Tesla ex-AI Glamor: Unending price cuts, Unending Profit erosion

Tesla (TSLA.O) released its Q4 2023 earnings report after the US stock market closed on January 25th, Beijing time. As the chaotic story subsides, the reality that Tesla will face in 2024 remains challenging:

1. Shanghai factory is back in full swing, but gross margin is still declining! The gross margin for automotive sales (excluding regulatory credits and vehicle leasing) in the fourth quarter has recovered to 16.6%, which is lower than market expectations.

2. High sales come at a cost: With the normal operation of the Shanghai factory, sales in the fourth quarter reached a record high of 485,000 units, with production reaching 495,000 units. The previously announced sales also exceeded market expectations. However, this achievement was achieved through price reductions and promotions, sacrificing profit for sales volume. As a result, although the sales volume is good, the revenue is average, with automotive revenue at 21.6 billion, in line with expectations.

3. Too many price reductions and insufficient cost reduction: The release of sales volume in the fourth quarter did lead to a decrease in fixed costs per vehicle. However, the cost reduction effect brought by the Cybertruck and other variable cost reductions did not match the magnitude of the price reductions. As a result, the gross margin per vehicle did not meet market expectations, with the gross margin (excluding credits and leasing) not exceeding 17%, lower than the second quarter.

4. Maintaining stability at a high level of investment: After the increase in R&D expenses and capital expenditures in the third quarter, there was a slight decrease in this quarter, indicating a stable state at a high level. The changes in management and sales expenses were not significant despite the increase in sales volume. Overall, the performance of the expense side was not dragging behind.

5. Operating profit of 2.1 billion, significantly lower than the market expectation of 2.3 billion: The main issue lies in the gross margin. In addition to the lower-than-expected automotive gross margin, both the revenue and gross margin performance of the energy and services business were mediocre. Revenue growth slowed down, and the gross margin showed a downward trend.

6. A "honest" outlook: Tesla is very honest about the lackluster prospects for 2024. The direct implication in the 2024 outlook is that the benefits from Model 3 and Model Y will be exhausted, making 2024 a year of slow growth for Tesla.

Dolphin Research's overall view:

In fact, in the second half of last year, Dolphin Research expressed our concerns through three articles recently.

this earnings report, as well as Tesla's price reductions and the decline in subsidies around the world since the beginning of the year, are following the analysis by Dolphin Research in the previous quarter.

Let me repeat it here:

"In the last quarter of 2023, Tesla may be able to rebound from the bottom of its operations in the fourth quarter of 2023. However, beyond 2023 and into 2024, Tesla may still be a year of high investment and low output. Of course, these high investments correspond to Tesla's longer-term competitive barriers, and Tesla's long-term logic remains intact. However, in the short term, the market's linear extrapolation of Tesla's performance is likely to face downward pressure."

The automotive business in 2024 is destined to be lackluster, which means that Tesla's stock price elasticity in 2024 will mainly depend on the next car platform. If it exceeds expectations and starts selling cars ahead of schedule (market expectations are by the end of 2025), it is estimated that it will create some positive news. Another factor is the progress of FSD V12.

If these two main stories are missing, Tesla in 2024 will likely hover around the neutral and conservative positions in Dolphin Research's valuation judgment, without any real upward potential.

Here is a detailed analysis of the earnings report:

1. Tesla: Exhausting Model 3 and Model Y product cycle

1.1 Difficulties in selling electric cars, Tesla's average selling price continues to decline

In the fourth quarter of 2023, Tesla's revenue was $25.2 billion, significantly lower than the sell-side consensus estimate of $25.6 billion on Bloomberg.

Although Tesla's sales in the fourth quarter were still good, meeting the target of 1.8 million units sold last year, continuous price reductions, mainly in North America, caused the average selling price to decline again, exceeding market expectations. As a result, automotive revenue can only be described as relatively flat.

In the past year or so, when the automotive business performed poorly, the energy and services businesses usually had good revenue and gross margin performance to offset the pressure on revenue and gross margin in the fiercely competitive automotive business. However, both of these businesses were lackluster this quarter. As a result, Tesla's year-on-year revenue growth rate has fallen below 5%.

