Tesla Profit Poised To Soar As Its Production Passed The Breakeven Scale
Summary
- After 2021, there should no longer be any doubt about the profitability of Tesla.
- It has clearly passed the pivot point of critical scale, recouped the fixed cost, and now began to harvest the benefit of the scale of production and expanding margin.
- Production is expected to increase quickly as outputs from established factories in Fremont and Shanghai maximize.
- New factories in Austin and Berlin and full self-driving software add further optionality and upward potential for shareholders.
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Thesis and Background
After 2021, there should no longer be any doubt about the profitability of Tesla (NASDAQ:TSLA). As announced in the company's recent earnings report (the emphases were added by me):
In 2021, we achieved the highest quarterly operating margin among all volume OEMs, demonstrating that EVs can be more profitable than combustion engine vehicles.
Additionally, we generated $5.5B of GAAP net income and $5.0B of free cash flow in 2021 – after spending $6.5B to build out new factories and on other capital expenditures.
Now looking forward, you will see that there are at least two good reasons to be bullish:
- First, you will see that TSLA has clearly passed the pivot point of the critical scale. Its profit is poised to soar from here as it now began to harvest the benefit of the scale of production and expanding margin. As it has overcome the hurdle of fixed cost, additional production will only incur mostly variable costs, and profit will therefore increase at a faster pace as a result.
- Second, in terms of valuation, there is no doubt that the business is expensively valued now. At almost 18x of sales, it is expensively valued both in relative terms and absolute terms (the overall market is valued at about 3x sales). However, considering its accelerated growth of profit, it can outgrow its current valuation in the next few years.
TSLA has passed the breakeven point
The following chart clearly shows that Tesla has overcome the pivot point of breakeven production around 2018. This chart plots the average CFO (cash from operations) per vehicle and also the average unit price per vehicle since 2015. You can see very clearly that Tesla was able to make an improving profit per vehicle while the unit price (i.e., the price tag on each vehicle) has actually been DECLINING. This is a clear indicator of passing the breakeven point, as to be further elaborated below.
Author and Seeking Alpha data
Profit is a function of volume, price, and cost, as shown in the next figure. Costs come in two varieties, fixed costs and the variable cost (shown as F and M * V in the figure, where M is the marginal cost of producing an additional unit and V is the production volume). Fixed costs include things like plant and equipment (especially the depreciation thereon) and also most capital costs (such as interest expenses). Fixed costs were incurred upfront and do not vary with the level of output. A production business has to first pass the breakeven point to make a profit. After it breaks the critical volume of sales, the fixed costs are spread out on more and more units and profit margins will improve. And as to be seen next, this is what exactly has happened and is happening with TSLA.
A Modern Approach to Graham and Dodd Investing by Thomas P. Au
TSLA’s fixed cost and variable cost
The next chart shows my analysis of TSLA’s fixed cost and variable costs. Note the plot is made in logarithmic scales. As you can see, the blue line shows its total revenue as a function of the total number of vehicles delivered. And again, in reality, such a relationship is typically a linear relationship under a logarithm scale (meaning that the relationship appears to be a straight line under a log scale). Now the orange line shows my estimated cost of revenues.
And as you can see, the break-even point occurred somewhere close to 100,000 vehicles (where the blue line and orange intersect). Moreover, by extrapolating the orange line to the left, you could see that the fixed cost is about $2 billion. Any cost beyond the fixed cost is mostly a variable cost, as shown by the green arrow. The difference between the blue and orange lines is the net profits. By calculating the slope of the orange line, we can also determine the variable cost to be about $40,000 per vehicle for TSLA.
Under a log scale, these above numbers are hard to see. So in the next section, we will tabulate these numbers to have a closer look.
Author
TSLA’s profit and return projections
This next table essentially summarizes what we've discussed so far, except in tabular form this time. It is made based on the key fundamental parameters that we have obtained, particularly the fixed cost and variable cost.
Based on these parameters, we can also make projections about the TSLA’s revenues and profits going forward. To summarize, the key parameters are A) the fixed cost is $2 billion and B) the variable cost per vehicle is $40,000. Finally, I also made the assumption that the operating expenses to be 13% of total sales and the average vehicle price tag to be $58,000, which is consistent with its current levels. Note these last assumptions also make my following analysis more on the conservative side, because operation cost would also be diluted on a per-vehicle basis as Tesla sells more units.
As can be seen from this table, based on the fixed and variable cost determined above, the EBITDA profit would be about $10.7B for the 930k vehicles TSLA sold in 2021, very close to the actual reported non-GAAP number of $11.6B.
