In a week full of news about Tariffs, Trade Wars, Italy’s government and debt issues, Presidential pardons and even a TV sitcom star’s twitter account, one recently newsworthy stock has been notably absent from the headlines – Tesla (TSLA - Free Report) .
The company is in between earnings reports and has been tight-lipped of late about production data on the Model 3 sedan. CEO Elon Musk’s tweets, while numerous, have been mostly banter with both supporters and detractors and a tangential thread about his frustrations with the “media” - and his intention to build a news service to sort fact from fiction. Given Musk’s current state of skepticism about the press, it’s no wonder there’s been a dearth of official releases.
There is one developing story however that sheds some actual light on Tesla’s financial situation. A report in German business magazine WirtschaftWoche on Thursday details the results of a project to reverse-engineer a Model 3 to determine the costs and methods of production. Performed by an independent engineering firm - but reportedly commissioned by a “major” German auto manufacturer – the project apparently started in January when two Model 3s were spotted being air-freighted to Germany. (It was revealed recently that those test cars were purchased for upwards of $100,000 each on the grey market.)
The engineers’ take on the Model 3 was overwhelmingly positive. In addition to generally praising the simplicity and elegance of the engineering, they broke down the likely cost of every physical component of the car down to the last nut and bolt and came up with a total of $18,000. After adding in $10,000 worth of production costs, they arrived at a total cost of $28,000. This suggests gross margins of 20% on the Model 3, even at the headline base price of $35,000 – and reportedly the Model 3s being sold currently are heavily optioned and selling for up to double that number.
Especially noteworthy was their laboratory analysis of the Model 3’s lithium-ion batteries. The German engineers determined that they contained only about 2.8% cobalt instead of the industry standard 8%. The price of the rare metal has tripled in the past two years and the majority of the tight worldwide supply lies in the Democratic Republic of Congo – which has been crippled by a bloody civil war and accusations of human rights violations including child labor. A significant reduction in Tesla’s reliance on cobalt portends good things about their Gigafactory’s ability to produce large numbers of batteries at a reasonable cost.
In the now infamous conference call after Tesla’s latest earnings report, one of the questions Musk declined to answer concerned margins on the Model 3. Some analysts assumed that he didn’t want to give a hard number because it was low or negative. If the German report is correct, it seems that rather than being evasive, Musk was simply playing his cards close to the vest.
By the Numbers
If the German figures about the cost of making Model 3s is correct and Tesla can produce 5,000 of them a week by the end of June, what will that mean for the company’s financial performance in 2018?
In Q1 2018, Tesla delivered 29,997 cars including 8,182 Model 3s, and reported revenues from vehicle sales of $2.56B. The cost of goods sold in autos was $2.1B, in line with the 20% margin suggested by the German engineering studies.
If they do meet the production target of 5,000 Model 3s per week by the end of June, and assuming costs of $28,000/vehicle for the Model 3, a sales price of $35,000, that sales of Model X and Model S vehicles are the same as in previous quarters and that fixed costs remain relatively constant, Q3 revenues would be somewhere in the area of $4.5B and net profit would be $116M.
Obviously, all of those are big “ifs”, but just a little bit of quick math shows that Musk’s claims that Tesla could be profitable this year are not a pipe dream.
Everything still hinges on Tesla’s ability to get to 5,000 Model 3s/week – which is far from certain - but investors who are bearish on the shares must be viewing these recent developments as potentially very bad news.
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