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Fatal confusion: can Tesla sustain profitability when supply and demand imbalances disappear?

$ Tesla.US released its Q3 2022 earnings report after the US stock market closed on the morning of October 20, Beijing time. The key points are as follows:

1. Lower than expected? The root cause is pricing: Despite strong revenue and profit from energy and services, the sharp decline in average vehicle prices caused Tesla's Q3 revenue of $21.45 billion to fall significantly short of the expected $22.2 billion. Its operating profit of $3.7 billion was also $200 million lower than market expectations.

If we look closely, the profitability issue stems not only from the revenue problem, but also from a decline in vehicle gross margins due to the deteriorating economics of individual vehicles. Additionally, expenses have been kept extremely tight, particularly in terms of a 20%+ YoY decline in stock-based compensation, which has prevented sales and R&D from growing much. Tesla's performance was much worse than expected, with the majority of the problem coming from its automotive business.

2. Car sales: First, sales volume posed a problem, followed by declines in unit price and vehicle economics. During China's National Day holiday, Tesla announced that its vehicle sales fell short of expectations. While the root cause is attributed to differences in determining supply problems from transportation versus demand problems resulting from orders, Tesla has already suffered a devastating blow along with the overall decline in electric vehicles.

According to the financial statement, both vehicle price and unit economics worsened this quarter: the decline in average vehicle price from Q2 was too rapid, causing the savings from per-car depreciation and variable costs to be insufficient to cover the decline in per-car price, further driving down gross margins and distancing itself from the critical watershed of 30%.

Apart from minor issues like exchange rates and an increased proportion of Model-3/Y vehicles with lower prices, the root cause is the enduring supply-demand contradiction that has been troubling Tesla, as well as the possibility of further reductions in Tesla's vehicle prices.

3. How far is Tesla from real price cuts after overcoming capacity bottlenecks? After Shanghai factory's return to full capacity at the end of June, and with the addition of the ramp-up of the Berlin factory, Tesla's production has gradually increased. Trends like customer booking amounts, third-party tracking of Tesla order backlogs, and Tesla's quickened output and delivery in China all indicate that Tesla's production capacity is quickly consuming its order backlog. Furthermore, Tesla's ridiculously high gross margins in comparison to its peers and a sales goal of 50% per year also imply that Tesla's price cut may be imminent.

For a more detailed analysis on the automotive business sector, please refer to the following text.

4. Energy and services "doing well": Despite problems in the automotive business, energy and service businesses did well this quarter, as shown by the acceleration in revenue growth and the continued positive gross margin.

Especially with regard to energy, its growth was previously hindered in the short-term by shortages of storage semiconductors, but this quarter saw a smaller impact in this regard. Additionally, revision to the pricing strategy for the supercharging business and growth in the used car business were both pleasing to see. Just these two businesses are basically in their "infancy" stage and, as a proportion of overall revenue, are so small that they can't make up for the problems in Tesla's car business, no matter how good they are.

Dolphin Analyst overall opinion: When Tesla's demand for car sales becomes the main contradiction, the real melee in the new energy vehicle market is coming!

Last quarter, the Dolphin Analyst was still saying that although Tesla's performance was mediocre, its faith was unbreakable, and the key to solving the problem was in production capacity. But now that production capacity is no longer an issue and the focus is gradually shifting to demand, Tesla's logic may undergo a major transformation soon. Here are two key questions to consider:

1) Is a price cut far off? Tesla's previous problem was that it had too many orders and not enough production capacity. Now that the production capacity of its Shanghai factory has increased from over 500,000 units at the end of 2021 to 750,000 units at the beginning of 2022 and is expected to reach 1,000,000 to 1,200,000 units by the end of the year, and other domestic car manufacturers are also releasing a lot of production capacity, Tesla in China no longer has any supply and demand contradictions, and a price cut is inevitable. At the same time, in overseas markets such as Europe (excluding North America), where they need to digest more of Tesla's production capacity from China, the sales of the entire new energy vehicle market in Europe in July and August were not good. As the current uncontested leader in global new energy vehicles, Tesla's foray into the low-price market will inevitably correspond to the melee in the global market, with suppressed high-interest environments worldwide.

2) Can the gross margin be maintained? If the US dollar continues to erode Tesla's car manufacturing profitability, coupled with the fact that Tesla's cars in China are going to be cheaper, whether Tesla can maintain its gross margin is a problem that needs to be seriously discussed. At least from the third quarter situation, the risk is worth noting: after all, when the cost of raw materials cannot go down in sync with the rapid decline in unit prices, relying solely on fixed cost depreciation to offset the pressure will be quite difficult.

