Making Sense Of Tesla’s $2,000 Price Cut

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Tesla (NYSE:TSLA) recently indicated that it would be cutting prices on all its vehicles in the U.S. by $2,000, to mitigate the impact of the reduction of the federal EV tax credit on its vehicles which took effect from January 1. The markets didn’t react favorably to the news, with the stock declining by close to 10% over the two subsequent trading sessions. There are likely to be two key concerns among investors. Firstly, markets are concerned whether the move could also be a response to slowing demand for premium versions of the Model 3 that the company is currently selling. Secondly, there are worries regarding the impact of the move on Tesla’s margins and profitability.

View our interactive dashboard analysis on what drove Tesla to profitability during Q3’18. You can modify any of our key drivers or forecasts to gauge the impact changes would have on the company’s results.

Reduction Of  Federal Tax Credit

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At the beginning of this year, the federal tax credit for Tesla buyers dropped to $3,750, from $7,500, as the company surpassed the sales threshold of 200k cars set by the government. The credit is set to fall further to $1,875 over the second half of the year, while disappearing in 2020. This makes Tesla the first automaker to lose access to the full credit, and moreover, this comes at a time when competition in the luxury EV market is heating up. For instance, Jaguar’s well-reviewed I-Pace SUV (starting at $69,500) is still likely to have access to the credit for some time going forward. By providing a $2,000 price reduction across its models, Tesla could reduce the impact of the incentive cut, particularly for vehicles such as the mid-range Model 3, which will now start at $44,000.

Tesla’s Margins Should Hold Up Despite Price Cut 

Tesla should be able to manage the price cut without significantly hurting its margins and profitability. Having an early start in the EV space could help Tesla move down the cost curve more quickly than its newer rivals. For example, the production process of Model 3 uses a significant amount of automation, which helps it drive down costs. Over Q3 the company noted that labor hours for the Model 3 declined by over 30% sequentially, driven by better economies of scale and automation. Tesla also has an advantage over the broader industry in terms of battery costs, with the company aiming for battery cell costs of under $100/kWh last year. These cost improvements should allow the company to absorb the price cut.

Model 3 Still Has A Lot More Room For Growth 

Tesla has only been selling the Model 3 in the U.S up to this point, and it could continue to see robust growth as deliveries commence in Europe and China starting February 2019. Moreover, the company has only been selling the vehicle via cash or loan options in the U.S until now, meaning that it could find more buyers as it ventures into leasing. Tesla could also see meaningful upside to Model 3 volumes as it begins to produce the entry-level version of the car ($35,000 onwards). Thus far, the company has only been selling mid- and higher-priced variants of the car, which have ranged from $46,000 to upwards of $60,000.

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