out the Shanghai project is very much a joint effort between Tesla and the Chinese establishment. That has resulted in record assistance and in record build time for the new facility. A picture taken in early September by a local Tesla enthusiast shows the robots to build the Model 3 are already installed:
Now pictures are already emerging of a second facility being built out next to the first one. It is not known what this Phase 2 building would comprise. It is quite likely it would be for battery manufacture and assembly.
The Model 3 should be running off the production lines before the end of the year. A volume of 150,000 Model 3s ex-Shanghai is anticipated for next year. Further production capacity would need to be ramped up for the Model Y.
In late August, the company had received another benefit by being included in Shanghai's Pilot Free Trade Zone. In another benefit, previously Tesla had been exempted from having to comply with the usual 50/50 joint venture rule.
It is reported that US$2 billion in loans are being provided by Chinese banks. These facilities are being advanced mainly by State-owned banks. It is understood that these are at special low rates, actually lower than the one-year rate published by the central bank.
Those Tesla cynics who doubted the Chinese venture just do not understand how things work in China. Once Tesla got support from Chinese government sources, the die was cast. Only those unaware of how things run in China would think otherwise.
Tesla's position was further strengthened by Chinese private industry backing. The most important of these was Internet giant Tencent (OTCPK:TCEHY). Tencent is the eighth largest company in the world by market cap. It could become a key future partner for Tesla and a potential source of whatever funding might be required. Tencent's investment portfolio comes to over US$70 billion. Its healthy free cash flow would enable it to invest further funds in Tesla without feeling the effect at all. Its expertise in AI and car automation could be of great benefit to Tesla's future product portfolio.
Additionally, Tesla will be building up close relationships with Chinese battery manufacturers. Reports over the last few days indicate a locally produced Model 3 battery is being assembled and tested in the Shanghai facility. It is thought this is either from China's largest battery manufacturer, CATL, or from the Chinese subsidiary of Korean battery giant LG Chem (OTCPK:LGCLF). China's dominant position in EVs is being further consolidated by its growing dominance in battery manufacture.
Next year will see how much penetration Tesla can get in the world's largest auto market. "New" car companies such as Tesla, BYD (OTCPK:BYDDF) and BAIC (OTC:BCCMY) are taking over the EV market from older EV players such as Nissan (OTCPK:NSANY) and BMW (OTCPK:BMWYY). China in 2020 could be a huge growth market for such newer auto companies. Old established ICE players such as Ford (NYSE:F) and General Motors (NYSE:GM) are likely to become increasingly marginal players. Moody's (NYSE:MCO) recent downgrading of Ford debt to junk status shows which way the wind is blowing.
EV sales this year are predicted by the China Association of Automobile Manufacturers to reach 1.6 million units. In time EV sales will replace ICE sales completely. That is Chinese government policy. This will lead to a long-term market opportunity of a further 26 million EVs per annum.
Asia And World Auto Markets
The global auto market comprising cars and light commercial vehicles in 2018 is illustrated below:
The US will probably continue to decline in importance in terms of volume. Its focus is likely to remain on ICE vehicles. The rest of the world will transition more rapidly to EVs.
Asian markets in recent years have shown promising growth in overall auto growth. India has become the world's 4th largest auto market. According to a McKinsey report, it is expected to become the 3rd largest by 2021. S-E Asian nations are increasing their share of the world's total. Their GDP growth rates and increasing populations mean this growing share will almost certainly continue to increase.
China's total auto market may have declined but its importance as the world's largest auto market by far is clear. Its focus on EVs is illustrated below:
China is going full tilt in the electrification process. This process will not be halted. Tesla and BYD are the world's leading BEV manufacturers and the Model 3 the world's most popular EV. China and Tesla are starting to look like a match made in heaven.
Similar figures issued for 2018 car sales only (not including LCVs) paint the same picture. Tesla has an underrated opportunity to launch sales out of China into the region. Obvious markets comprise:
- Japan: The world's 3rd largest car market with 5.2 million cars sold last year.
- India: Tthe world's 5th largest car market with 3.3 million cars sold last year.
- South Korea: The world's 12th largest car market with 1.5 million cars sold last year.
- Australia: The world's 15th largest car market with 1.1 million cars sold last year.
- Indonesia: The world's 16th largest car market with 1.1 million cars sold last year.
- Thailand: The world's 17th largest car market with 1 million cars sold last year.
Tesla had success in the past in high market penetration of their products in smallish markets. Norway, Hong Kong and the Netherlands are examples of this. The Asian markets give tremendous opportunities to replicate this but on a far larger scale out of Shanghai. Since May customers from Hong Kong, Japan, Macau, Australia and New Zealand have been able to configure their Model 3 requirements on the Tesla website. South Korea has since followed and more will come online as Shanghai production ramps up. The brand equity of Tesla is very strong around Asia, itself a very brand-conscious continent.
