Tesla: "AI Hype" sounds good, but reality is too harsh

Tesla (TSLA.O) released its second-quarter report for 2024 after the U.S. stock market closed on the morning of July 24th Beijing time: The facts show that the story-driven valuation that has been detached from reality since the second quarter is facing the harsh reality of the market, just like the overly pessimistic expectations at the end of last year:

1. Car "face" supported by regulatory credits: The $19.9 billion in car revenue seems to be $200 million higher than expected, but it is mainly due to the regulatory credit income that is twice as high as the market expected. Moreover, carbon credits are both revenue and pure profit. Excluding regulatory credits, Tesla's car business in the second quarter actually maintained sales volume under pressure, but the decline in unit price was too large, significantly weakening the profitability per vehicle.

2. Behind the sales volume, declining profitability per vehicle: Among the three major revenue segments of cars - car sales, car leasing, and regulatory credits, the gross margin of the truly important car sales sector has dropped to 14.6% this quarter, far below the market's expected 16.2%, a decrease of 1.7 percentage points from the previous quarter! Obviously, Tesla used discounted sales in June to halt the sharp decline in sales in April and May. Although quarterly sales exceeded market expectations, the cost behind it was not low.

3. Energy business is indeed impressive: With a 160% increase in energy installation volume (already disclosed in the quarterly shipment report due to outstanding performance), 100% revenue growth, and a 25% gross margin performance, it is truly a bright spot compared to the struggling car business. However, with a quarterly revenue of $3 billion, it is still a "small player" compared to the $20 billion in quarterly car revenue.

4. Strict control of operating expenses: Tesla was very restrained in R&D and sales expenses this quarter. Despite the improvement in revenue and gross margin performance driven by energy and service business income outside of regulatory credits and cars, the operating profit fell $200 million lower than expected, a 33% year-on-year decrease, mainly due to $620 million in restructuring expenses this quarter, which were the costs of Tesla's recent layoffs. However, this issue is one-time and will reduce future expenses, so there is no need to worry.

5. Cash flow-oriented operation: This quarter's focus was very clear. In addition to cost-cutting through layoffs to reduce future costs, Tesla deliberately reduced production and inventory consumption to achieve over $3.5 billion in operating cash flow in the second quarter. Capital expenditures also fell to a level slightly above $2 billion in the fourth quarter of last year, resulting in a net increase of nearly $4 billion in cash and cash equivalents in the second quarter.

6. New cars, AI still uncertain: The description of new cars still involves using both new and old production capacity, with production scheduled to start in the first half of 2025. As for Robotaxi, apart from the previously announced delay of the launch event to October 10th, there is no substantial additional information.

Dolphin's overall view:

In the second half of last year, Dolphin once expressed through three articles ["FSD Smart Driving: Unable to Support Tesla's Next Valuation Miracle"](https://longportapp.com/zh-CN/topics/10183089?When Tesla was systematically reviewed, it was already clear about the issues Tesla will face in 2024. The recent continuous rise in stock price is not only due to the better-than-expected car deliveries on the fundamental level, but also driven by a new round of AI stories:

1) Better-than-expected deliveries in the second quarter: 444,000 vehicles were delivered in the second quarter, exceeding BBG's expectation of 438,000 vehicles and the consensus expectation of 415,000 vehicles. The production volume was nearly 33,000 vehicles lower than the sales volume, indicating that Tesla is actively destocking and implementing practices to control production capacity to maintain cash flow.

2) Musk's compensation plan was approved, leading Tesla back into the narrative camp of AI. The approval of FSD testing in China, the upcoming release of Robotaxi, and even Musk's support for Trump have all contributed to Tesla's "hard" takeoff without solid fundamental support, pushing the stock price from 150 to over 250.

Looking at the performance in the second quarter, due to weak deliveries in April and May, the market had very pessimistic expectations for Tesla's second-quarter deliveries. In the U.S., Tesla started offering a 0.99% car loan rate to subsidize car buyers in May and June. In Europe, the upcoming additional 21% tariff also stimulated some car buying behavior in advance. As a result, Tesla's sales exceeded market expectations, but still experienced a 5% year-on-year decline.