Overall, Dolphin Analyst believes that it is wise to avoid investing in Tesla until the melee begins and the outcome becomes clear: Of course, during the melee, Tesla has the capital to dominate the market-high car prices and gross profit margins make it easy to wage price wars, but the pressure from industry peers will be greater.

However, for Tesla, in the short term, this is likely to mean a decline in gross profit margin, and the market needs to readjust its long-term sales and gross margin expectations. Without clearer guidance and a few quarters of data validation, Tesla's financial certainty is declining, and a price drop is not surprising.

This article is an original article by Dolphin Analyst. Unauthorized reproduction is prohibited. After interpreting the financial statements, the content of the telephone conference call will be made available immediately. Interested users can add the WeChat account "dolphinR123" to join the Dolphin Analyst circle and discuss investment viewpoints. Below is a detailed analysis of the financial report:

1. Overall: Tesla's turning point has come?

1.1 Falling unit prices drag down revenue. In the third quarter of 2022, Tesla's revenue was USD 21.45 billion, a year-on-year increase of 56%. Despite the clear announcement of automobile sales, the overall revenue is lower than the market expected USD 22.2 billion.

The problem of falling short of expectations this time is quite serious: mainly because the unit price of the automobile business is relatively low, and the problem of the unit gross profit margin that has not recovered after the Shanghai epidemic under low unit prices.

1.2 Sales and R&D are very conservative, and profits are not so low only by being conservative. In the third quarter of 2022, it achieved an operating profit of USD 3.7 billion, which is also lower than the market expectation of USD 3.9 billion, a year-on-year increase of 84%.

In the case of significantly lower than expected gross profit margin and revenue, it is inevitable that profits are lower than expected, but the final profit gap is much smaller, mainly due to sales and R&D expenses. This quarter is particularly conservative (corresponding to media reports of Tesla layoffs).

1.3 The Shanghai factory has resumed, but Tesla's basic gross margin has not improved. As the most important observation index for each quarter, the company achieved an overall gross profit margin of 25% in the third quarter of 2022, while the market originally expected that Tesla's gross profit margin could recover to 26.6% after the Shanghai epidemic that walked out of the second quarter.

The core problem behind this is all in the car business, because energy storage and service businesses are in a better situation in terms of both revenue growth and gross profit margins.

1.4 In the third quarter of 2022, the company's R&D expenses were CNY 730 million, and its sales and administrative expenses were CNY 960 million. The absolute value is almost the same as that of the second quarter when the vehicle cannot be delivered under the epidemic, both are at a very low level, much lower than the market expectation. Tesla's equity incentives continue to be very low, with the amount remaining the same as last quarter, a year-on-year reduction of 23%. In this way, Tesla's expense ratio is only 7.9%, which is the first time it has clearly fallen below the 10% watermark.

2.1 The fatal question of the automobile business: Has Tesla's supply and demand inflection point arrived?

2.1 Doubts caused by "falling" sales: Are orders not keeping up, or are goods really on the road?

During the National Day holiday in China, Tesla's latest rapid decline, dragging new energy vehicles down. The culprit of the problem is the production and sales data for the third quarter released by Tesla on October 2: The production is still good, but the sales are disappointing. After the Chinese production area recovered, Tesla's production quickly caught up, with a production volume of 366,000 vehicles in the third quarter, which basically met expectations. The main issue is sales: only 344,000 vehicles were sold, a year-on-year growth rate of only 42.5%, which is far below the roughly 70% growth rate prior to the Shanghai COVID-19 outbreak. As a result, growth in the first three quarters of this year was only 45%, making it very difficult to achieve the target of 50% delivery for the entire year.

Moreover, there is a gap of over 20,000 cars between production and sales! Since 2020, except during the Wuhan and Shanghai outbreaks, Tesla has been producing and selling at the same rate, with customers having to wait for delivery. During the last Wuhan outbreak, the second quarter of 2020, deliveries significantly exceeded production, compensating for undelivered production during the outbreak. However, during the current Shanghai outbreak, production already exceeded deliveries during the second quarter, and has again exceeded deliveries during the third quarter.

Has the most worrisome inflection point emerged: customer orders cannot keep up with Tesla's production, is Tesla's supply-demand inflection point approaching? After all, as the Dolphin analyst previously analyzed, Tesla's cure is production capacity, but now that production has caught up, will sales fall behind?