In all countries there are a number of factors that determine the potential for Tesla. These can be summarised as:
- The size of the market.
- Government policy and incentives for EVs.
- The relative costs of electricity and of petrol.
The cumulative supply of EVs as at end 2018 in Japan stood at 257,363 cars (this compares to Norway at 296,215). That makes Japan the fourth largest EV market in the world so far.
In Japan the cost of electricity is high, but so is the cost of petrol. Initial reviews and customer reaction have been very positive for the Model 3.
There have been two specific negatives for Tesla in Japan. Firstly there has been the government and industry push for hydrogen fuel cell vehicles. This now seems to be waning somewhat. Secondly, the Japanese in general want smallish cars and the Model "S' and "X" were big by Japanese standards. The size of the Model 3 and the upcoming Model "Y" will suit Japanese requirements far better.
Local competition is well-established. This is led by the "Prius" hybrid from Toyota (NYSE:TM), the "Leaf" from Nissan and the Mitsubishi "Outlander" PHEV. Japan can be quite an insular country but these models have flat-lined in sales. That presents new opportunities.
The government-directed push for hydrogen fuel cell vehicles may still persist. Toyota and Honda (NYSE:HMC) have invested substantial sums in research. Their "Mirai" and "Clarity" models have sold quite well. The process does have substantial drawbacks. Most notably there are the fire risks in hydrogen fuel cell refuelling. There is additionally an inherent inefficiency in the fuel cell process compared to that of battery EVs. The fire risk was starkly illustrated in June in California when an explosion closed ten fuel cell stations. They are still not fully up and running now.
The recent official launch of the Model 3 in the country seemed to spark a good deal of interest. The country has good incentives for EVs from both central and local government. These can total 20 million won (US$16,600) per vehicle. The government has a target for 5.3% of sales to be EVs by next year.
A standard Model 3 is being priced at 32 million won (US$26,500). This would make it a competitive car in the general auto market. Electricity is quite cheap and petrol expensive. The government has banned various polluting diesel vehicles. These all combine to offer a great opportunity for Tesla.
There is of course a strong entrenched local industry in Korea. This is represented especially strongly by Hyundai (OTCPK:HYMTF) and Kia (OTCPK:KIMTF). Hyundai is setting high hopes on their new "Ioniq" Electric model as well as their "Nexo" hydrogen fuel cell model. Tesla have so far installed 22 superchargers and 172 Level 2 chargers in the country.
This had previously been a bumper market for Tesla for their Model S and Model X cars. There are about 11,500 EVs in Hong Kong of which approximately half are the Tesla Model "S" and "X."
The end of August saw the handover of the first 10 Model 3 cars to patient customers. This coincided with the inauguration of the largest supercharger location in Asia, featuring 20 stalls, as pictured below:
Tesla now has 24 charging locations in Hong Kong with a total of 130 stalls. In addition, there are 1300 public charging stations.
Future total sales will be affected by the fluctuating incentives to own EVs in Hong Kong. The reduced tax breaks for EVs, which stymied the market in 2017, are due to run until 2021. The continuing high popularity of Tesla is evidenced by the strong second hand market for Tesla cars for which tax incentives are less important.
The territory has shown that Asian high-rise cities can be good locations for EV sales. This is something that Tesla cynics have constantly stated would not happen.
The country has a high ratio of households living in houses rather than apartments. There is a very high incidence of households using solar energy. Electricity tariffs are high. The country is affluent.
These are all bullish factors for EVs. The bearish factor is that the government is not especially environmentally friendly. Progress for Tesla in the country should be meaningful this year and next. It may not meet full potential due to the lack of government support.
Currently, under 1% of autos on the road are EVs. Orders for the Model 3 opened up on Tesla's website in August. It was estimated in a recent poll that for a consumer to buy a Model 3 he would be spending an additional A$30,000 (US$20,400) over their current car. Notwithstanding this, reports now refer to "thousands" of Model 3 orders waiting to be supplied. This number has not been confirmed by factual sources. What is certain is that the number of Australians looking to buy EVs or hybrids has spiralled up rapidly. That could well make Australia a booming market for Tesla in the next few years.
This is of course a small market. Total auto sales last year were about 160,000. That is slightly more than Norway's market. Yet Norway is the world's third largest EV market and represents very substantial sales for the company. The Netherlands, Iceland and Denmark are other smallish auto markets which have seen rapid growth for Tesla in 2019.
New Zealand could become a similar niche market. The government is embarking on a drive to switch from ICE vehicles to EVs. Electricity is cheap and petrol expensive. 80% of energy is from renewable sources. 85% of homes have off-street parking. The people are very environmentally minded on the whole.
