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Tesla - margins rise despite falling prices

Nicholas Hyett, Equity Analyst | 27 July 2021 | A A A
Tesla - margins rise despite falling prices

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Tesla Inc USD0.001

Sell: 709.16 | Buy: 710.00 | Change 0.11 (0.02%)
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Tesla reported second quarter revenue of $12.0bn, ahead of market expectations for $11.3bn, and up 98% year-on-year. That reflects a 148% increase in Model 3/Y deliveries, more than offsetting a decline in Model S/X deliveries due to product updates. Average sales prices fell 2% year-on-year, reflecting higher sales of lower priced cars in China.

Operating margins hit 11.0%, up from 5.7% last quarter and 5.4% a year ago. That's despite a $176m share based payment to Elon Musk, lower regulatory credit revenues and a bitcoin related impairment of $23m. As a result of the improved operating profit, earnings per share rose to $1.02, well ahead of analyst expectations.

Tesla shares rose 1.4% in aftermarket trading.

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Our View

Tesla's enjoying the benefits of a huge uplift in production in the last 12 months. More cars rattling through the production line lowers per-unit costs, so margins and profits can come for the ride.

A 169% year-on-year increase in Model 3 and Model Y production, and 148% increase in deliveries, has more than offset the headwind from lower sales of premium Model S and Model X cars. Underlying gross margins, have risen to 25.8% as a result, up from 18.7% a year ago. That's all the more impressive given the lower average selling price from cars sold in China.

But Tesla has more work to do. It's 500,000 cars in 2020 pales in comparison to VW's 5.3m, 212,000 of which are electric cars.

Its answer is a huge factory building programme. The first European Model Ys are expected in 2021, with a new factory in Texas also due for completion this year. However, Tesla's "if we build it, they will come" approach does come with risks. The group's production is running well below its capacity. Together with vehicle price cuts last year that suggests demand for Teslas might not be growing quite as fast as the group would like.

It's worth noting that Tesla's arguably sub-scale manufacturing operation is currently being supported by sales of regulatory credits - which equated to over 200% of reported profits in 2020.

Tesla earns credits in recognition of its zero-emission vehicles and sells them to other manufacturers who need to offset their emissions. Broadly speaking, as more Teslas hit the road, the group earns more credits. These credits are a valuable source of cash flow for now, but as rivals increase their electric vehicle output Tesla's credits will become less valuable. Ultimately Tesla needs the core automotive manufacturing business to stand on its own two feet.

This cuts to our core concern with Tesla. The group's valuation, which at $633.5bn and a PE ratio of 119.4 makes it by far the most valuable automotive company in the world, is predicated on massive growth. But rivals are pouring billions into closing the technological gap, and competition in China is already hotting up. Add to that market wide shortages in vital computer chip components and the ramp up isn't without its challenges.

Longer term Tesla hopes to reduce cost and increase its competitiveness via increased vertical integration - including manufacturing its own battery components - with the aim of ultimately manufacturing a profitable $25,000 car. The group is also banking on its self-driving technology - installing "Full Self-Driving" into cars in October, with "hundreds of thousands" of its cars able to drive themselves this year. Both do have the potential to change the competitive calculus for Tesla, but the company has made big claims before that took far longer than anticipated to deliver and there are no guarantees.

We would be remiss not to also mention that Tesla has taken a big bet on Bitcoin, with $1.3bn in the cryptocurrency in the balance sheet. Investors could argue that if they wanted to have exposure to Bitcoin they would have bought some themselves. We seriously question the rationale for the purchase.

In its core business Tesla has enjoyed a period of technological superiority, with a great brand and perhaps most importantly a great investment story. However, as the valuation has risen, so have expectations. Meeting those will be no easy feat.

Tesla key facts

  • Price/Earnings ratio: 119.4
  • 10 year average Price/Earnings ratio: 62.8
  • Prospective dividend yield (next 12 months): 0.0%

All ratios are sourced from Refinitiv. Please remember yields are variable and not a reliable indicator of future income. Keep in mind key figures shouldn't be looked at on their own - it's important to understand the big picture.

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Second Quarter Results

Total revenue included $10.2bn in Automotive revenues, up 97% year-on-year despite a 17% fall in automotive credits, which came in at $354m. Automotive gross margin in the quarter reached 28.4%, or 25.8% once regulatory credits are eliminated. Elsewhere in the business, Energy Storage saw sales more than double year-on-year to $801m, while Services & Other revenue rise 95.3% to $951m.

Capital Expenditure rose 176% to $1.5bn. That reflects ongoing construction of the Berlin and Texas Gigafactories, expansion at plants in Shanghai and California, and continuing investment in product development.

Despite the increased capital expenditure, the group reported $619m of free cash flow, up from $418m a year ago. As a result, net cash rose from $6.3bn at the start of the quarter to $6.8bn.

Tesla didn't update longer term production or profit guidance, although reiterated that it has sufficient liquidity to fund its product roadmap and long-term expansion plans. The first Berlin and Texas Model Ys are expected in 2021, although the launch of the Semi truck programme has been pushed to 2022 due to supply chain challenges. The group is currently producing at the limits of available parts - with particular challenges in semiconductor supply.

Find out more about Tesla shares including how to invest

This article is original Hargreaves Lansdown content, published by Hargreaves Lansdown. Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Refinitiv. These estimates are not a reliable indicator of future performance. Yields are variable and not guaranteed. Investments rise and fall in value so investors could make a loss.

This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research for more information.

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