The real cost, however, is that significant subsidies on car sales led to excessive price reductions per vehicle. With variable costs already very low, the room for further cost reduction was limited. The gross profit margin per vehicle directly dropped to below 15%.

On the positive side, looking at the current inventory levels, after reducing production to match current dynamic sales, the pressure from car inventory has decreased, cash flow has returned, and the risk of further margin erosion due to price reductions to clear inventory has decreased.

On the other hand, trade friction is also starting to weigh on Tesla. Under the additional 21% tariff in Europe, although the prices of vehicles exported from China to Europe have increased, they can only cover a small portion of the additional tariff costs. The gross profit margin of Tesla's European business will continue to be eroded by tariffs.

Apart from the gross profit margin issue, the key issue in the current car manufacturing situation is that without new car incentives, after consecutive year-on-year declines in deliveries in the first and second quarters, how to achieve the market's current expectation of maintaining annual sales at 1.8 million vehicles without decline. Especially in China, in the second half of the year, there will be a large number of new pure electric vehicles launched in the price range where Tesla operates, posing significant sales pressure on Tesla in China

Under comprehensive calculation, Tesla can only rely on AI stories for now, especially in the third quarter, where the car-making business is simple and there are no new developments in the AI story. We can only wait for the fourth-quarter autonomous driving conference and possible new car release news to anticipate the upward potential in 2025.

Below is a detailed analysis of the financial report:

I. Tesla: Model 3 & Y growing old?

1.1 Revenue exceeded market expectations, mainly due to high growth in the energy business

In the second quarter of 2024, Tesla's revenue was $25.5 billion, a year-on-year increase of nearly 2.3%, exceeding expectations. The total revenue of $25.5 billion outperformed the Bloomberg's consensus expectation of $24.1 billion, marking a return to positive revenue growth.

However, the key automotive business revenue this quarter was $19.9 billion, slightly exceeding the market consensus of $19.7 billion. The main reason for the better-than-expected performance was the lack of any foreseeable pure profit income - regulatory credits. Automotive sales (excluding regulatory credits) this quarter were $18.5 billion, actually lower than the market's expected $18.7 billion.

The key to the overall revenue exceeding expectations this quarter lies in the high growth of the energy business. The energy storage shipments this quarter grew by nearly 160% year-on-year, leading to a 100% year-on-year growth in revenue. The service business also slightly exceeded expectations, ultimately surpassing the market's expectations for overall revenue.

1.2 Gross profit margin of car sales declined, barely stabilized by carbon credits

In each performance report, the automotive gross profit margin has always been more significant than revenue, and the real incremental information during the financial report is the performance of the automotive gross profit margin. This quarter's performance was too stretched, especially with the automotive gross profit margin excluding carbon credits dropping to 14.6%, significantly lower than the market's expected 16.2%. However, with the doubling growth in basic pure profit carbon credit income, the overall automotive gross profit margin barely stabilized, remaining flat compared to the previous quarter.

In other businesses, the energy business gross profit margin remained stable, and the service business saw an improvement in gross profit margin after expanding the coverage of non-Tesla users in North America starting in February with the Supercharger stations. Finally, the group's overall gross profit margin was 18%, slightly exceeding the market's expected 17.2%.

However, on the expense side, due to Tesla's continuous investment in research and development in areas such as Robotaxi, DOJO supercomputing, robotics, and new car platforms, although R&D expenses contracted this quarter, they remained relatively rigid. Sales and administrative expenses also decreased compared to the previous quarter due to the implementation of layoffs, resulting in a 7% decrease in expenses compared to the previous quarter. With sales volume rebounding this quarter, operating leverage was released to some extent.

However, due to restructuring expenses from layoffs in the second quarter (6.2 billion), the final operating profit was $1.6 billion, a year-on-year decrease of 33%. The operating profit margin was 6.3%, lower than the market's expected 7.5%.

1.3 Car Gross Margin Significantly Below Expectations

As the most important observation indicator for each quarter, the car gross margin is crucial, especially in the current situation of declining sales and intensified competition. In order to clearly understand the true situation of the car gross margin, Dolphin has separately extracted the carbon credit car sales gross margin, car leasing gross margin, and the overall car business gross margin.