Official government policy is for there to be 64,000 EVs on the road by 2021. That still pales in comparison with Norway's target to phase out all ICE sales by 2025. However, it is expected that new government incentives will shortly be introduced. New Zealand under its progressive prime minister Jacinda Ardern is likely to become a major EV market within the next few years.
The government is ramping up incentives. This follows on its announcement last year that sales of petrol vehicles will be halted by 2040. All government vehicles are to be EVs by 2030.
Electricity prices are low in the country and the culture is ripe for EVs. How affordable Tesla vehicles will be there is the biggest issue. This will become clearer soon.
This country is an example of both the promise and the challenges involved for Tesla in Asia. The government is putting in place substantial incentives for EVs. It is determined to promote EVs over ICE vehicles. However incentives will favour local production over imported vehicles.
A local utility Energy Absolute is transforming itself into an EV and battery manufacturer and planning to launch 3 "Mini Mobility" models next year. Their first model will sell at 1.2 million baht (US$38,000) and is especially aimed at the taxi market.
China's largest EV manufacturer BYD Auto has a contract for over 1,000 vehicles in Bangkok. For the Tesla Model 3 however, as things stand at present taxes could equal about US$30,000. That would make it uncompetitive except as a niche vehicle.
This is a small but affluent market where cars are arguably the most expensive of any country in the world due to government taxes. Despite the costs, Mercedes, BMW and Audi are all best-selling brands in the country. The revenue from extremely high taxes on cars in Singapore is no doubt redirected to a certain extent to financing the public transport network, in which the government has been heavily investing. Improving public transport is their first transport policy priority,
The government has an unusual way of measuring pollution and imposing taxes on cars based on electricity generation costs as they would be in Singapore. The country is a leading hub for oil and gas industries who are major investors in the country's economy.
The Environment Minister was quoted in August as saying he preferred hydrogen fuel cell vehicles to battery autos. The government has commissioned Kellogg Brown & Root (NYSE:KBR) to study various hydrogen uses in the economy. Hyundai's "Neko" fuel cell model will be used in some initial trials.
The minister also doubted the practicality of the charging station model in a country where 85% of the population live in government housing. The success of Tesla in Hong Kong shows however it can be practical.
There is a positive example of French company Blue SG who have set up, and will be expanding, a pick-up and drop-off rental EV network. This is illustrated below in a photo I took in downtown Singapore:
There has been a well-publicised spat between Elon Musk and the Singapore authorities over the lack of EV incentives in the country. There are reported to be only about 300 EVs on the roads of Singapore. However, it is thought that about 130 Tesla Model 3s have been booked by affluent Singaporeans. Tesla could become a niche market for the company but wider acceptance will depend on the direction government policy takes.
There was a stir caused in 2017 when an Indian government minister stated the country would sell only EVs by the year 2030. This startling statement proved to be startlingly untrue.
The government now has a target of 30% by 2030. This seems unlikely to be attained either. However, there may be significant progress in India's polluted and jammed city streets. Much of the impetus is being placed on 2 and 3 wheelers.
The next phase of India's FAME (Faster Adoption of Manufacturing of Hybrid & Electric Vehicles) programme is set to concentrate mainly on tax incentives for use of EVs. The experience of other countries has shown what a rapid effect this can have on EV sales. There is a big drive to build out electric charging stations.
India has two big incentives to encourage the use of EVs. Firstly, the country has major pollution problems in its crowded city streets. Secondly, the country faces huge oil import costs every year.
In such a market Tesla may only be a niche player for the ever-growing number of very rich Indians. They are however a fairly substantial number of these in their own right.
Risks for Tesla
There are of course riders to the thesis of Tesla's growth in Asia.
- Tesla itself might face further capital constraints in its expansion programme.
- Fuel cell vehicles may prove more popular than battery EVs in key Asian markets.
- Competition may come out with superior vehicles to those of Tesla.
- China may face economic problems if the US ramps up its trade war as the US election approaches in 2020.
- Political risks in various Asian countries, such as rising tension between South Korea and Japan.
- If US protectionism increases still further, Asian countries may retaliate in kind against US products.
The risks are mainly of a macro-political and economic nature. Tesla itself seems to have several years of capital availability and superior product in which to establish itself in Asia.
Next year will see substantial and fast-growing sales for Tesla concentrated in China. Chinese government support is evidenced by the tax exemptions, the low interest rates, the joint venture rules, and support in the construction process.
However, other Asian countries will become increasingly important. Model 3s produced in China will spearhead a drive throughout the region. This will show itself in two ways. There should be niche sales in large car markets. There should be substantial sales in small markets as has been seen in Europe this year.
The incredibly rapid build-out of the Shanghai plant and the size of the Chinese and Asian markets look set to lead to a quantum leap in Tesla revenues and profitability in 2020. The stock price does not yet reflect this.
Disclosure: I am/we are long TSLA BYDDF. 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.