Can Tesla Sustain Its Profitability Going Forward?

by Trefis Team
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Tesla (NYSE:TSLA) posted its first quarterly profit in two years this Wednesday, driven by its continued production ramp of the mass market Model 3 sedan and slightly better cost management. While revenues soared by almost 70% sequentially, its GAAP net income came in at $254 million. Free cash flows were also strong, coming in at $881 million, causing the company to reiterate that it would not be raising fresh capital to pay its impending debt maturities. While the results were encouraging, there have been some concerns as to whether the company can sustain this momentum. In this note, we take a look at some of the factors which are likely to drive Tesla’s performance in the near term.

Model 3 Ramp Pays Dividends

Tesla’s automotive revenues soared by almost 90% sequentially to $5.9 billion. The company delivered a total of 56,065 Model 3 sedans to customers over the quarter, as it ironed out production issues, and scaled up manufacturing to as much as 5,300 cars per week towards the end of the quarter. Tesla’s gross margins for the vehicle also grew to over 20% on a GAAP basis, exceeding its guidance. The improvement was driven by a larger mix of all-wheel drive (AWD) vehicles, which start at $55,000, a premium of about $6,000 over the long-range rear-wheel drive car. Tesla is also witnessing better economies of scale with the new model, noting that labor hours for the Model 3 declined by over 30% from the second quarter to the third, while indicating that it also fell below the levels for the premium Model S and X.

There Could Be Some Near-Term headwinds

While we believe that Tesla’s turnaround is largely here to stay, there could be some near-term headwinds. Firstly, the market for the premium Model 3s that the company is currently delivering (potential ASP of over $55,000 over the quarter for AWD models) is likely to gradually saturate, and Tesla is beginning to offer a new rear-wheel drive vehicle with a 260-mile range priced starting at $46,000. A larger mix of mid-range models could hurt average selling prices and gross margins for the company. The company has also indicated that there could be a negative impact of tariffs from Chinese sourced components, due to the current trade tensions between the U.S and China. Moreover, the one-time Federal tax credit that Tesla customers can avail on their cars is set to halve from $7,500 to $3,750 for vehicles delivered from the beginning of 2019, with the credit further reducing from mid-2019. This could effectively make Tesla’s cars more expensive in the U.S., potentially hurting demand.

We have created a dashboard analysis on some of the trends that drove Tesla’s profits and free cash flows in the third quarter.

What Drove The Company’s Net Profits And Cash Flows Over The Quarter?

Tesla’s net income was driven primarily by stronger automotive revenues, which rose by about $2.7 billion sequentially. The company’s cost of revenues also grew at a slower pace, allowing gross margins to expand. Tesla also made progress in reducing its R&D and SG&A spending over the quarter, leading to stronger operating margins and profits. Below, we illustrate the various factors that were responsible for the net income growth.

Tesla’s Free Cash Flow increased to around $880 million over the quarter. While the company’s overall revenue growth and margin improvements were the primary drivers of sequential cash flow growth, Tesla also saw lower capital expenditures and lower payments to suppliers, with accounts payable on its balance sheet growing by 50% sequentially to $3.6 billion.

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