On Seeking Alpha and elsewhere Tesla (TSLA) is hotly debated from an investment standpoint, one of the most contested points is whether Tesla can be or ever will be profitable. Central to the thesis that makes TSLA the most shorted stock on the NASDAQ, with 28% short interest, is that Tesla fails to be GAAP profitable, especially without ZEV sales, despite selling vehicles with ASP’s around $100,000. With this in mind, bears can not fathom a way that Tesla moving downmarket will amend the situation. View the short interest activity for the last year below:
In one of my prior articles covering Tesla, I examined average deliveries per delivery center, a metric I believe helps ‘hear through the noise’ of various Tesla metrics that are often cited as relevant such as ‘loss per car sold’ (A short favorite) or ‘falling demand’ (something that has been occurring with Model S for several years for the according to bears despite Tesla maintaining deliveries YoY in the same period). In this article, I explored the number of US deliveries for various automakers and averaged the number of deliveries with the number of dealerships, then did the same for Tesla and the number of stores/galleries they operated. What I found is that Tesla is selling less vehicles per store than their competitors currently, suggesting there is room for improvement potentially. The reason I mention this prior article is I believe it provides a nice example for precisely why moving down-market will help Tesla.
Movie theaters make most of their money off of popcorn and soda sales, with the vast majority of ticket sales going to licensing fees to show the movie as well as covering costs of SG&A. If you look at Model 3 as the “movie ticket”, the thing to cover the costs and keep the lights on and attract people through the door, and the S/X and eventually Roadster as the ‘popcorn and soda’, then one can quickly see how the Model 3 will drastically improve the profitability of Tesla as a whole, even if the average vehicle is sold just above break-even.
If we take the roughly $24,000 on SG&A (covering costs of galleries, sales and service centers and their employees) per vehicle produced (2.477 B actual, I used 2.4B in my calculations and 100,000 vehicles instead of 101,312) for Tesla in 2017, take half the total and then average that between the number of US stores/galleries in operation we would get 50,000/~100 = 5,000 vehicles per store, or $120 Million in costs (5,000 * 24,000). Now, assuming less than a 5x increase in these costs as Tesla increases deliveries 5x+ with the Model 3 (from 50,000 US deliveries to 300,000+) as they will not need an additional employee or delivery trip, etc. for each delivery, let us be conservative and assume still a 4x increase in SGA per location.
1) $480 Million per location / 25,000 = $19,200 per vehicle, a reduction of 20%.
2) At 2.5X increase in costs (more inline with what I expect to be the maximum increase per store): $300 Million / 25,000 deliveries per location in a year = $12,000, or half of the current cost per vehicle (50% reduction).
3) If we assume these costs are fixed and that the number of deliveries can be increased 5 fold without an increase in employees or costs per store of any large impact, like an incremental cost of $2,000 per vehicle, we would get the 2017 rate of $120M per store, plus $2,000 * 250,000 / 100 stores = $100,000 additional costs per store ($2,000 per M3, ~250K M3 delivered in US at ~100 stores) or 120.1 M per store. 120.1 M per store / 30,000 vehicles per store (50,000 S/X, 250K M3 / 100 stores) = $4000 SG&A per vehicle, or a 6x reduction in cost per vehicle delivered. Given that 5% of a little less than the expected ASP of $42,000 is $2,000, I think this is a reasonable estimate for the total cost of getting each vehicle to the customer. It is also in line with the delivery fee Tesla charges of around $1,200 ($1K for M3), which one would assume actually covers the cost of delivery.
As can be seen with the above scenarios, it is extremely unlikely that the SG&A per vehicle does not improve with each delivery sold by a factor of at least 20%, and it could be by as much as 600%.
As there is no incremental cost per vehicle that receives software such as autopilot or other resulting tech from R&D, it is even easier to see how the cost of this department will reduce on a ‘per vehicle’ basis exponentially as Tesla ramps the Model 3 and introduces other lines based on the Model 3 platform (namely the Y, Roadster and parts of the Semi).
If my forecasts are correct and Tesla achieves at least a 300% decrease in costs per vehicle in both R&D of fleet wide tech and sales/service infrastructure (not to mention superchargers) it is extremely viable for Tesla to be profitable once they achieve a significant run-rate (at least 4,000 a week Model 3).
Given, however, their desire to expand to a few million vehicles a year as well as expanding into more market segments such as long-haul trucking and the SUV segment, I expect Tesla to operate in Amazon fashion, growing wildly with huge reserves of profit being basically non-existent for several years to come as the value of the overall company increases dramatically.
The Road To Profitability
The ‘Tesla loses X $ sold per vehicle’ argument has always been laughable, but this will quickly be turned over on its head as those watching witness Tesla start to become slightly more profitable on a per unit basis as they continue to increase production with Model 3 and expand their offerings further. Helping with the matter is that Tesla expects to use a wide variety of components found in the Model 3 for both the upcoming Tesla Semi and new Roadster in addition to the Model Y. This will further decrease incremental development costs for new products on the production side as well as further spreading out costs of SG&A on the sales and service side. This brings me, however, to what I believe is the biggest threat or disadvantage Tesla faces beyond a global recession at this time.
Tesla’s Biggest Disadvantage
Compared to the incumbent automakers, Tesla, as well as the numerous other automotive startups that have emerged in recent years biggest challenge is subsidizing a number of capital intensive products without having revenue from existing offerings. While Musk’s company is crossing a major milestone as they increase production capacity from barely over 100,000 to over half a million between their first 3 vehicles (original Roadster excluded), they are a long way from the sort of volumes enjoyed by other luxury automakers, and planets away from the likes of VW (VLKAY), Toyota, GM (GM) or Ford (F). Even with the impending chance that many of the technologies developed for ICE vehicles do not translate well to the EV world, these Goliath's still will generate billions in profit for years to come. For this reason, although I believe Tesla will be operating all of their product segments on a profitable basis (and with margins that improve over time), I believe the company will be forced to run at break-even or even operating-losses until they achieve a volume of around 2.5 Million vehicles produced and delivered each year (as detailed more in a blog post). Depending on the speed at which Tesla desires to grow over the coming years, I could see Tesla deciding to raise more money, but in a way that is negligible compared to the increased speed at which they expand.
Despite historical evidence suggesting otherwise, it is much more likely Tesla achieves profitability this year than seems reflected in the stock price, as shown by the insanely high levels of short interest. While I expect each product to be profitable on an independent basis, and to help with company wide costs, particularly in SG&A and R&D, I expect the company to continue reinvesting every dollar earned and possibly more in efforts to continue their mission of providing more sustainable means of transportation and energy solutions to the world. With the current production rate for the three products being roughly 250,000 a year and rising, Tesla has come a long way from just 80,000 deliveries in 2016, but has a long way to go to reach levels of competitor's who already are annually moving millions of units.
Recent dips in the stock provided great exit points for shorts and entry points for longs, with a few more opportunities to come possibly in the coming weeks. I believe a short squeeze is imminent, and definitely caution those betting against this stock to take their profits when they have the chance.
As Tesla continues to grow, I do not expect any serious returns to shareholders (other than growth in value of the overall company) until 2023-2025.
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Disclosure: I am/we are long 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: I am not a registered investment adviser and the above information is not to be construed as investment advice but my individual opinion. Always consult a professional before investing.