The False Tale That “Tesla is far more profitable than other car manufacturers”.
This work has benefitted from the financial analyses that Troy Teslike has produced. Summaries of his work are available on Troy’s twitter feed, and the full analyses (2 weeks ahead of the twitter feed) are available for a small monthly fee on his Patreon. I have no financial linkage with Troy Teslike.
As Tesla has repeatedly cut prices in all the markets it serves to maintain demand at a level required to keep its’ factories utilized at a unit cost efficient level, there has been the continuous narrative that the company’s margins are so fat it can slash prices to a level to put its competitors out of business. This is a significantly false narrative based upon Tesla’s margins when they were still selling to the “early adopter” and fashion-niche relatively price-insensitive consumers. Those margins were also significantly aided by the post-2020 inability of other car manufacturers to ramp back up production (of both ICE and electric vehicles), allowing Tesla to significantly raise prices, a lack of aggressive competition in China and any real competition in the US. In addition, the early adopter consumer fulfilment was also stretched out by the partial shutdowns of the Shanghai plant in Q2 and Q3 of last year which limited production levels. One more positive margin factor was the post-2020 shutdown near-zero interest rates at which consumers could finance their relatively expensive Tesla cars.
The Positive Margin Factors All Reversing
All of these positive factors are now rapidly reversing. In December of 2022 Tesla’s order book in the US and China to all intents and purposes hit zero. This was after the first set of Chinese price cuts in October had only produced a small bump in demand that rapidly faded. All of the early adopter and fashion-niche consumers had been fulfilled in the US and China. In the latter case, the second round of price cuts simply maintained demand and the China order book hardly increased (it has remained at low levels through April 2023). In the US, the price cuts were greatly aided by the US$7,500 IRA subsidy but even with the double-whammy of Tesla price cuts and the US IRA subsidy (a combined price cut of 20% or more depending on the model), Tesla US sales only increased by between 25% and 30% Q1 2023 vs Q4 2022 and inventory levels started to increase again (accelerating upwards in recent weeks) and the order book only bounced for some weeks before starting to fall back. Other car manufacturers are now starting to get back to near full production, interest rates have risen substantially, and some real competition is seeping into the US market, and Tesla’s own US production capacity is increasing.
The “recession” is now increasingly blamed by many Tesla commentators and pundits for the need to cut prices further in the US, but this recession has hardly begun – meaning that much of the inability to boost demand is a Tesla problem, not a general economy problem; Tesla demand elasticity to price is nowhere near what many believe (and Musk has stated), shown by the linear response to the massive combined Tesla plus IRA price cuts. In the US, Tesla EVs are still substantially more costly than ICE cars and with a recession oil prices may very well fall substantially, reducing US gasoline prices. In addition, the dealer markups of its’ competitors are now rapidly disappearing to be soon replaced with discounts. This will affect the dealer profits but not the competitor manufacturer profits; ICE (and some EV) competitor prices to the retail customer will fall substantially without affecting the profits of Ford, GM etc. As we progress though the balance of the year, the US (and European) recession will become much more of an issue that will hit all car makers.
How did Tesla “rescue” its Q1 delivery numbers? It sold as many cars as possible to the remaining early-adopter and fashion conscious consumers in Europe and the Rest of the World (ROW) outside China and the US, aided by January price cuts to still expensive prices when compared to China and the US, plus it made its more expensive S and X models available globally. This was helped by the ramp up of the Berlin factory to what has been reported as 5,000 cars per week in April. By the end of February, the European order book was already tumbling down quickly toward zero and inventory was building so Tesla had to cut prices again in Europe – at least 6%; the January price cuts had only provided a small reprieve. It’s important to note that the margin impact of these cuts was only felt in the last month of Q1, so Tesla’s Q2 already started with a full-quarter additional profit margin reduction vs Q1 (1 months reduced prices vs. 3 months) in Europe. This did reduce European inventory levels for a month. In the Rest of the World, the order book was also significantly reduced leaving very little extra sales boost available. The net result of all these price cuts is that Tesla’s operating margin fell to 11.4% from 16% in Q4 2022 and from 19.2% in Q1 2022; Tesla’s overall profits fell as they sold more cars.
