Success of The Giga Factory Can Unlock Tremendous Value For Tesla

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TSLA
Tesla

Tesla Motors (NYSE:TSLA) is a unique car company. It is unique because it is not merely selling cars, but also selling a new technology. Essentially, betting on Tesla Motors involves betting on a new technology. The company not only has to sell cars but also to build out the infrastructure necessary for supporting the operation of those cars. In Tesla’s case this involves building out a network of superchargers, battery swap stations, and service stations. The company’s blueprint for success is as follows: it started out by selling luxury sedans and followed that up with a luxury SUV, but its big bet is on a smaller sedan called Gen III. That vehicle is expected to be priced around $35,000 and can increase the volumes sold by the company to levels far higher than its tally of close to 32,000 sales in 2014, and the 55,000 target of 2015. The company is targeting 500,000 unit sales in 2020.

We have a price estimate of $170 for Tesla, which is about 30% below the current market price.

See Our Complete Analysis For Tesla Motors Here

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Giga Factory

That target depends, in turn, on the success of another ambitious project: the $5 billion Giga Factory. The idea behind the Giga Factory is that the current supply chain in making lithium ion batteries is not very cost effective. If you think about the supply chain involved in the manufacturing and distribution process of a battery, you will see some element being mined in South America and then shipped to North America for refining and processing and then shipped to Japan or South Korea for further refining and processing, and then back to North America where it will be put in a car that will be sold in Europe. This is a horribly inefficient process. Tesla’s big move is to bring all these different parts under the same roof. This move alone will save the company a lot of money. Besides savings in labor costs, increased demand will reduce the battery’s price — the adding up of a number of single digit percentages which might bring down the cost of producing and selling a battery by as much as 30%. Given that 25% of the cost of making a car is battery costs, this can result in improved margins.

So the process involves three steps, each of which results in some cost savings. The centralization of the supply chain saves around 10%, a reduction in labor costs probably another 10%, but the rest of the savings are dependent on increasing demand for Tesla’s vehicles. This is the trickier part and requires the success of the electric vehicle technology. If demand for Tesla’s vehicles increases, it puts the company in a position where it has leverage over suppliers of lithium ion batteries and can negotiate lower prices. However, if demand stalls, then negotiating those price reductions might not prove as easy.

It is possible to visualize a scenario in which Tesla manages to sell 500,00 cars. In this scenario, we can assume that 20% of those cars will be Model S sedans, 15% will be Model X, 5% will Roadsters, and the rest Gen III vehicles. The result of selling 500,000 units by 2020 will be an increase in gross margins of at least 10%. Even though the margins may face some downward pressure after reaching that figure due to the extra expenditures involved in building out the infrastructure required for supporting those volumes, the impact on the stock price will be significant. The stock price can improve by almost as much as 40% from our current price estimate, which underlines the importance of the Giga Factory project for the company.

See our complete analysis for this scenario