Tesla Needs Even More Than Ludicrous Speed
(Bloomberg Opinion) -- Tesla Inc. refers to its most head-snapping level of acceleration as “ludicrous” mode. What the company needs, though, is escape velocity.
And what it needs to escape are its operating costs. The company didn’t manage to turn a profit despite record vehicle deliveries in its last quarter. As cheaper Model 3s account for a bigger proportion of sales, bringing down average selling prices, so Tesla needs to bring costs down faster to compensate. Comparing the gross margin on its core automotive business with the various expenses Tesla needs to absorb shows what it is up against.
Auto gross profit margin dipped again in the second quarter, to 18.9%. Think of this as the money Tesla has to meet all the expenses below that line. These include research and development; sales, general and administrative expenses, and net interest. They also have to cover the consistent losses in Tesla’s “Services and other” division, albeit offset somewhat by the positive gross margin from the energy operation (this was equivalent to just 0.8% of auto revenue in the quarter just gone). Adding all those up, here is how they compare with the auto gross margin:
There were anomalous dips in the cost structure in the third quarter of 2016 and the second half of 2018, which also happen to be the only quarters of the past five years in which Tesla reported a GAAP net profit. All were characterized by unusually stringent R&D and SG&A spending. Late 2018 also benefited from initial mass sales of the Model 3 being concentrated in higher-spec, higher-priced versions.
Stock-based compensation has also played a big role here. This expense is typically stripped out of analysts’ “adjusted” earnings numbers (as opposed to GAAP figures). It soared in the third and fourth quarters of 2018 to $1.29 billion combined, more than the aggregate for the prior four quarters. Even without this, however, the autos gross margin only matched the adjusted expenses, rather than resulting in a profit. And if the margin on sales of greenhouse-gas emission credits are also removed, a gap remains:
This cost burden is the structural barrier to profitability, exacerbated by a combination of slower growth expected through the rest of 2019 and declining revenue per vehicle. This is why earnings forecasts for Tesla, which usually start out optimistic, are so often revised down into negative territory. Former unabashed bull Adam Jonas, the sell-side analyst covering Tesla for Morgan Stanley, just cut his GAAP EPS number for 2020 from a positive 32 cents to a loss of more than 10 times that, $3.39. Consensus forecasts for net income across 2019 and 2020 were $1.31 billion, combined, a year ago. As of Friday: a projected loss of $1 billion.
Tesla is targeting gross margins above 20% to cover its expense burden, and CEO Elon Musk on last week’s earnings call said “full self-driving” (FSD) upgrades would be an important part of this. In theory, as the company rolls out this capability to owners that have paid for the hardware, so it can book that revenue (and persuade others to buy the option), boosting gross margins. Tesla noted in its quarterly filing with the Securities and Exchange Commission, which dropped Monday morning, that deferred revenue on services including “FSD” features had swelled to $1.19 billion in June versus $883 million at the start of the year. The company expects to book almost half that balance as revenue over the next 12 months.
But as the reaction to Tesla’s “autonomy day” in April demonstrated – as well as the downward revisions to earnings and revenue forecasts – its FSD claims are being heavily discounted. Cuts to R&D spending over the past year also sit oddly with expectations of near-term breakthroughs. And against such tantalizing visions, today’s reality of stubborn costs are what matter for the bottom line.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Liam Denning is a Bloomberg Opinion columnist covering energy, mining and commodities. He previously was editor of the Wall Street Journal's Heard on the Street column and wrote for the Financial Times' Lex column. He was also an investment banker.
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