Tesla has blamed this problem on transportation strategy adjustments: "Although the shortage of parts has improved significantly, delivery and transportation challenges have grown even larger. Tesla vehicle deliveries have historically been concentrated at the end of each quarter because vehicles need to be produced and centrally collected in each region. However, as our production capacity continues to grow, it has become increasingly difficult to obtain inexpensive transportation services during peak delivery weeks. In the third quarter, production in various regions was more balanced, resulting in more vehicles in transit towards the end of the quarter. These vehicles will be delivered to our customers after their arrival at their destination."

Obviously, the market does not really believe this vague explanation: according to third-party data, Tesla's undelivered orders decreased significantly by September, and the demand for export shipping from domestic ports after the Shanghai outbreak has rapidly declined, leading to a sharp drop in shipping rates.

Regarding this issue, the current inclination of Dolphin Analyst is that the production-sales ratio issue this quarter is indeed due to transportation strategy adjustments, but the fundamental risk of slowing demand released by increased production capacity should be paid more attention to. First, regarding the question of "in-transit vehicles" not yet delivered:

1) What is going on with the "in-transit vehicles" that are outside of deliveries?

Tesla has always produced and sold its cars in equal amounts. Cars are produced one by one on the assembly line. Therefore, when sending cars, Tesla waits until a certain amount of cars has accumulated before batch delivery, and arranges the delivery order based on the time of transportation to different destinations. The ultimate goal is to deliver all of the cars produced by the end of the quarter. For example:

The Chinese-made cars that are exported to Europe are shipped in the second month of the season, while orders from US domestic users are usually shipped in the third month. Orders on the East Coast are in the first two weeks of the last month, while those on the West Coast are in the last two weeks of the last month since the California factory is located on the West Coast, resulting in shorter shipping times for orders in the West Coast region.

By the end of the quarter, there are almost no cars to be delivered in transit. However, globally, Tesla delivers to users basically in the last month of each quarter.

The situation in Shanghai is similar, with exports being concentrated in the second month of the season and domestic sales being concentrated in the third month of the season. In this way, the final delivery to users is basically in the last month of the season, and all vehicles are both shipped and delivered.

This rhythm can also be seen very clearly from the domestic deliveries in China: domestic retail sales are concentrated in the last month of each quarter, while exports are generally concentrated in the second month of each quarter, two months after volume accumulation, corresponding to a significant increase in the number of registrations in the third month of each quarter in Europe.

There weren't many cars produced earlier, so this operation wasn't too big of a problem. But as production increases rapidly, logistics pressure is high when it comes to the last month of the quarter and a large amount of deliveries must be made in a short period.

Therefore, the announcement conveyed by the company is that starting in the third quarter, the company will optimize the delivery method—over the entire quarter, each production area will gather production in small batches per week and transport them to various destinations around the world, ultimately achieving a more balanced delivery every week. However, this means that cars produced in the last few weeks of each quarter will still be in transit at the end of the quarter, already dispatched but not yet delivered, and with rapidly growing sales volume, the number of cars in transit at the end of the next quarter will be higher than that at the end of the previous quarter.

2) So why worry about sales?

The explanation of the transportation problem seems very reasonable, but the problem is that the issue of in-transit vehicles, if there are enough new orders for the season, should correspond to an increase in customer prepayments, but this season is not the case: orders have decreased and returned to the level of the first quarter of this year.

And if we combine the third-party estimation of Tesla's 300,000 orders in hand at the end of September, even if we add the Dolphin Analyst's estimated "in-transit vehicles" of 20,000, compared to February's 400,000 units, the decline is still too fast, which means that the remaining orders are being quickly consumed.

Therefore, the Dolphin Analyst estimates that the sharp increase in prices in the first half of Tesla followed by the significant suppression of loan-sensitive optional consumption rates all around the world by the Fed, along with the rapid release of production capacity at the Shanghai factory, these three factors resonate and Tesla's remaining orders have been quickly consumed by newly added production capacity.

And if we look ahead, according to media reports, the Shanghai factory will be able to produce 1.2 million vehicles by the end of the year after the completion of Phase III expansion, corresponding to an annual production capacity of 1.2 million vehicles in 2023. Coupled with the 600,000 production capacity of the California factory, and the 3,000-4,000 production capacity of the Berlin and Texas factories, there should be no major problems with an annual production of 2 million vehicles in 2023.