1.2 Profitability fell short again

In each earnings report, the performance of the automotive gross margin is more important than revenue. However, as the dividends from the Model 3 and Model Y cars come to an end, Tesla's performance continues to disappoint (detailed analysis below).

Even though Tesla's efficiency champion, the Shanghai factory, resumed production and the new Model 3 ramp-up went smoothly (reaching full production in just two months), the per-vehicle gross margin continued to decline, resulting in an operating profit of only $2.1 billion, nearly halving compared to the same period last year and lower than the market's expected $2.3 billion.The operating profit margin is only 8.2%, once again lower than market expectations.

The poor performance of the operating profit this quarter is not due to operating expenses: although Tesla has been investing in new car platforms, DOJO computing power, and robotics, the R&D, management/marketing, and other operating expenses are still relatively controllable, and even capital expenditures have converged compared to the third quarter.

The key issue lies in the gross profit margin: the decline in bicycle prices behind the sluggish revenue growth has already determined the pressure on the operating profit in the fourth quarter, the seasonal decline in the energy business, and the temporary halt in profit improvement in the service business.

1.3 The profitability of bicycles has once again fallen! As the most important indicator to observe each quarter, the overall gross profit margin in the fourth quarter of this year was only 17.6%, which is lower than the previous quarter, even with the full recovery of the Shanghai factory and higher car sales. The market expectation was 18.1%, which is higher than the previous quarter.

Among them, the gross profit margin of the automotive business is 18.9%, significantly lower than the market expectation of 19.7%, and the main reason for the difference is the price reduction of cars. Specifically:

II. Endless price cuts pressing auto business

In the fourth quarter, Tesla's revenue per car sold (excluding carbon credits and car leasing sales) was $43,500, a decrease of nearly $1,000 compared to the previous quarter, with an actual decrease of 2%, slightly lower than the decrease in the third quarter, but still significant.

In detail, in the fourth quarter, the overall prices of cars in the Chinese market were within the range of price increases, but the United States market saw more price reductions, with the 3 and Y product lines generally experiencing a decrease of 3-5%. If we consider additional discounts on inventory cars and insurance benefits, the actual decrease is even greater.

Currently, even a strong company like Tesla still faces fierce competition in the US market, as Dolphin Research has previously discussed in depth: in the US market in 2023, the structural dividends seem to have shifted towards hybrid vehicles, including Toyota's hybrid energy-saving vehicles. In an industry chain that is still incomplete, there is still significant competition pressure for electric vehicles.

In the case of declining bicycle prices, the cost per bicycle needs to decrease at a higher proportion in order to increase the gross profit margin. Usually, Tesla's cost reduction comes from four dimensions: 1) the scale dilution of sales release and the full utilization of production capacity;2) Cost reduction through technology; 3) Natural cost reduction of battery raw materials; 4) Government subsidies.

Originally, the market had expectations for Tesla in the fourth quarter, including a rebound in sales, full recovery of the Shanghai Tesla factory, full government subsidies in North America, and natural cost reduction of lithium carbonate. The market expected that even if the price of Tesla vehicles decreased in the fourth quarter, the gross profit margin per vehicle would significantly improve, returning to a level slightly lower than the second quarter but stronger than the third quarter. The result was indeed a recovery, but it was closer to the bottom line level of the third quarter.

2.1 Price reduction to boost sales, but auto unit economy is poor

By combining the company's depreciation and amortization expenses, Dolphin Research can roughly estimate the depreciation and variable costs per vehicle, which provides a clear picture of the economics of individual vehicles:

1) Recovery of economies of scale in vehicle depreciation and amortization costs: With the increase in sales and the return of the Shanghai factory, the depreciation and amortization costs per vehicle did decrease by $300, with a depreciation cost of $2,500, approximately the level of the second quarter.

2) Insufficient decrease in variable costs per vehicle: The gross profit margin per vehicle did not meet expectations this time, mainly because the decrease in variable costs per vehicle did not cover the decrease in unit price. The decrease in variable costs per vehicle was less than $900, which did not cover the $1,000 decrease in unit price, resulting in the inability to fully leverage the profit from the release of economies of scale.