Author
The next most important uncertainty is its production growth. Just a bit of historical background to show how much uncertainty there is.
- Tesla's total vehicle volume was just over 100k in 2017, and it delivered a total of 930k vehicles in 2021. In terms of vehicle delivery, its growth since 2017 has been a spectacular 67% CAGR per year.
- For 2022, it is expected to deliver 1.42 million cars.
- the margin of uncertainties widens as we look further out. TSLA’s management's target is at 20 million by 2030, already ambitious enough in my view, about 25x of 2021 volume and a growth rate of 43% CAGR per year. While according to ARK Invest CEO Cathie Wood, Tesla can sell 20m vehicles a year by 2025. And Morningstar analysis assumes Tesla only delivers around 5.7 million vehicles by 2030, well below management’s target.
I am going to assume a more moderate 30% CAGR for the next 5 years – I’d rather err on the side of being conservative. And you can see that “even” at 30% CAGR, the business can outgrow its current high valuation rather quickly.
Right now, there is no doubt that the business is expensively valued. At almost 18x of sales, it is expensively valued both in relative terms and absolute terms (the overall market is valued at about 3x sales). However, as the above table shows, given its business fundamentals and even under some conservative assumptions, its price to sales ratio would be about 4.9x in a few years.
Also, in terms of EV/EBITDA multiple, it's about 83x under its current price and debt levels - again quite expensive. But in a few years, it will be about 26x. To put things under perspective, the fair valuation implied in the analyses from several leading institutions (such as Bank of America) is about 60x to 100x EV/EBITDA.
Author and Seeking Alpha data
Risks
There are risks involved with TSLA investment. At a grand level, it has a heavy speculative flavor and is definitely not for all investors. To detail a few major risks:
- Again, it is very difficult to predict its production growth. It is not anything particularly wrong with TSLA. It is just in general difficult to predict things that grow at fast rates. As aforementioned, TSLA management's target is ambitiously at 20 million by 2030, a growth rate of 43% CAGR per year starting 2021. It is very uncertain whether such an ambitious goal can be reached or not. For example, Morningstar analysis assumes Tesla only delivers around 5.7 million vehicles by 2030, well below management’s target. That is the reason why my analyses assume a more conservative rate of 30% CAGR, resulting in about 3.1 million vehicles by 2025.
- Its ongoing production expansion projects are facing delays. Giga Shanghai is producing cars, but only at a partial capacity that is substantially lower than its target capacity. Its Giga Berlin and Texas are still under construction and Giga Berlin has hit numerous delays.
- In the near term, TSLA and other car manufacturers continue to be hobbled by the global shortage of semiconductor chips and congestion at shipping ports. It is unclear how these short-term interruptions can renormalize.
- In the longer term, the competition in the EV space is also heating up. TSLA’s market share in some of the major markets is under a lot of pressure not only from established car manufacturers but also EV companies in the US and abroad. Traditional players, particularly Volkswagen (OTCPK:VWAGY) and the Ford (F) Mach E are taking market share in the EU and U.S., respectively. In China, another key EV market, NIO (NIO) is currently Tesla’s biggest competition, followed by Li Auto (LI) and XPeng (XPEV). Whether TSLA can maintain its competitive advantage in the EV space in the longer term is uncertain.
Conclusion and final thoughts
After 2021, there should no longer be any doubt about the profitability of Tesla. Profit is poised to soar after it has passed its breakeven production scale and to outgrow its current high valuation in the next few years. In particular,
- It has clearly passed the pivot point of critical scale, recouped the fixed cost, and now began to harvest the benefit of the scale of production and expanding margin. Its average cash from operations per vehicle has been improving while the unit prices have been DECLINING - a clear indicator of passing the breakeven point.
- Its break-even point is estimated to be somewhere close to 100,000 vehicles and the variable cost to be about $40,000 per vehicle for TSLA. As production is expected to increase further as outputs from established factories in Fremont and Shanghai maximize, the fixed cost will be further diluted and profit accelerated.
- Lastly, new factories in Austin and Berlin and full self-driving software add further optionality and upward potential for shareholders.
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This article was written by
** Disclosure: I am associated with Sensor Unlimited.
** Master of Science, 2004, Stanford University, Stanford, CA
Department of Management Science and Engineering, with concentration in quantitative investment
** PhD, 2006, Stanford University, Stanford, CA
Department of Mechanical Engineering, with concentration in advanced and renewable energy solutions
** 15 years of investment management experiences
Since 2006, have been actively analyzing stocks and the overall market, managing various portfolios and accounts and providing investment counseling to many relatives and friends.
