Here’s How Tesla Plans To Meet Its Model 3 Production Demand

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After receiving more than 350,000 pre-orders for its Model 3 sedan, Tesla Motors (NYSE:TSLA) is planning to boost its annual production capacity to 500,000 vehicles by 2018. This is 10 times higher than the 50,000 cars Tesla delivered in 2015. To raise funds for this huge capacity expansion, the company plans to sell about $1.4 billion in stock, which would dilute the return of existing shareholders to some extent.  Tesla received a better than expected response to its Model 3 sedan which was promoted as the electric vehicle for “masses” priced at $35,000 and the next challenge for the company is to increase production capacity to deliver these orders. The company has also roped in Audi’s Peter Hochholdinger who will join Tesla’s vehicle production division and work towards streamlining and improving current production and develop a manufacturing plan to meet the ambitious production goal. According to our estimates, Model 3 is the most valuable segment for Tesla and while the company has generated enough demand for this vehicle, meeting production targets will be key for Tesla’s valuation.

Several Challenges To Meet Accelerated Production Plan

In order to meet its production targets Tesla is ramping up production at an accelerated pace which will lead to high capital expenditure. The company plans to produce 200,000 Model 3 sedans  by the second half of next year and is also expanding sales and service and adding charging stations. This is an ambitious target given that the company produced only 50,000 vehicles (Model S and Model X combined) last year. While raising funds through sale of stock to expand production capacity will dilute earnings of existing shareholder it will solve only one part of the problem. The company needs to overhaul its manufacturing program to meet this target and address challenges such as securing part supplies and ensuring overall quality of the vehicles. Tesla is looking to hire veterans from the industry to address this issue and the recent executive hired from Audi is an indication of this intent.   The company plans to be tough on suppliers who cannot meet the deadlines, but strengthening of the overall supply chain will be critical to meet these ambitious production targets.

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According to our estimates, Model 3 Gen III (Gen III) accounts for nearly 45% of Tesla’s valuation and we expect its market share to increase to more than 20% by the end of our forecast period.

While Model 3’s popularity has been proved by the overwhelming pre-orders received by Tesla, ramping up production to meet this demand will be key for the company’s valuation. While high capital expenditure in the initial stages will put a pressure on the cash flow, the company’s ability to generate a gross margin of 20% from Model 3 (as per our estimates) will also impact its valuation. We believe Tesla faces a challenge to effectively ramp up its production capacity to meet the overwhelming demand. The company’s ability to deliver on its promise will be the key deciding factor for its valuation in future.

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