3) Further decline in automotive gross profit margin: The final gross profit margin per vehicle was $7,200, and the gross profit margin of automotive sales (excluding leasing and credits) was 16.6%, still hovering between 15% and 17%, without recovering to above 17%. As a result, the gross profit margin of Tesla's vehicle sales business has evolved into this:

2.2 Revenue barely supported by sales volume:

In the fourth quarter, the overall automotive sales and credit revenue totaled $21.6 billion, only a 1% increase YoY, which is basically in line with market expectations, mainly due to poor unit price performance. Among them, after Tesla announced that it would sell cars in the United States through leasing, automotive leasing revenue was $500 million, which did not show significant growth compared to the third quarter.

As for regulatory credits, they contributed $430 million in revenue this quarter, which is mediocre. In the long-term outlook, this revenue is unlikely to contribute substantial income and profit, as the entire automotive industry will shift towards green energy driving.

2.3 The fatal question: Can the automotive gross profit margin stop declining in 2024, and how many vehicles can be sold?

Compared to the barely recovering but below expectations gross profit margin of the automotive sector in the fourth quarter, the more critical question at the beginning of 2024 is: How much can car sales grow in 2024? Can the automotive gross profit margin hold up?

Regarding the first question, Dolphin Research has already hinted in previous in-depth analyses that 2024 is likely to be a period of stagnation for Tesla. The pillars of Model 3 and Model Y's profitability will be exhausted, and the new target of achieving annual sales of 5 million new cars will not be realized until 2025.

Based on the information disclosed by the company so far, in 2024, Tesla will shift from being the leader in production and the second in price (producing as much as it sells) to achieving a balance between price and production. The company will gradually start to manage its gross profit margin targets.

As a result, the Shanghai factory will not expand in 2024 and will not contribute to incremental sales. The production volume of the California factory in the United States will also remain relatively stable. The marginal increase will mainly come from the two new factories in Texas and Germany. However, once the weekly production capacity of these two new factories reaches five to six thousand vehicles, the labor cost of increasing shifts will no longer be a factor. The Cybertruck produced by the Texas factory can currently contribute a marginal production volume of around 125,000 vehicles.

Therefore, the overall increase in car sales in 2024 will be around 300,000 vehicles, representing a year-on-year increase of slightly over 15%. Dolphin Research has noticed that many market expectations currently consider 300,000 vehicles as the baseline and 400,000 vehicles as the average, resulting in a sales range of 2.1-2.2 million vehicles in 2024. However, even so, 2024 is undoubtedly not the year when Tesla achieves a compound annual growth rate of 50%.

The more pressing issue at the moment is whether the gross profit margin per vehicle in 2024 can be maintained. At least from the first quarter's situation, there is significant pressure:

In China, Tesla has already started to reduce prices at the beginning of the year, with price cuts ranging from 2% to 6%.

In the United States, starting from January 1, 2024, the Model 3 will lose all IRA subsidies because it uses lithium iron phosphate batteries from China. The IRA subsidy for the Model Y may also be reduced from $7,500 to $3,750.

In Europe, the subsidy of 6,750 euros for electric vehicles in Germany will end ahead of schedule at the end of 2023. In France, the 5,000 euro subsidy for the Model 3, due to its export from China, ended on December 15, 2023, while the Model Y still enjoys the subsidy.

After reaching full production capacity at the Shanghai factory, Tesla's inventory seems to be piling up again. By observing the cumulative value of Tesla's production-sales difference (since Tesla operates directly, the production-sales difference represents Tesla's inventory plus vehicles that have been shipped but have not yet reached customers), the inventory, including vehicles in transit, had accumulated to 110,000 vehicles by the end of the fourth quarter, accounting for over 20% of the fourth-quarter production volume.Due to the accumulation of production, Dolphin Research has noticed that the delivery time for Chinese buyers has fallen back to 2-6 weeks for ready-to-deliver vehicles.

Another risk to be aware of is the successful wage increase driven by the strike of American auto workers. It is necessary to pay attention to whether Tesla factories in the United States and even Europe have a trend towards unionization. If this situation occurs, the labor costs of Tesla factories may also increase.

Dolphin Research has noticed that the current market's expectation for Tesla's 2024 automobile gross margin (including credits) is generally in line with the second quarter of 2023, at over 19%. Considering the gradual withdrawal of global new energy vehicle subsidies and the difficulty for Tesla to raise prices, as well as the impact of Cybertruck on gross margin, Dolphin Research believes that there is also a risk of downward adjustment in the market's expectation for the 2024 gross margin.

