Tesla's Profit Margin Recovery: Key Hurdles Ahead

The electric vehicle titan, Tesla, faced a sharp decline in its stock value following the release of its third-quarter report, which fell below expectations, along with a cautious outlook for the futureBetween October 17 and 27, shares plummeted from $254 to $205, marking a significant 19.3% drop.

In a further twist, several major Wall Street firms adjusted Tesla's fair valuation downward after the earnings announcementAnalysts at Morningstar noted that they anticipate more significant price corrections, recommending that investors wait for a stronger safety margin before entering the stock again.

Morningstar has reduced its fair value estimate for Tesla to $210.

On October 18, Eastern Time, Tesla reported its third-quarter financial results, which showed overall growth that did not meet market expectations

Total revenue reached $23.35 billion, up just 9% year-on-year, marking the slowest growth rate in three yearsNet income plunged to $1.853 billion, a staggering 44% decline compared to the same period last year.

Particularly concerning for the market was Tesla's combined gross margin of 17.9%, which fell from 18.2% in the second quarter, marking the fifth consecutive quarterly decline and the lowest level in four years.

Seth Goldstein, an equity analyst at Morningstar, explained that Tesla’s financial results reflect the ongoing impact of the company's price reductions on vehicle sales this yearWith further price cuts anticipated in the fourth quarter and the introduction of the new Cybertruck model, which is set to begin deliveries, Goldstein predicts that Tesla’s profit margins will continue to face pressure through 2024.

Goldstein expressed optimism for the long term, suggesting that as Tesla reduces its unit production and increases sales of its self-driving subscription software, the company’s gross margins will gradually recover.

However, he also adjusted Tesla's fair value estimate from $215 per share to $210, emphasizing the potential for greater price setbacks and advising investors to remain on the sidelines until a more robust safety margin is available.

Conversely, Shen Daixiang, a technology analyst at Puyin International, maintained a more optimistic outlook, keeping his price target for Tesla at $275.1. He noted Tesla's continued strong position in the global smart electric vehicle market and its ongoing cost reduction capabilities

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However, he acknowledged the challenges that the Cybertruck’s ramp-up phase and R&D investments in autonomous driving and AI technology would impose on profit margins in the near term.

During the earnings call on October 19, Elon Musk elaborated on the numerous risks and challenges facing Tesla at presentThese included the impact of high interest rates on vehicle sales, the Full Self-Driving (FSD) system, and the profit outlook for the Cybertruck.

Overall, Musk exhibited a rare cautious demeanor in his remarksHe mentioned that under the current high interest rate environment in the U.S., consumers are inclined to focus more on monthly payments when purchasing vehicles, and if rates remain elevated, buying cars will become increasingly difficult

Additionally, Musk voiced concerns about the global economic landscape, comparing Tesla to a "world-class ship" that faces challenges even in a stormHe later apologized for what he deemed "paranoid commentary," leading analysts from Morgan Stanley to note that this was one of the most cautious Tesla earnings calls they had experienced in years.

Market worries were raised about whether Tesla would meet its annual target of 1.8 million vehicle deliveriesIn the third quarter, Tesla produced 430,500 electric vehicles and delivered 435,100, marking a 6% sequential declineIn response, Shen believed that Tesla could still achieve its delivery goal of 1.8 million, with total deliveries potentially reaching 1.82 million and 2.34 million by 2024.

The energy storage sector presents the most promising prospects.

Tesla's valuation appears reasonable.

Following the earnings announcement, renewed comparisons emerged between Tesla and its competitor BYD

In terms of sales, the gap is narrowingIn the third quarter, BYD sold 431,600 pure electric vehicles, a 23% increase over the second quarter, nearly closing the gap with Tesla by only 3,400 unitsVincent Sun, a Morningstar equity analyst, noted that BYD’s sales momentum remains robust in the second half of the year and predicted an annual sales total of 2.9 million vehicles, a 55% year-on-year increase, with sales forecasts for BYD in 2023-2025 being raised by 5% to 7%.

BYD’s performance is surging, reporting an expected profit of 9.546 billion to 11.546 billion RMB for the third quarter, signifying a 67% to 101% year-on-year increase.

Vincent Sun highlighted that BYD's current model lineup is built on advanced internal blade batteries and DM-i technology, providing strong competition in terms of mileage and energy efficiency

“We estimate that with the company's delivery expansions, revenues from 2022 to 2025 will achieve a CAGR of 23%. Developments in battery density may also lead to long-term profitability improvements; thus, lower unit production costs might enhance automotive profit outlooksWe expect the company's net profit to grow at a CAGR of 40% during 2022-2025.”

In contrast, Tesla is significantly increasing its R&D expenditures, with third-quarter spending rising 58.39% year-on-year to $1.161 billionThe company emphasized that in a high interest rate environment, the prudent strategy is to focus on R&D and capital expenditures that support future growth.

Currently, energy storage has emerged as one of Tesla's most profitable and promising business segments

In the third quarter, Tesla’s energy storage business performed exceptionally well, with revenues from energy production and storage reaching $1.559 billion, a 40% year-on-year increase, and storage product installations rising 90% year-on-year to 4.0 GWhThe energy and services segment has now contributed over $500 million in quarterly profits for Tesla.

At present, the Megafactory super energy storage facility in California has completed its second phase of expansion, boosting its production capacity to 40 GWhMeanwhile, the Shanghai energy storage super facility is slated for an initial annual production capacity of 10,000 commercial energy storage batteries, amounting to nearly 40 GWh, with products positioned for the global market.

Additionally, projects such as the Cybertruck and the AI development project, Dojo, are seen as critical areas for driving Tesla's future growth

Although Musk revealed that over a million Cybertrucks have been pre-ordered and that this new model will begin deliveries at the Texas factory on November 30, he also controversially attempted to temper market expectations regarding revenue from this vehicleMusk stated, “To achieve mass production of the Cybertruck and generate positive cash flow at a price people can afford will require a lot of work on our partIt’s a fantastic product, but from a financial perspective, it still needs another year to 18 months to make a significant positive cash flow contribution.”

Tesla’s various business lines are gradually unfolding, prompting Shen Daixiang to propose that a sum-of-the-parts approach be adopted for Tesla’s valuationAssigning target market sales ratios of 6.0x, 6.0x, 2.0x, and 25.0x for Tesla’s automotive sales, automotive leasing, energy, and services respectively in 2024 yields a target price of $275.1. “Considering that this year’s vehicle sales forecasts are already well reflected in the stock price and that the upside surprise potential for vehicle production on the supply side is low, we currently view Tesla’s 2024 P/E at 55x as reasonable.”

(The stocks mentioned in this article are for illustrative purposes only and do not constitute a recommendation for buying or selling.)

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