How A Slower Than Expected Production Ramp For Model 3 Could Impact Tesla’s Stock

Tesla (NYSE:TSLA) published its production and delivery figures for Q3 2017, indicating that it manufactured just 260 Model 3 cars since it began production in late July, well below its guidance of 1,500 units. While Tesla attributes this to production bottlenecks caused by delays in activating some manufacturing subsystems, it said that there were no fundamental issues with Model 3 production or supply chain. Demand for the Model 3 has been strong, with Tesla estimated to have notched over 450k reservations for the vehicle, with current waiting periods estimated at between 12 to 18 months. The company’s ability to manufacture the vehicle profitably at scale will be the most crucial lever of its valuation. Tesla had previously indicated that it would reach a production run rate of 5k units per week by the end of 2017 while scaling up to almost 10k cars per week at some point next year. Tesla also guided for gross margins of as much as 25% on the sedan at some point next year. Our valuation model for Tesla assumes that the company will deliver 275k Model 3 sedans next year (about 7 % of the EV/HEV market), growing to about 620k in 2024 (10% of the market). However, if Tesla sees a slower production ramp, with deliveries in 2018 standing at just 150k (3.8% share), growing to about 450k in 2024 (7% share), there could be some further downside.

We have a $205 per share price estimate for Tesla, which is well below the current market price. Read our current stance on Tesla here.

Model X And S Deliveries See Limited Growth

While deliveries of Tesla’s premium vehicles, the Model X and Model S, came in at all-time highs of 25,930 over Q3, year-over-year growth was muted at just 4.5%. Deliveries of these two vehicles have remained roughly at these levels over the last four quarters, raising concerns that sales have leveled off. The company expects to deliver a total of about 100,000 Model S and X vehicles this year, implying that deliveries over the holiday quarter could total about 27k. While competition in the market is expected to heat up in the medium-term, with luxury brands such as Volvo, Mercedes, and Porsche all doubling down on their EV plans, Tesla’s premium lineup may still have some scope for growth. Firstly, the company has been able to cut costs and pass the benefits on to customers (it dropped prices on the Model X by about $3,000 a few months ago), driven by improved manufacturing efficiencies and lower battery costs. Additionally, China is also making a big push towards electrifying its auto industry. There have been reports that it may consider relaxing rules that require foreign automotive companies to have a local partner, potentially allowing Tesla to manufacture its vehicles in the country.

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