These two key issues require special attention to any possible information and guidance provided by the company during the conference call. Dolphin Research will release the summary on the App, so please stay tuned.

2.4. If the outlook for Tesla's 2024 automobile sales volume and gross margin is not optimistic, what else can Tesla focus on in 2024?

The progress of the new platform that represents the next growth cycle: The current market expectation is that car production will begin at the end of 2025. Recent reports suggest that production of this project, codenamed Redwood, will start in mid-2025. Elon Musk previously revealed that this car will be produced in Texas first, followed by Mexico, and possibly later in Shanghai.

Progress in autonomous driving:

During Tesla's rise in 2023, the fundamentals of car manufacturing actually deteriorated rather than improved. Its rise mainly came from its storytelling: autonomous driving, AI robot imagination, the service business imagination brought by charging stations, and the high growth of the energy business, among others.

At the end of 2022, after a non-linear increase in cumulative mileage following the last major iteration of FSD, it entered a linear cumulative upward phase again. Key points to focus on include the landing speed of the latest version of FSD V12 in batches, as well as the user penetration rate.

However, overall, it can be clearly seen that during the period when the automotive business is in a downturn, in other businesses, compared to the storytelling valuation that was prominent in 2023, 2024 will place more emphasis on implementation, and there is not much room for valuation.

In addition, regarding the Tesla AI story, Musk previously mentioned the issue of controlling interest on Twitter, roughly meaning that if he does not have control, he may not place the AI business within Tesla. It is also necessary to pay attention to the risk of dilution of equity that Musk's questioning and concerns may bring to Tesla shareholders.

III. Expenditure: Stabilizing after climbing the stairs

Tesla has previously increased its capital expenditure for projects such as DOJO and AI robots. Looking at the situation in the fourth quarter, capital expenditure and research and development expenses have stabilized at a high level, without further increase.

Among them, research and development expenses were $1.1 billion, slightly lower than the previous quarter, while sales and administrative expenses increased slightly with the rise in car sales. Overall, operating expenses remained stable this quarter. Even the capital expenditure of $2.3 billion has declined.

In the end, Tesla's operating profit was $2.1 billion, with an operating profit margin of 8.2%, both lower than market expectations. The net profit of around $8 billion this quarter has a significant deviation from the operating profit, mainly due to a provision for deferred taxes of -$5.7 billion (a non-cash tax calculation issue caused by deferred assets). This does not need to be a concern, as the core profit is actually around $2 billion.

IV. Energy slowdown, continued imagination in services

4.1 Energy slowdown: Tesla's energy storage and solar business involve selling photovoltaic systems and energy storage systems to residential customers (to C), small and medium-sized commercial customers (to B), and large commercial and utility customers.

In the fourth quarter of this year, revenue reached $1.4 billion, with growth rate rapidly declining to 10%, significantly lower than the market's expected $1.77 billion. Previously, energy storage installations slowed down due to seasonal factors, with a year-on-year decline of 30% and a quarter-on-quarter stagnation for the first time. Photovoltaic installations declined on a quarter-on-quarter basis due to higher interest rates, but the year-on-year decline was not as severe.

However, the gross margin of the energy business has also declined to 22% due to the drag from photovoltaics and the seasonal slowdown in energy storage installations. Nevertheless, the gross margin of the energy business is still higher than that of domestic peers and Tesla's own automotive business.

However, from a commercial perspective, this business belongs to the long-term with a story, short-term feasible, but with low long-term business barriers. The growth of this business seems to have encountered problems in the fourth quarter.

4.2 Services and others: In the fourth quarter, Tesla's service business achieved revenue of $2.2 billion, with a year-on-year decline of 27%. The imagination business of post-sales services such as charging piles and insurance is reflected in this segment. However, currently, the largest contribution to revenue in this segment still comes from selling car parts and used cars. The space for used cars has become smaller due to increased competition from new energy vehicles and the recovery of global automotive production capacity.Moreover, due to the gradual weakening of the second-hand car market, the gross profit margin of this business has also declined. In this quarter, it dropped from the previous level of 6-8% to 3%.