As the production capacity is quickly released, the current global situation is that China's auto consumption has had a large stimulus year, and the further withdrawal of subsidies next year and the global high-interest environment are suppressing the optional consumption of automobiles that require loans. The policy only has the favorable factor of lifting the top limit of vehicle subsidies for high-volume new energy vehicle companies like Tesla, of the anti-inflation bill in the US region.

Currently, according to overseas banks' tracking of car delivery times:

1.) In September, the delivery time for US Model 3 dropped from 13 weeks to 9 weeks, and the delivery time for Model Y from 28 weeks to 24 weeks;

2.) The delivery time for the best-selling rear-wheel drive Model Y in China has dropped from 4-8 weeks to 1-4 weeks; the delivery time for the all-wheel drive Model Y has dropped from 10-14 weeks in early September to 1-10 weeks; the delivery time for China Model 3 has also dropped from 8 weeks at the beginning of the month to 5 weeks, still 14 weeks at the end of August.

Note that the delivery time of one week is basically no longer waiting, as the car that has been made in the factory to the hands of the consumer needs about a week.

For Tesla, especially those produced in China, the rapid alleviation of supply and demand contradictions ultimately points to a high probability of price reduction: although Tesla in China has not officially reduced prices, customers who bought insurance from Tesla stores in September had a final sale price reduction of RMB 8,000, and another 7,000 yuan discount in October, so they have already started to reduce prices indirectly. Next, at least the direct price reduction of the Model 3 and Y produced in China will be in sight.

After all, the company's auto manufacturing gross margin is in a state of 25-30% basic invincibility, with production capacity keeping up, there is enough confidence to lower prices, but peers may be more miserable. In fact, from the third quarter financial report, Tesla has begun to lower prices.

2.2 Chain problems caused by price reductions: The economics of individual cars have deteriorated.

This quarter, Tesla's sales volume and individual car prices are issues, and individual car prices have brought two relatively serious problems: a decline in automotive business profit margins and lower-than-expected revenues from automotive business. Let's look at the first problem:

  1. This quarter, single-car revenue (including credits) was $52,600, down $2,500 from the previous quarter. Tesla's explanation is that the price was too high in the second quarter due to a shortage of car supplies caused by the pandemic, and even though the delivery ratio of Model 3 and Y has increased, the price of a single car can at least maintain the price of the previous quarter. While combining with the company's depreciation to estimate the depreciation and variable cost of a single bike, the Dolphin Analyst clearly sees an economic statement of the single bike:

1.) Compared with last quarter, the price of a single bike decreased by RMB 2500 (affected by the appreciation of the US dollar), but the depreciation cost and variable cost of a single bike decreased by more than RMB 850 and RMB 900, respectively. In total, the cost of a single bike decreased by only RMB 1800, resulting in a decrease in the profit of a single bike to only RMB 14,500.

2.) From the perspective of cost rate, the depreciation and amortization cost rate of a single bike continues to decline, but the variable cost of a single bike is rising. The total cost of materials is also rising.

3.) Tesla said that the increase in the cost of materials, bulk goods, and logistics, as well as the ramp-up of the Texas and Berlin factories, have dragged down its profits. However, from the perspective of unit economics behind the scale economics calculated by the Dolphin Analyst, the true core problem is the decrease in unit price, which Tesla did not explicitly mention.

In the end, the gross profit margin of the automotive sales business this quarter was 27.5%, lower than last quarter's gross profit margin, and continues to be far away from the watershed of a gross profit margin of 30%.

Low unit price drags down automotive income: In the third quarter, the overall sales and points income of automobiles was USD 18.7 billion, a year-on-year increase of 55%, which is much lower than the expected USD 20.2 billion. The revenue from automobile leasing business is USD 620 million, a year-on-year increase of 61%.

Meanwhile, the regulatory points have been further reduced this quarter, with only USD 286 million in revenue, accounting for 1.5% of the total revenue and 8% of the pre-tax profit, which is basically back to normal.

Looking ahead, Shanghai Tesla production is bursting, and it is highly likely that there will be a price cut for the Tesla cars produced in Shanghai. If the price of raw materials does not begin to decrease, the trend of the automotive business gross profit margin is very likely to continue to decline, especially if Tesla wants to maintain a 50% sales growth rate target for this year and next year, the price must fall. However, it is becoming increasingly difficult for the Dolphin Analyst's previously estimated gross profit margin of 30% to be reached again.

Production end: Production capacity bottleneck has been resolved

For the company to achieve its target of selling 50% annually for several years, it needs to keep up with production capacity. The sales target of 50% next year basically means that the production capacity needs to be around 2 million vehicles.

