Musk’s price war leaves Tesla with self-inflicted wounds

We finally got those cheap Teslas — sort of. Yet more price cuts for Tesla's electric vehicles arrived ahead of Wednesday evening’s results, with the base Model 3 slipping just under the totemic $40,000 (R728,016) level. That doesn’t bode well for the current quarter if the latest numbers are anything to go by.

A combination of price cuts and ho-hum sales figures so far this year have centred the ever lively debate about Elon Musk’s EV juggernaut on one question: Where will automotive gross margins pan out? To give you a sense of the answer, Tesla decided to change its format and drop that number from the report. But I calculated it here.

The figure on the right, adjusted for the revenue Tesla makes selling regulatory credits for zero-emission vehicles, is the one people focus on. Coming in below 20%, a five-point drop versus the prior quarter and a huge 11-point drop year-over-year, shows the price cuts are biting. 

Discounts are nothing new in cars, but they feel new for a carmaker which has long boasted about being supply, rather than demand, constrained. On that front, some other figures are also concerning. Despite the price cuts, deliveries increased just 4.5% compared to the prior quarter and sales of the premium priced Models S and X collapsed. As a result, the implied average selling price, excluding leased vehicles and regulatory credits, fell by about $5,000 (R90,966) per vehicle. The implied gross margin, meanwhile, fell below $9,000 (R163,739) per vehicle, its lowest level in four years.

Deliveries are up almost 37%, year over year, which is more encouraging. However, that wasn’t fast enough to match production, which is up 44%. Far from being supply constrained, Tesla has now notched up four quarters in a row producing more vehicles than it delivered, almost 78,000 cumulatively. The resulting swollen inventory has reversed Tesla’s favourable cash conversion cycle. This had flipped negative in early 2021, meaning Tesla was being financed partly by its suppliers. A big reason was Tesla getting much more efficient in minimising the inventory it carried. This quarter, that measure flipped back into positive territory, stoking a big working capital headwind and pushing free cash flow down to its lowest level in almost three years, just $441m (R8bn) . The consensus forecast: $3.2bn (R58.3bn).

As concerns built about Tesla’s gross margin during the quarter, one counterargument was that its margins were so high, they could take the strain to protect growth. In other words, Tesla’s profitability gave it more leeway than traditional automakers to engage in an old-fashioned price war. Tesla echoed this in its announcement, citing the macroeconomic environment as a “unique opportunity” for the company.

It’s true that Tesla’s automotive gross margins, even now, put it ahead of competitors. Then again, those competitors don’t trade at anything close to 51 times forward GAAP earnings, as Tesla does. Its $570bn-odd (R10.4-trillion) market cap, despite having dropped by more than half from its peak, rests on the notion that Tesla can both grow at phenomenal rates and simultaneously realise industry-beating margins. That would certainly be a novel combination in the autos business.

Tesla’s stock multiple demands growth above all and the price cuts speak to that. Speaking on Wednesday’s call, Musk added a typically futurist spin to this, saying that increasing the number of Teslas on the road — even by selling them at no profit — lays the groundwork for autonomous fleets, a persistent if as-yet-unrealised pitch.

Thus far, however, price cuts haven’t spurred a jump in sales and inventory has kept on building. Why else preface results with yet another price cut? As Tesla indicated itself at its recent, somewhat meandering investor day, the EV revolution Tesla’s valuation epitomises requires an even cheaper model for the masses that is nonetheless very profitable. Getting there will require Tesla delivering the game-changing manufacturing efficiencies it touted that day. For now, discounted Teslas serve mostly to remind us how expensive the company remains.

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