Xiaolu Chu
Tesla (NASDAQ:TSLA) has recently cut its prices substantially. The company cut the prices of its models by as much as 20%, partially in an effort to qualify the vehicles for new U.S. tax credits. However, the company also had major price cuts in Europe and China, other markets where there were no new tax credits, but competition is increasing. That’s angered a number of current customers.
Tesla Volume Problems
Tesla’s problem is whether it can continue to hit its volume targets.
Tesla Press Release
Tesla Initial Volume Targets – Tesla Press Release
Elon Musk, in mid-2022, already set the target of growing its production volume by 50% annualized. 2022, the first year with that target, has already missed, albeit not by much. YoY production growth was given at 47%. However, what’s more concerning to us is the drop-off in delivers versus production for the company.
In the company’s 2021 results, deliveries for the year slightly outpaced the company’s deliveries including in the 4th quarter. The company’s delivery growth was only 40% YoY or 7% less. To us, this indicates that the company is struggling to find customers, but reluctant to decrease its production immediately to correspond.
Times Are Changing
Tesla’s problems are that times are changing.
We’ve talked about this for a while, but in our view, the company’s days of dominating are over. The company no longer offers a new and exciting differentiating factor. Customers we’ve talked to state that they no longer view a Tesla as the most exciting EV, but instead see offerings such as the Ford Lightning, Rivian, or Lucid Air as more exciting.
The company’s competition is increasing rapidly.
Green Car reports
Tesla Market Share U.S. – Green Car Reports
The above chart shows Tesla’s changing market share. The company has lost first mover advantage to some segments (such as pick-up trucks) and in other segments we think it’s unlikely the company gets first-mover advantage (such as full self-driving). Tesla’s 69% 2021 market share has dropped to 65% in 2022 preliminary numbers indicate.
We expect that pace of decline to increase as new manufacturers figure out their own supply issues and ramp up volume. The F150 Lightning waitlist is more than 3-years, and Ford has been able to continue ramping up prices versus Tesla which has been forced to decline prices on its vehicles. The changing times shows a dual risk to the company.
As volume growth slows down and the company is forced to decrease prices to attempt to maintain volume as much as possible, the company will suffer lower revenue growth and lower profit margins on that revenue.
Tesla Overall Competition
Globally the U.S. is still the most profitable market by far for Tesla. Across the world, the company is seeing competition ramp up much faster in other regions.
Tesla has a very low double-digit market share in China, versus a market share of almost 30% for market leader BYD. The company is clearly not the leader in China, and even with continued declines in prices (10-13.5% just a few weeks ago for the second price cut in 3 months), the company’s market share is remaining lower.
The company’s December vehicle deliveries out of its Shanghai factory was down 44% month-over-month. This is a telling statement in our view:
Full production capacity at the Shanghai factory is around 85,000 vehicles per month, Junheng Li, chief executive officer of equity research firm JL Warren Capital LLC, said in a Nov. 22 note. “Without more promotions, new orders from the domestic market will likely normalize to 25,000 in December,” she said, adding increased production couldn’t all be absorbed by exports.
The company isn’t helping itself either. It’s had multiple recalls in China opening discussion over its safety record. Most importantly, after a tough December for Tesla, on January 1, China decided to end its EV subsidy. That subsidy was roughly 10%, so call it roughly $4000 on the price of a Tesla. That was a major part of demand and could imply a similar hit to vehicle prices.
Margins and Profits for Cars
We expect the company’s margins and profits to decrease substantially hurting the company’s ability to justify its valuation.
Tesla Press Release
Tesla Margins – Tesla Press Release
The last few years have had a number of factors that have strongly supported Tesla. EVs have started to receive incredibly strong international government support. Improving infrastructure has also supported demand for EVs. At the same time, other competing manufacturers were barely entering the market and struggling to produce vehicles.
During 2023 we expect those factors to change dramatically along with other factors to hurt the company.
The first is that legacy vehicle makers are solving their production issues. Toyota, which made 9.2 million vehicles in the last fiscal year is now forecasting 10.6 million vehicles in 2023. That means a massive number of new lower cost vehicles (both hybrid and gas) in a world where there was a point that used vehicles cost more than MSRP.
The second is that competing EV production is expected to increase dramatically. Rivian, one of the fastest growing Tesla competitors, is expecting volumes to grow from 25k in 2022, to 50k in 2023. Ford is expecting to grow from 2022 targets of 50k vehicles towards exiting 2023 at a run-rate of 600k vehicles, already having gathered the necessary battery capacity.
The third is that interest rates have risen significantly. That’ll put substantial pressure on the market for vehicles, especially more expensive vehicles, potentially highlighted by Tesla’s price declines. New vehicle sales are expected to increase but overall vehicle sales will decline, hurting the markets.
Putting all of this together, we expect Tesla’s 27.9% automotive gross margin, which declined 2.9% YoY to decline rapidly. The industry standard operating margin is closer to 10% versus Tesla’s 17%, and we expect Tesla to move towards that. For a company that earned $9 billion in FCF TTM, or a <3% FCF yield, that’s concerning about its ability to drive future returns.
Our View
Reading the history of our opinion on Tesla, it’s no surprise where we stand.
Seeking Alpha
Now, Tesla alone is a great company. The company makes some pretty darn cool vehicles. It defined an industry and it’s ramped up production at a legendary rate. Investors, expectedly, were entranced by the company’s ability to do what no other car company to date had done. Unfortunately, that doesn’t justify a limitless valuation.
Building vehicles is still volatile, tough on margins, and incredibly capital intensive. Tesla has never been through an interest-rate induced recession along with the impact on vehicle sales. It’s never hit a point where supply outweighs demand for its vehicles. The company’s recent vehicle production announcement has revealed some concerning details worth discussing.
We expect Tesla’s share price to continue to decline to below a $200 billion market capitalization. At that point the company’s long-term potential will be based on whether it can define new segments for its vehicles (i.e. the Cybertruck or Semis). That remains to be seen.
Thesis Risk
The largest risk to our thesis is that Tesla’s valuation has come down much more to Earth. The company’s market capitalization is down to less than $400 billion versus a peak of more than $1 trillion. Toyota is at a $225 billion market capitalization, so Tesla is now 70% larger instead of 5x as large. The company’s large business and substantial drop so far means that it doesn’t have as far too drop.
Conclusion
Tesla recently closed out the year with some troubling numbers in our view that are worth discussion. The company is rapidly losing market share and it appears to see demand destruction. Local commentators believe that in competitive markets, such as Tesla Shanghai domestic demand is less than the factory production and vehicles are being exported.
A classic sign of this is the company’s spate in recent price declines, which has substantially angered the company’s customers. We expect this to rapidly compress the company’s margins at a time when the company is already struggling to make the cash flow and revenue to justify its valuation. That makes the company a poor investment going forward.
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