Due to the small scale of the car leasing business and its stable gross margin, the overall car gross margin is a comprehensive result. The detailed breakdown is mainly to observe the carbon credit car sales gross margin.

In the second quarter, the car sales gross margin (carbon credit and leasing) was only 13.9%, a decrease of 1.7% compared to the previous quarter's 15.6%, significantly below market expectations.

Therefore, the key question here is why Tesla's car business gross margin declined so significantly this quarter?

II. Unit Economics: Did FSD Contribute Less to the Gross Margin This Quarter?

In the second quarter, Tesla's revenue per car sold (excluding carbon credits and car leasing sales) was $42,700, a decrease of about 2% compared to the previous quarter, basically in line with market expectations.

In the second quarter, Tesla in China initiated a new round of price reductions in April (with reductions ranging from 2% to 5%), while the U.S. market saw a mix of price increases and decreases (Model 3 series increased in price, Model Y only saw an increase in the standard range version, while the rest decreased in price, Model S/X decreased in price). Starting in May, Tesla began offering a 0.99% low-interest loan for purchasing Model Y (equivalent to a subsidy of up to $6,000-$8,000 per vehicle for Model Y), and in Germany from June, Tesla provided a €6,000 subsidy for Model Y. The market expected the price reduction for this quarter to be between 2% and 3%, and the sales price was basically in line with market expectations.

But the most crucial point is that the "magic pen" FSD, which funds love the most, contributed to the revenue side last quarter, allowing the single car price to remain stable even in the case of a significant global price reduction. However, this quarter, the contribution of FSD to the revenue side and gross margin side seems to have declined significantly.

Last quarter, FSD contributed around 1.7 percentage points to the gross margin of the automotive business (if based on an estimated 90% gross margin for FSD, the revenue side contributed approximately 330 million), while the actual gross margin of the automotive business (excluding carbon credits) was around 14.7% last quarter. However, the contribution of FSD to the revenue side and gross margin side this quarter seems to have declined significantly, leading to a 2% sequential decline in single car revenue, and the gross margin of the automotive business this quarter (excluding carbon credits) remained basically flat compared to last quarter (14.6% this quarter).

Dolphin believes that the decline in the contribution of FSD to the revenue and gross margin sides is partly due to the negative impact of FSD price reductions (reducing the price of FSD in North America from $12,000 to $8,000, and in Canada from $16,000 to $11,000), and partly due to the slow progress of FSD in the second quarter, with the delayed release of FSD V12.4 leading to a lack of significant increase in penetration rates after the price reduction.

Please pay attention to the following chart. This part of the revenue from software fees is recorded in automotive sales revenue, so when this type of software revenue increases, it indirectly raises the single car revenue and gross margin.

After discussing single car prices, let's turn back to single car costs. Typically, Tesla's cost reduction comes from four dimensions - 1) dilution of scale from sales volume release and full utilization of capacity; 2) technological cost reduction; 3) natural cost reduction of battery raw materials; 4) government subsidies. Specifically:

2.1 Price reduction to boost sales volume, single car economics cannot sustain

Dolphin breaks down single car costs into single car depreciation and single car variable costs. The second quarter's single car economic account is as follows:

1) Single car depreciation effect: Sales volume in the second quarter has rebounded slightly, with some scale effects released, but the space for dilution of depreciation in the short term is not much as the German factory temporarily halted production and the Chinese factory reduced production. The depreciation cost per car in the second quarter was $2.9 thousand, only a slight decrease of $0.3 thousand compared to the previous quarter.

2) Single car variable costs: The single car variable cost in the second quarter was $33.9 thousand, an increase of $0.4 thousand compared to the previous quarter. Although raw materials, freight, and tariff costs have all decreased, and with the ramp-up of 4680 battery production (4680 battery production increased by 50% compared to the first quarter), there has been some improvement in battery costs. However, the increase in the proportion of negative gross margin models like Cybertruck (Tesla is expected to achieve profitability only by the end of the year) has dragged down single car variable costs.

3) Decline in Automobile Gross Margin: Ultimately, due to the continued decline in unit prices, reduced revenue contribution from FSD this quarter, and an increase in variable costs per unit, the automobile gross margin has declined again.