Lower Q2 Tesla Margins Already Baked In
So how does Q2 look? Well it opened with another round of price cuts around the world – excluding only China (where its margins are already down to the bone on the Model 3). In Europe, inventory levels jumped at the beginning of April with the order book boost from the February price cuts now fading away, so on April 14th prices across Europe dropped as much as 10% for some models (less for others). So now quarter 2 margins in Europe will be impacted by the February and April price cuts. On April 4th, prices on the Model 3 in Australia were dropped by an additional 5% plus there were significant reductions in other parts of the ROW (with 25% cuts in Israel being the extreme); again, more margin pressures. It is notable that BYD has begun significantly entering many of the non-European ROW markets in the past few months; increasing the competition on Tesla in those markets. In Europe, the Geely brands are already well established (MG, Volvo, Polestar, Lynk & Co.) and other Chinese manufacturers are increasingly entering the market – adding to the level of competition that is already fierce with the European brands (e.g. VW, Audi, BMW. Mini, Mercedes, Renault, Peugeot, Fiat, Dacia) striving to maintain market share in EVs. As the order book started to wane in the US, and inventory started to build, Tesla prices were also cut there twice in April – by as much as a further 10%. If the combined effects of these price cuts do not produce an operating margin below 10% in Q2 it will be a miracle. Sales may increase slightly quarter over quarter, but profits will once again drop.
Tesla Q2 Margins Will Place it Within The Car Manufacturer Pack; Not as a Leader
Let’s say that the Tesla operating margin drops to 9% in Q2 (it may actually drop further as this assumes some serious cost cutting, and prices may be forced down further as the recession starts to bite in the US and Europe and the Shanghai Black Hole rears its ugly head [see below]), how does that compare to other car manufacturers? Well in Q4 2022, still relatively comparable to the present, Ford operating profit was 4.82%, GM 7.09%, Toyota 6.85%, VW (which includes VW, Audi and Porsche brands) in Q1 2023 8.57%, Stellantis in H2 2022 12%, BYD (including its battery business) in Q1 2023 4.16%. With respect to BYD, let’s remember that it is selling 95% of its cars in the hyper-competitive Chinese EV market where Tesla is perhaps breaking even on its China sales while having a much more premium mix of products than BYD. With respect to all the companies selling predominantly ICE cars in the US, let’s remember that Tesla is benefitting from a US$7,500 EV subsidy on most of its cars (US$3,750 on most Model 3’s). In Europe, Tesla sales are still benefitting from some EV subsidies even though those subsidies are falling over time (an end of 2022 change in Germany removed all PHEV subsidies, while keeping some BEV subsidies, actually benefitting Tesla). So, even with all the government subsidies, Tesla will be in the car manufacturer profit pack and most definitely not in a position to “bankrupt” its’ competitors. That reality disappeared with the past 6 months of price cuts although this does not seem to have sunk into many analysts, commentators and shareholders brains. The widespread use of Tesla gross profits in comparison to other manufacturer’s net profits perhaps helps this narrative persist.
The Shanghai Possible Black Hole
Perhaps the biggest possible problem for Tesla will be keeping its Shanghai plant fully utilized and marginally profitable. BYD and other Chinese manufacturers are already significantly attacking its non-China Asian markets and many additional Chinese products will be released internationally in the balance of the year. To add to the problem, the rapidly expanding Model Y output of the Berlin plant is reducing the need for Shanghai produced Model Y’s in Europe, and the demand for Model 3’s in Europe (not produced in Berlin) is not strong. Tesla has two options; sell more Shanghai production in China where the profitability is already marginal (and the extra sales may need another price drop) or drop prices again in Europe especially on the Model 3 (which will reduce profitability of the Shanghai exports). The other option of reducing Shanghai output seems not to be an option and would reduce margins by increasing per unit costs. This conundrum for Tesla is a weak point that especially BYD, but also the other large Chinese manufacturers, could exploit to severely limit or even reduce Tesla sales in China. With their much wider product ranges, and better China margins in the case of BYD, they could accept lower margins on the cars that compete with the Model 3 and Model Y to make Tesla Shanghai a loss-making plant. The biggest tell on this will be the pricing of the soon to be released BYD Sea Lion, which is a direct competitor to the Tesla Model Y. If the Sea Lion is priced in the range Yuan 200,000 to 250,000 as rumoured it will directly and substantially challenge the China pricing of the Tesla Model Y which is currently priced at Yuan 261,900 (Base model), 311,900 (Long Range), and 361,900 (Performance); that could cause a massive headache for Tesla. Most probably forcing Tesla to reduce Model Y prices in China and perhaps across Asia. As reducing Model Y prices in Europe would also reduce the profitability of all of Berlin’s increasing output, that will probably not be an option. The recent announcement about exporting Tesla Shanghai cars to Canada (the US is not an option with the US tariffs against China and the IRA) will only fill a small amount of the Shanghai black hole given the small size of the Canadian market.
