Tesla Beats Estimates, Projects Attractive Margins On The Model 3

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Tesla Motors (NYSE:TSLA) posted a smaller-than-expected second quarter loss on Wednesday, driven by revenues that nearly doubled year-over-year. The stock rallied by more than 7% in after-market trading, amid strong reservations for its mass-market Model 3 sedan and a better near-term outlook for its luxury vehicles. Below are some of the key takeaways from the company’s earnings release.

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Model S and Model X Deliveries Slow, But Outlook Improves

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Tesla delivered a total 22,026 Model S and Model X cars over Q2,  growth of around 53% versus the year-ago period. However, deliveries declined by 12% sequentially, on account of a production shortfall of 100 kWh battery packs through early June. While Tesla’s delivery figures have been somewhat sluggish over the last four quarters (below a 100k annual run rate), things are likely to get better over the second half of 2017. Tesla noted that the order rate for these vehicles was about 15% higher in July, compared to its Q2 average weekly order rate. There is a possibility that the publicity surrounding the Model 3 is also helping Tesla move more premium vehicles, as the delivery period for current bookings on the relatively more affordable sedan stands at more than a year. Tesla may also have a long-term competitive advantage in the luxury market on account of declining battery costs, which could give the company more headroom to reduce pricing or improve specifications of the Model S and X.

Model 3 Manufacturing In Focus

Tesla launched its new mass-market sedan, the Model 3, late last month, handing over the keys to the first few vehicles to employees. Initial reviews of the car from the automotive press have been overwhelmingly positive, and Tesla notes that Model 3 now averages more than 1,800 net reservations per day. In comparison, sales of GM’s Chevy Bolt averaged just over 1,800 cars per month over the first four months of this year. While Tesla appears to have a compelling product on its hands, the vehicle’s prospects will ultimately lie in Tesla’s ability to ramp up manufacturing. The company intends to scale up Model 3 production from just over 1,500 vehicles in Q3 to a weekly run rate of 5,000 vehicles by the end of this year. Moreover, Tesla intends to produce almost 10k cars per week at some point next year. Much of Tesla’s valuation hinges on the success of its manufacturing ramp up, and this is something that investors will keep a close eye on over the next several quarters.

Tesla has simplified the design of the Model 3 to make production easier, learning from its mistakes with the Model S and X. The company intends to initially offer the car with just 100 permutations, compared to over 1,500 permutations for the Model S.  The company indicated that it expects gross margins on the Model 3 to turn positive from Q4 2017, while noting that margins could reach 25% at some point in 2018. This is impressive, considering that the company’s far more expensive Model S and Model X vehicles garner similar margins (Non-GAAP automotive margins stood at 25% last quarter). Tesla’s Detroit-based rivals, GM and Ford, typically see gross margins of under 15%. The relatively high gross margins and planned volume ramp could help Tesla move towards operating profitability, as its fixed cost allocation improves.

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