3.1 Shanghai Factory: Setting New Records Once Again. According to Tesla's description of its Shanghai factory, its annual output exceeds 750,000 vehicles. The output has set yet another new record in this quarter. Combining with media reports, the Dolphin Analyst expects the weekly production to reach more than 20,000 vehicles by the end of this year, and after the third phase expansion, the weekly production can reach more than 25,000 vehicles, corresponding to an annual output of 1.3 million vehicles. 3.2 New factory: Capacity climbing

The European Berlin factory currently produces 2,000 Model Ys with 2170 batteries per week, which is basically in line with Tesla's expectations. At the end of last quarter, the output was 1,000 vehicles. The description of the new factory in Texas is still climbing its production capacity. In addition, the Semi truck produced by Tesla's Nevada factory is planned to be delivered starting December.

Data source: Tesla financial report

4. Energy and Services: Both Are Good

5.1 Plain Energy Storage: Tesla's energy storage and photovoltaic business includes the sale of solar energy systems and energy storage systems to residential customers and small and large commercial and utility-level customers. In the third quarter of 2022, revenue reached 1.1 billion US dollars. Although summer was a relatively busy season for installations, revenue grew by 39% year-on-year. Moreover, the gross profit margin was also good, maintained at above 9%.

The energy storage capacity increased by 62% year-on-year, and it was still in decline last quarter. The pressure on the supply of energy storage semiconductors is still significant, and the Megapack factory in California is still climbing its production capacity.

Meanwhile, photovoltaic installations also increased by 13% year-on-year, mainly driven by household photovoltaic installations. The growth rate of to B projects fluctuated greatly and remains low.

5.2 Services Soared and Gross Profit Margin is Continuously Maintained: In the third quarter of 2022, Tesla achieved $1.65 billion in revenue from its services business, an increase of 84% year-on-year; the gross profit margin has remained positive on a large scale, and it improved slightly to 4% this quarter, mainly due to the used cars and parts businesses.

This business is based on inventory vehicles. As there are more and more Tesla inventory vehicles on the road, this business is expected to continue to grow rapidly, especially with the sustained increase in oil prices. The market demand for Tesla's second-hand new energy vehicles is very strong, and the used car business is very good.

In addition, the company's supercharging service is also accelerating monetization. The pricing has switched from the original fixed pricing to a different floating pricing model based on how busy the charging stations are, and the revenue from paid charging is currently three times that of the same period last year.

Dolphin Analyst's previous articles, please refer to:

July 21, 2022, Financial Report Interpretation: What Can Tesla Rely On Without the Shanghai Factory? 2022年7月21日电话会《 Musk: I'm embarrassed by the repeated price increases

2022年6月6日观点更新《 Did the US Stock Market Shake-Up Mistakenly Kill Apple, Tesla, and Nvidia?

2022年4月21日《Thunder is Roaring in the New Energy Field, Tesla Continues to Boom》

2022年4月21日《 New Factory Production Capacity Boost, Tesla to Deliver 1.5 Million Vehicles in 2022 (Meeting Minutes)

2022年2月28日观点更新《 Investing in Tesla: Safety Comes First in Times of Change

2022年1月27日电话会《 Tesla: Musk Reiterates the Importance and Potential Value of FSD (Telephone Conference Minutes)

2022年01月27日财报点评《Tesla's Brilliant Performance, Will it Take a Mid-game Break?

2021年12月6日观点更新《 Where is Tesla Stock Heading as Musk Attempts to Pay His Taxes?

2021年10月21日电话会《 Tesla: Annual Sales of One Million Vehicles are Just Around the Corner, Will Musk Let Go?

2021年10月21日财报点评《 Tesla: Cathy Wood Rallies for $3,000, is the Sky the Limit?》 On July 27th, 2021, the Telephone Conference of Tesla's Q2 2021 Performance and Summary was held.

On July 27th, 2021, the Financial Report Review of Tesla: There Is Always One More Amazing Thing They Can Do! was published.

On April 27th, 2021, the Tesla 2021 Q1 Performance Live Summary was held.

On April 27th, 2021, the Financial Report Review of Tesla's First Quarterly Report Without Surprises: What to Expect Next? was published.

On June 3rd, 2021, the Conclusion of Tesla (Part 2): Overrated or Underrated, Where Is Tesla's Story Going? was published.

On May 21st, 2021, a long article was published, covering Tesla's "magic" and its potential for the next decade.

Risk Disclosure and Statement for This Article: Dolphin Analyst's Disclaimer and General Disclosures

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