Why Did Tesla’s Profits Trend Lower In Q4?

Tesla (NASDAQ: TSLA) published its Q4 2018 results on Wednesday, January 30, reporting its second straight quarter of profitability. However, the company’s net income trended sequentially lower, missing market expectations on account of lower sales of renewable energy credits and some cost pressure due to higher import duties for some parts from China. Below we take a look at some of the factors that impacted Tesla’s earnings.

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Some Margin Pressures

Tesla indicated that adjusted gross margins for its automotive business decreased to 24.7% in Q4 from 25.5%, partly due to a negative impact of higher import duties for some auto parts from China, due to the ongoing trade war. However, margins for the Model 3 remained flat compared to Q3, coming in above 20% despite the aforementioned headwinds. While the company said that labor hours per Model 3 declined by about 20% compared to Q3 and by about 65% in the second half of 2018, it’s possible that these gains were offset by the introduction of the mid-range Model 3 over the quarter. While the scale-up of the Model 3 should help the company bolster margins, there could be some near-term headwinds. For one, with the winding down of the federal tax credit for Tesla vehicles, the company will have to increasingly emphasize producing the mid-range and potentially lower-end Model 3 in order to keep prices low, after exclusively selling the high-end model over much of 2018.

Tesla Is Still Dependent On Renewable Energy Credits

Tesla’s Zero Emission Vehicle credits sales declined from $52 million in Q3 2018 to under $1 million in Q4, and it appears that this was another key reason for the company’s profit decline, considering that these credits are almost pure profit for the company. Tesla also indicated that non-ZEV credit sales declined by $43 million in Q4. California and nine other U.S. states have a ZEV regime that requires automakers that sell internal combustion engine-based vehicles to earn a certain number of ZEV credits every year by selling zero-emission vehicles, or by purchasing the credits from companies such as Tesla which produce only EVs. We believe that sales of such credits could decline in the long run, as there is a possibility that the number of credits available in the market will start to outstrip the number of credits required by manufacturers as electric vehicle sales gain traction, causing prices to decline. (related: Tesla’s Lucrative ZEV Credits May Not Be Sustainable)

Breaking Down The Profit Decline

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