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For historical articles by Dolphin Research, please refer to:

December 1, 2023 Hot Review: Tesla Cybertruck: High Pricing, Low Economy

October 19, 2023 Earnings Report Analysis: Killing the Bubble Moment! Tesla, the Reality is Harsh

October 19, 2023 Earnings Report Conference Call: CT Climbing Slowly, Slow Factory Construction in Mexico, Musk's Fear of Bankruptcy

October 12, 2023 In-depth Analysis: FSD Autonomous Driving: Can it Sustain Tesla's Next Valuation Miracle?

September 22, 2023 In-depth Analysis: Lion King Meets the Wolf Pack, Can Tesla "Protect the Home"?

September 19, 2023 In-depth Analysis: Tesla: How Far is Musk's "Trillion Dollar Empire Dream"?September 1, 2023 Hot Review: "New Model 3 on sale, prices rise instead of fall?" (Link: here)

July 20, 2023 Earnings Report Analysis: "Trillion-dollar Tesla, only true fans dare to embrace" (Link: here)

July 20, 2023 Earnings Report Conference Call: "Tesla Minutes: Gross margin breached, Tesla may continue to lower prices" (Link: here)

April 20, 2023 Earnings Report Analysis: "Tesla: Promising year on paper, challenging year in reality, 'long-term commitment' is difficult" (Link: here)

April 20, 2023 Earnings Report Conference Call: "Tesla: Confident in selling cars at zero profit, reaping benefits from autonomous driving" (Link: here)

January 26, 2023 Earnings Report Analysis: "Tesla's story reshaped, a moment to test faith!" (Link: here)

January 26, 2023 Conference Call: "Tesla Minutes: 'No competitor for telescopic autonomous driving, the second Tesla may be in China'" (Link: here)

October 20, 2022 Earnings Report Analysis: "Fatal question: When demand is insufficient, how to maintain profitability per vehicle?" (Link: here) Phone meeting on October 20, 2022: "Summary: 'Internal Combustion Engine Cars Must Die, No Production Cuts at Any Time'" (link: 《纪要：“燃油车必死，任何时候不减产”》)

Financial report analysis on July 21, 2022: "What Can Tesla Rely on Without the Shanghai Factory?"

Phone meeting on July 21, 2022: "Musk: I'm Embarrassed by the Repeated Price Increases"

Viewpoint update on June 6, 2022: "Did the US Stock Market Overreact? Were Apple, Tesla, and Nvidia Wrongly Punished?"

Article on April 21, 2022: "New Energy Roars, Tesla Continues to Soar"

Meeting minutes on April 21, 2022: "New Factory Production Capacity Ramps Up, Tesla to Deliver 1.5 Million Vehicles in 2022"

Viewpoint update on February 28, 2022: "When Investing in Tesla, Safety Comes First"

Phone meeting on January 27, 2022: "Tesla: Musk Reiterates the Importance and Value Potential of FSD (Phone Meeting Summary)"

Financial report review on January 27, 2022: "Will Tesla, the Unrivaled Leader, Take a Mid-game Break?"

Viewpoint update on December 6, 2021: "Musk Selling Shares to Pay Taxes, Where Will Tesla's Stock Price Go?"Telephone Meeting on October 21, 2021: "Tesla: A Million Sales on the Horizon, Will Musk Let Go?"

Financial Report Review on October 21, 2021: "Tesla: Wood Sister Shouts $3000, Is the Sky the Limit?"

Telephone Meeting on July 27, 2021: "Tesla Q2 2021 Earnings Conference Call Summary"

Financial Report Review on July 27, 2021: "Tesla: There's No Best, Only Better!"

Telephone Meeting on April 27, 2021: "Tesla 2021 Q1 Earnings Live Summary"

Financial Report Review on April 27, 2021: "Tesla: After a Quarter with No Surprises or Shocks, What Can We Expect?"

In-depth Analysis on June 3, 2021: "Tesla (Part 2): Was it a Mistake or Overvaluation? Where Does Tesla's Story Go From Here?"

In-depth Analysis on May 21, 2021: "10 Years, 300 Times: How Long Can the "Magical" Tesla Continue?"

Risk Disclosure and Statement for this Article: Dolphin Research Disclaimer and General Disclosure