2.2 Pressure on Unit Prices Leads to Decline in Vehicle Sales Revenue: In the second quarter, the total revenue of the overall automobile business (including credits) was $19.9 billion, a year-on-year decrease of 6.5%. The main reasons for this decline are the continued year-on-year decrease in unit prices and sales volume.

Regulatory credits accounted for $890 million this quarter, doubling compared to the previous quarter, which resulted in the overall automobile revenue (including credits) slightly exceeding market expectations. However, as North American automakers accelerate their transition to new energy, the contribution of carbon credits to Tesla is not sustainable.

2.3 Can Tesla Rely Solely on the October Robotaxi Launch for the Remainder of 2024?

From a fundamental perspective of car manufacturing, due to the aging of the Model 3/Y models, Tesla's market share in China, Europe, and the United States showed a declining trend in the second quarter, indicating a continuous deterioration in the fundamentals of car manufacturing. Market expectations for this year's sales volume have been further lowered, with the current consensus around 1.8 million vehicles, which is roughly the same level as last year.

Tesla also stated in its financial report that the growth rate of car sales in 2024 will be significantly lower than that of 2023. The next wave of growth will mainly come from advancements in autonomous driving technology (Robotaxi and FSD) and the launch of new generation products (Model 2).

The key issue in the second half of the year regarding car manufacturing is that without new car incentives, after consecutive year-on-year declines in deliveries in the first and second quarters, how to achieve the market's current expectation of maintaining annual sales volume at around 1.8 million vehicles without further decline.

In terms of gross margin, Tesla has already begun implementing a strategy to control capacity to maintain gross margins: Looking at the production-sales relationship in the second quarter, Tesla sold 444,000 vehicles, but only produced 411,000 vehicles, reflecting Tesla's proactive destocking strategy. Observing the cumulative production-sales difference at Tesla (due to Tesla's direct sales, the production-sales difference includes Tesla's inventory + vehicles shipped but not yet delivered to customers), the inventory including in-transit vehicles decreased to 120,000 vehicles at the end of the second quarter, accounting for 29% of the second-quarter production.

The quarterly inventory turnover days decreased from 28 days in the previous quarter to 18 days this quarter. Due to the decrease in inventory, there was an improvement in working capital (inventory decreased by approximately $1.8 billion), and capital expenditures also fell to a level slightly above $2 billion in the fourth quarter of last year. Free cash flow increased from -$2.5 billion in the previous quarter to $1.3 billion this quarter, with a net increase of nearly $4 billion in cash and cash equivalents

Looking at the outlook for the automotive business in the second half of the year:

1) In the Chinese market, the price reduction in the first quarter cannot offset the decline in market share. The competition for electric vehicles priced between 200,000 to 300,000 RMB is extremely fierce this year. Price wars are expected to continue in this price range. Tesla has not directly reduced prices, but has introduced a 5-year interest-free installment policy as a way to indirectly lower prices (based on the current standard annual interest rate of 2.5%, purchasing a Model Y through the 5-year interest-free policy can save up to over 26,000 RMB). However, with existing models aging, Tesla still faces significant sales pressure in China when continuously introducing new models. It is expected that Tesla's market share in China will continue to decline.

2) In the US market, the switch to using Panasonic's 2170 batteries for Model 3 (except for the base rear-wheel drive Model 3) has regained the $7,500 federal tax credit, which is a positive factor for sales in the US market. It is expected that Tesla's market share in the US can be maintained.

3) In the European market, due to the imposition of tariffs on imported vehicles from China starting in July (currently set for a maximum of 4 months), and since most of the Model 3s sold in Europe are imported from China, Tesla faces a total of nearly 30.8% in export tariffs (an additional 20.8% on top of the original 10%). Tesla has also raised the price of the Model 3 in Europe by about 1,500 euros, which still does not offset the cost increase due to tariffs (cost increase per vehicle is about $6,000-7,000). It is expected that Tesla's sales volume and gross profit margin in Europe will be under pressure.

