Tesla (TSLA) is famous for setting ambitious production and delivery goals, and its guidance for 2020 was no exception. In January, the upstart electric vehicle company announced that, “For full year 2020, vehicle deliveries should comfortably exceed 500,000 units.” Tesla has reiterated this guidance on numerous occasions since, including during its most recent quarterly earnings call in July.
Despite the company’s public confidence, however, it appears increasingly unlikely that it will be able to achieve its delivery goal. Worse still, there are growing signs of an overcapacity problem, something that could threaten to derail Tesla’s growth story – and its vaulting valuation – predicated on an assumption of essentially limitless demand.
Let’s begin with a review of deliveries to date. In Q3, Tesla delivered 139,300 vehicles, bringing total 2020 deliveries to 318,350. At its current rate, the company should easily exceed 2019’s record 367,656 deliveries. But in order to meet the bottom end of its guidance, Tesla will need to deliver 181,650 vehicles in Q4. That means it will have to deliver 42,350 more vehicles than it did in its record-setting Q3 – a 30% increase quarter over quarter. That would be a tall order even in good times; with the global economy still reeling from the disruptions of the COVID-19 pandemic, these are not especially good times for any automaker.
Now that we know the scale of the challenge faces Tesla to meet its guidance, we can turn to the question of whether it is even possible for the company to deliver 181,650 units in Q4. Tesla has claimed that its factory in Fremont, California is capable of producing around 500,000 vehicles per year, while its factory in Shanghai, China is supposedly rated for 200,000 vehicles per year. That brings its notional maximum annual production capacity to 700,000, or 175,000 per quarter. What this means is that, even if the company runs its factories at full capacity throughout Q4 and sells every single unit produced, it would still fall short of its delivery guidance.
That is not the end of the story, however, as it also has a substantial inventory of unsold vehicles. According to Seeking Alpha’s Donn Bailey, Tesla had 18,342 units in its inventory at the end of Q2. Q3 added another 5,736, which brings the total to 24,708. In order to meet its guidance of 500,000 deliveries, the company would need to sell 6,650 of these inventory units, in addition to all 175,000 built during the quarter.
Based on the above calculations, we must conclude that it is still theoretically possible for Tesla to meet its delivery guidance. But is it probable? To answer that, we must consider its actual manufacturing capacity utilization.
Capacity Utilization Problems
In Q3, Tesla built 145,036 vehicles, which implies a mere 82% capacity utilization. If the company can get that utilization rate up, there might yet be a ray of hope for meeting its guidance. Assuming Tesla can sell all of its accumulated inventory (an assumption we will address in the next paragraph), it would need to build and sell 156,940 units, implying capacity utilization of 89%.
Making the company’s situation harder is the fact that not all of its inventory of 24,708 vehicles is saleable. Showroom cars and courtesy vehicles cannot be sold. Vehicles that have been in inventory for an extended period may be outdated and difficult to sell. Thus, a significant portion of Tesla’s official inventory is unavailable to fill the production gap. While we can only guess the true number, let’s make the generous assumption that only 25% of its inventory is unsaleable. That leaves us with 18,531 inventory units, meaning Tesla will have to build at least 163,117 units in Q4 – a capacity utilization of 93%.
Unfortunately for a manufacturer already going full tilt, such improvements can be very difficult to achieve in short order. But even if Tesla can work some manufacturing miracles, it is unlikely that it would be enough.
The Demand Question
Even if the company can expand production by 13% quarter over quarter to 163,117 units, it is unlikely it will be able to sell them all given the current economic climate and demand situation. After all, its inventory grew by 5,736 units in Q3. Erasing most of its accumulated inventory and selling every vehicle built in Q4 is simply unrealistic.
Moreover, there are mounting signs of softening demand. Tesla’s most mature markets have seen stagnant, or even falling, sales. In Western Europe, sales were down 18% in the first half of the year, and appear to have continued their slide in Q3. In response to this uninspiring trend, the company has sought to focus investors’ attention on newer markets, especially China.
Unfortunately, the Chinese growth narrative has also come under pressure of late. Last month, the company announced plans to start shipping Chinese-made Tesla vehicles to customers in other markets, something it had previously said would not happen in light of overwhelming domestic Chinese demand. On September 30th, it once again slashed prices across a range of models in China, with some seeing discounts approaching 10%.
With its mature markets either stagnant or contracting, and its supposed top growth market proving somewhat less enthusiastic than anticipated, Tesla is likely to struggle to sell all the vehicles it builds in Q4, even if it does not ramp up production significantly.
Investor’s Eye View
Tesla’s guidance of 500,000 deliveries in 2020 was always ambitious. At this point, it is little more than a pipe dream. Even if the company sets new production records, it would need to sell everything it makes and then some to even come close to its goal. With economic headwinds and recessionary pressures still very much in force, the prospect of a surge in demand for high-end cars in Q4 seems unlikely.
So, what does this mean for Tesla stock? In the short term, if the company can blow away its 2019 delivery record, it may be able to spin 2020 as a win in spite of falling short of even the low end of its guidance. As such, it would be wise for CEO Elon Musk to walk back Tesla’s guidance in the near future. I would not be surprised if he does so during the Q3 earnings call later this month. If Musk refuses to soften guidance, it could set Tesla up for failure – and a negative market reaction in early 2021.
Taking a longer view, it is increasingly evident that Tesla’s claims of limitless demand are unfounded. Stagnation in the United States, sliding sales in Europe, and insufficient demand in China to soak up all of Shanghai’s production all point to a company struggling to move metal. Tesla appears already to be fighting to sell everything it produces, despite leaving about 20% of its claimed capacity unutilized. Taken in this light, the company’s widely publicized plans to open a number of new factories, starting with one in Germany, looks rather unwise. But the narrative of endless growth is what has propelled the stock – and underpins its staggering $380 billion valuation. Thus, Tesla cannot afford to pull back from its capacity expansion plans.
In conclusion, Tesla stock is built on a story of endless growth. It is set to fall short of a key symbolic goal meant to bolster that story, but that is unlikely to have a serious impact on the stock in the short term. Longer term, though, the company’s struggle, and probable failure, to achieve its goal of 500,000 deliveries shows how different the reality of demand is from the narrative. In the battle between fantasy and reality, reality always wins eventually. The cracks are starting to show in Tesla’s growth narrative, which will likely result in an eventual deflation of its bulging share price, but investors should approach this name with extreme caution.
Disclosure: I am/we are short 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.