Why A Chinese Factory Could Be Value Accretive For Tesla

by Trefis Team
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According to a report from The Wall Street Journal, Tesla (NYSE:TSLA) has reached an agreement with the Shanghai government to set up a wholly owned manufacturing unit in China, a first for a foreign automotive company. While the company hasn’t made an official announcement, with details such as the timeline for a buildout remaining unclear,  having a local manufacturing base could allow Tesla to cut costs and scale up its exposure to the rapidly growing Chinese electric vehicle market. Below we take a look at what the deal could mean for the company.

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

China’s Fast Growing EV Market

China is the world’s largest market for electric vehicles, and growth is only expected ramp up in the coming years driven by favorable government policy. For instance, the Chinese government is targeting annual electric vehicle sales of 7 million by 2025, up from 351k last year. China has also made it mandatory for all automotive companies operating in the country to begin producing EVs by 2019. Tesla currently imports vehicles manufactured at its manufacturing facility in U.S. to sell in China. However, sales in China still account for just a fraction of the company’s sales (under $1.1 billion last year or about 14% of total revenues). This could be partly due to higher prices, as Tesla vehicles priced at a premium of about 50% compared to the U.S due to high import fees and taxes.

Facility Could Help Tesla Cut Costs, Although Import Duties May Persist

Foreign automakers are required to form joint ventures with local manufacturers if they want to produce vehicles in China, in order to avoid the country’s 25% import duties. These JV arrangements entail that companies share profits, and potentially some of their intellectual property, with their local partners – a move to which Tesla has been averse. With the proposed agreement, Tesla would be able to independently build cars at a free trade zone, without having a local partner. However, the vehicles manufactured there are likely to be treated as imports, facing the 25% tariff. That said, there may be some other avenues for the company to cut costs and boost efficiencies. For instance, Tesla could tap into the Chinese manufacturing ecosystem and supply chain, while also employing lower cost labor. There is also a possibility that the company could use the facility as a manufacturing hub for exports to other Asian countries. Shipping costs (although small) could also be reduced.

How Scaling Up In China Could Impact Tesla’s Valuation

While we believe that a facility could take time to set up, given that Tesla is currently preoccupied with ironing out production issues and ramping up deliveries of its mass-market Model 3 Sedan at its plant in Fremont, California, a new plant in China could be significantly value-accretive for the company. For instance, if sales in China help Tesla to increase the market share of the Model 3 (as percentage of global EV/HEV sales) from 9.5% in 2024 per our current model to about 11.5%, with the Model S and X also seeing market share improve by about 20 bps to about 1.2% each, there could be an upside of over 25% to Tesla’s valuation, assuming that margins and net price realizations are similar.

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