As for the fundamentals of the automotive business this year, there is still no hope. Investors are more concerned about the progress of FSD/Robataxi and the next generation vehicle platform:

Due to the delayed release of FSD V12.4, the progress of FSD in the second quarter is still slow. Elon Musk commented that the delay in pushing out FSD V12.4 was due to insufficient driving smoothness, as too much focus was placed on training for intervention operations and neglected training for normal driving. As for Tesla's Robotaxi, on the software side, it highly depends on the performance and smoothness of FSD, and on the hardware side, more prototype vehicles need to be manufactured for testing, leading to a further delay in the release from August 8th to October.

Elon Musk also mentioned that Tesla's autonomous driving technology computing power bottleneck has been resolved (the expansion of the Texas Gigafactory is nearing completion, which will accommodate Tesla's largest H100 cluster to date, and computing power is expected to increase significantly by the end of the year). However, the current bottleneck of FSD still lies in the testing and training methods (mainly limited by too many interventions during mileage), but Dolphin believes that compared to hardware bottlenecks, software bottleneck resolution is more uncertain. As for the short-term deployment speed of Robotaxi, it is also difficult to predict due to regulatory and technical issues.

The description of new vehicles still involves using both old and new production capacities, with production expected to start in the first half of 2025. Besides the previously announced delay of the Robotaxi launch event to October 10th, there is no substantial additional information

III. Expenditure End: Tightening Control on Operating Expenses

In addition to being more cautious in investing in car production capacity, Tesla has also started to restrain its capital expenditures this quarter. Although infrastructure spending on AI-related computing power continues to be invested, it increased by about $600 million in the second quarter, but overall capital expenditures have fallen to just over $2 billion in the fourth quarter of last year.

In terms of research and development expenses and sales expenses, Tesla was actually very restrained this quarter. Research and development expenses were $1.07 billion this quarter, a decrease of about $80 million compared to the previous quarter, while sales and administrative expenses decreased by about $100 million due to significant layoffs. Overall expenses were lower than market expectations.

However, due to the $620 million restructuring expenses related to layoffs this quarter, Tesla's operating profit for this quarter was $1.6 billion, slightly lower than the market expectation of $1.8 billion. However, the restructuring expenses are one-time expenses and there is no need to worry too much.

4. Energy Surges, Services Are Okay, But the Younger Brothers Can't Support the Sky Falling on the Car Industry

4.1 Energy High Growth: Tesla's energy storage and solar business include selling solar systems and energy storage systems to residential customers, small to medium-sized commercial and large commercial and utility-grade customers.

This year's second quarter revenue reached $3 billion, a 100% year-on-year increase, seemingly significantly higher than market expectations. In fact, because the company had already disclosed installation figures due to good energy installations when announcing second-quarter sales, and the company had previously given a 75% year-on-year growth guidance.

Looking at the delivery results, energy storage installations reached 9.4 GWh, more than doubling from 4 GWh in the first quarter. This is likely due to the project-based nature of energy storage, resulting in significant quarterly fluctuations. The cumulative installation volume for the first half of the year is approximately 78% year-on-year growth, which is in line with Tesla's original guidance of 75% year-on-year growth in energy storage installations for the year. It can be said that they are on track under high guidance.

Moreover, the energy business involves signing contracts in advance to lock in prices, and delivery costs are strongly influenced by current lithium prices. Due to the continuous decline in lithium prices, the energy business's gross profit margin has reached a new high of nearly 25%, far exceeding the less than 15% gross profit margin performance of the car sales business, and also exceeding market expectations by about one percentage point

4.2. In the second quarter, Tesla achieved a service business revenue of $2.6 billion, a year-on-year increase of 21%, which is basically in a stable state. The imaginative businesses such as charging piles and insurance are all included in this segment. However, currently, the largest contribution to the revenue of this business still comes from selling car parts and used cars. In the second quarter, the progress of third-party opening in the charging pile business was not disclosed by Tesla.

In terms of gross profit margin, the improvement in the gross profit margin of car maintenance services (likely related to staff reductions in car repair) has increased the gross profit margin of services and other businesses by nearly three percentage points to almost 6.5%, exceeding market expectations.