The Massive Mistake Of Not Prioritizing The Model 2
The massive mistake of prioritizing the Cybertruck (and the Semi), which is only relevant to US consumers in large numbers (and even then the multi-year delays to its release mean that it will land in a highly competitive segment and certainly not as a ”first-mover”), over a much cheaper Tesla car (the “Model 2”) becomes apparent. With the Model 2 probably not arriving in China and Europe until 2025 at the earliest, Tesla is severely limited with its two main up-market models. In China, the cheap EV space is already phenomenally competitive, and any Tesla model will be just another option if it arrives two years from now. By 2025, the Chinese manufacturers may have created the same reality in the ROW. Only in the US may Tesla have an advantage, especially with the US$7,500 IRA subsidy (unless the Republicans win the 2024 elections and cancel it). An outlier would be if GM utilized its partnership with SAIC-GM-Wuling to assemble the latter’s cars in the US with US-produced batteries; or even perhaps in Mexico. Also, margins on smaller cheaper cars are generally much lower than on larger and more expensive cars. Any thoughts that Tesla will somehow magically overcome this reality are wishful thinking. An additional issue will be the probability of the US$7500 subsidy (as well as local state subsidies) being reduced as EV’s gain a greater market share in the US and the cost of the subsidy escalates. This is what has happened in both Europe and China, impacting EV manufacturer margins.
Tesla Changes The Narrative To The Disposable Razor Model.
As the ability to keep going with the “we have phenomenal margins and can bankrupt the other manufacturers” and the “the demand curve is infinite” narratives rapidly deteriorates, Tesla management have switched to the “disposable razor” model narrative. They may not make much profit up front, but they will make it up on “software and services” in the future, just like Gillette makes its money off the ongoing sale of razor blades; they promise. This is a rehash of the “self-driving” and “robo-taxi” narratives that Mr. Musk has been pushing for many, many years without any actual fruition in the real world. They have always been “coming soon”. It was notable in the Q1 earnings call that Mr. Musk would not answer a question on the take up rate of FSD (full self-driving), perhaps it being about 8 years late with respect to Mr. Musk’s promises has started to have an effect on consumers. In addition to the highly questionable actuality of such claims there is also the problem of the discounting of those future cash flows, especially now that we have returned somewhat to “normal” interest rates.
Mt. Musk’s promises should perhaps come with a warning label. He did it again with respect to FSD in the Q1 earnings call, commenting that FSD “may be as early as later this year”.
Let’s imagine that Tesla becomes priced as a somewhat higher than normally profitable automobile manufacturer, with a price to earnings multiple of 10 (e.g. as with Toyota, GM and VW have a p/e of 5). It will be lucky to make US$3 a share in profit this year, US$3*10 = US$30 per share. If we assume some significant profit growth as the EV market expands (although there is no guarantee that Tesla profit will grow at the same rate as the sales of overall EV market given increasing competition and probable loss of market share, together with the possible need for lower margins to increase volume) maybe we give it an optimistic earnings multiple of 30 (with 30% yearly profit growth that’s a PEG ratio of 1), so that US$3*30 = US$90 per share; BYD’s P/E ratio is currently 34. So, a possible share price range of US$30 to US$90, which seems more than reasonable given that its fiscal 2023 profits may be significantly lower than US$3, and that its profit (as against its volume) growth rate may also be substantially lower than 30% per year, given all of the pressures noted above. As of the end of April 25th, Tesla’s share price was US$160.57 (with a p/e ratio of 47 based on the trailing year’s profits, which will be higher than fiscal 2023 profits).
Sources of Tesla inventory data in the US and Europe:
https://tesladata.mattjung.net/total-new-inventory/
https://tesladata.mattjung.net/tesla-europe-inventory-per-model-all-countries/?days=&model=m3
https://tesladata.mattjung.net/tesla-europe-inventory-per-model-all-countries/?days=&model=my
Please note that this content is provided for general interest, I am not a financial advisor, and this in no way represents financial advice with respect to ownership of Tesla stock.