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Comments (371)
This is certainly a good point. The approach is trying to strike a balance between being wrong precisely and being correct approximately. There are good reasons to lump all fixed cost instead of analyzing them one factor at a time, and I believe the approach correctly captured the current dynamics. For example, 1. many of the costs are common even when new factory opens (e.g., capital costs, administrative, et al).2. Moreover, since al of Tesla's assembly factories are building largely the same models, a large portion of the fixed cost can be shared and spread out (engineering, tools, logistics, et al).* Many comments are also regarding the 30% CAGR assumed for the next a few years in its production.
Admittedly, 30% is just an assumption – and in my mind, a conservative assumption. If you have different estimates of the growth rate, could you also elaborate why? Not trying to challenge anyone’s estimates, just genuinely interested in different approaches and perspectives.
In a few short years the EV build out at all those ICE manufactures you discount will be complete and the Tesla factory eco system will be minuscule in comparison. What's funny is the auto majors in their timelines have been thru it all. Wars, recession, depressions and more. Tesla has been thru nothing but on government handouts since its inception. In a time frame measured in months it will go from a market it had alone to be one of many trapped with cars that are beyond outdated. I will say greed rants like yours are fascinating that someone would put that silliness into print. I have read and seen decades of it. It always ends the same and never an exception.
As the world’s preeminent EV company plus energy and software, I see the market cap growing in 2022.
Long TSLA!
Not a given, but they are hitting the milestones.
It’s the competition that is concerned, because meaningful may come to late.
2021: 21%
2022: most likely below 20%
2025: 14%
2035: 5-6%
Manufacturing costs in China are lower ... which is MOST important when you are selling in China because automakers face significant price pressure there. Shipping costs, import/export fees , and costs related to delayed delivery, must be factored in when vehicles are shipped from China to other geographies.In Europe and the US, Tesla and its competition face the same economics. They either manufacture within the local cost structure or import vehicles to sell into the local market. In most cases, it is less expensive to manufacture vehicles within the local market unless one is selling in low volumes.
2020 = 1000x PE
2021 = 400x PE
Q4 21 = 85x PE at $900shThe trend is making the TSLA.Q valuation tantrum a moot point.Balance sheet is cash positive with credit getting an upgrade.YOY growth is over 80% and guiding for the same in 2022.Gross margins are off the hook huge. As is operating income. And both are trending up.As Austin and Berlin ramp up margins will take a small hit, but by year end they will fatten up, as profits will likely double YOY.Nitpick your way to avoiding Tesla if you must... or, wise up and buy shares on weakness.Keep it real, keep it simple... and enjoy the ride :-)
8GB eMMC Recall--YES
Model X steering assist motor bolt recall--NO
Model S steering assist motor bolt recall--NO
Tesla safety update--YES
Model S safety update--YES
Accessory adaptor 14-30, 10-30 and 6-50 recall--NO
Seat belt inspection recall--NO5 out of 8 were shop visits and thats just a sample. I will add most of those is just shoddy build quality. FYI I have owned many Tesla's. I have torn town a dozen of them down to the last nut and bolt. Some things amaze me. Some not so much.
--- That would be true for a mature company that is building different models in each factory; at the moment, ALL of Tesla's assembly factories are building the same two models, with just one building the Models S and X. How many other OEMs even attempt to build the same model in every factory?For Tesla, the Models 3 and Y are currently their most popular models and their most profitable models. With Texas and Germany coming online, we're about to see 3 and Y production more than double, while the cost of production will go down. The article is quite logical for the way things stand in the near future but may change as Tesla brings more, new, models into their stable. As yet, we have no solid idea of how much the Cybertruck or the Semi will cost to manufacture and that WILL change the curves, one way or another.
FOR PHANTOM BREAKING COMPLAINTSwww.bloomberg.com/..."The sudden breaking (sic) has happened many times. It’s terrifying."
Btw there is nobody in the industry (including tesla engineers that left) that thinks you can do level 4 ADAS (only Elon calls adas "fsd") with cameras and no lidar
If Boston Dynamics could do it Tesla will certainly have robots doing lots of work.
I bet Tesla has a better time filling jobs than most of their competition, car production line workers, AI specialists and software developers.
The free stock, cheaper car and buying even more stock at cut rate prices beats having to accept $17/hr at a UAW plant with no ownership. Instead you get a nasty, hateful combat with your employer as with UAW & their victim OEM's.
Germany might take a while to get fully staffed but it will be with exceptional hard working people.