For historical articles by Dolphin Jun, please refer to:

• Financial report analysis on April 24, 2024: "FSD Contribution is a Stroke of Genius, Who Still Says Tesla is 'Paper Mache'?"
• Financial report conference call on April 24, 2024: "Will the Next Generation Model 2 Be Released Early?"
• Financial report analysis on January 25, 2024: "Tesla Without the AI Coat: Unstoppable Prices, Unstoppable Bleeding"
• Financial report conference call on January 25, 2024: "Tesla Fourth Quarter Minutes: Sales Volume in 24 Years Misses '50%', But Expenses Keep Rising"December 1, 2023 Hot Review "Tesla Cybertruck: Priced too high, but low in economy"

October 19, 2023 Financial Report Interpretation "Killing the Bubble Moment! Tesla, the reality is harsh"

October 19, 2023 Financial Report Conference Call "CT climbs slowly, slow factory construction in Mexico, Musk has bankruptcy 'phobia'"

October 12, 2023 In-depth "FSD Autopilot: Can't support Tesla's next valuation miracle"

September 22, 2023 In-depth "The Lion King meets the Wolf Pack, can Tesla 'watch over the house'?"

September 19, 2023 In-depth "Tesla: How far is Musk's 'trillion-dollar empire dream' from reality?"

September 1, 2023 Hot Review "New Model 3 on sale, price not dropping but rising?"Interpretation of the financial report on July 20, 2023: "Tesla, a trillion-dollar company, only dare to be embraced by true fans"

Financial report conference call on July 20, 2023: "Tesla Minutes: Gross margin breached, Tesla may continue to lower prices"

Interpretation of the financial report on April 20, 2023: "Tesla: Big promises, small execution, 'long-term companionship' is too difficult"

Financial report conference call on April 20, 2023: "Tesla: Confidently selling cars at zero profit, harvesting with autonomous driving"

Interpretation of the financial report on January 26, 2023: "Tesla's story reshaped, the moment of testing faith has arrived!"

Conference call on January 26, 2023: "Tesla Minutes: 'Autonomous driving has no rivals even with binoculars, the second Tesla may be in China'"

Interpretation of the financial report on October 20, 2022: "Fatal question: When demand is insufficient, how can single-car profitability be maintained?"

Conference call on October 20, 2022: "Minutes: 'Internal combustion engine cars are doomed, no production cuts at any time'"

Interpretation of the financial report on July 21, 2022: "Without the Shanghai factory pumping blood, what can Tesla rely on?"July 21, 2022 Conference Call " Musk: Raising prices repeatedly, I'm still fearless"

June 6, 2022 Opinion Update " Big Shake-up in US Stocks, Apple, Tesla, Nvidia - Wrongly Killed?"

April 21, 2022 " New Energy Thundering, Tesla Continues to Shine"

April 21, 2022 " New Factory Production Capacity Climbing, Tesla to Deliver 1.5 Million Vehicles in 2022 (Meeting Minutes)"

February 28, 2022 Opinion Update " Scattered Minds, Investing in Tesla - Safety First"

January 27, 2022 Conference Call " Tesla: Musk Reiterates the Importance and Value Potential of FSD (Conference Call Summary)"

January 27, 2022 Financial Report Review " Tesla, the Unstoppable Force, Will Take a Midterm Break?"

December 6, 2021 Opinion Update " Musk Sells Tickets to Pay Taxes, Where Will Tesla's Stock Price Go?"

October 21, 2021 Conference Call " Tesla: Annual Sales of One Million Within Reach, Will Musk Let Go?"

October 21, 2021 Financial Report Review " Tesla: Cathie Wood Shouts $3000, Is the Sky the Limit?"July 27, 2021 Conference Call "Tesla 2021 Q2 Earnings Conference Call Summary"

July 27, 2021 Financial Report Review "Tesla: Not the most bullish, only more bullish!"

April 27, 2021 Conference Call "Tesla 2021 Q1 Earnings Live Summary"

April 27, 2021 Financial Report Review "After Tesla's first quarter report without surprises or shocks, what else can be expected?"

June 3, 2021 In-depth "Tesla (Part 2): Misjudgment or overvaluation, where does Tesla's story go?"

May 21, 2021 In-depth "10 years, 300 times growth, how much longer can the 'magical' Tesla be magical?"

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