A Tesla Blind Spot

As an electric vehicle manufacturer, Tesla (NASDAQ:TSLA) earned $418.6 million in 2018, $594 million in 2019, and $354 million in Q1 2020 revenues from regulatory credits. Let’s see, $354 million, compared to $68 million in Tesla’s Q1 2020 net income (profits after all expenses and taxes). Without this $354 million in regulatory credits, Tesla wouldn’t have been profitable in Q1 2020. No discussion about S&P inclusion. Not even close.

The U.S. federal and state government policies determine the extent of these credits and whether they stay in place. While this is a blind spot – unknown to many Tesla investors, and dependent on government whim, investors can take solace that these regulatory credits have been around for many years. We also don’t believe they’re likely to go away soon.

Our dashboard analysis How Do Regulatory Credits Impact Tesla’s Gross Margins? takes a closer look at what Tesla’s quarterly margins and profits would look like excluding credit sales. Parts of the analysis are summarized below.

What Are Regulatory Credits?

• Several U.S. states and countries have Zero Emissions Vehicle (ZEV) regulations that require that clean vehicle account for a certain mix of auto manufacturers’ sales each year.
• If automotive companies, which still largely sell internal combustion engine-based vehicles, don’t meet these standards, they can buy credits from the likes of Tesla that earn credits, as they only sell electric vehicles.
• Although the revenues from these credits are quite volatile they are very lucrative for Tesla, as it likely incurs no direct costs to earn them.
• We estimate that Tesla’s Automotive Gross margins for Q1’20 (a quarter that saw particularly high credit sales) would have been lower by over 500 bps had Tesla not recognized regulatory credit revenues.

What Would Tesla’s Automotive Gross Margins Look Like Excluding Credit Sales?

• Tesla’s reported Automotive Gross Margins stood at 25.5% in Q1’20, with Automotive Gross Profits standing at $1.3 billion and Automotive Revenue standing at $5.1 billion.
• Regulatory Credit sales stood at $354 million in Q1 2020, up from around $133 million in Q4 2019.
• By subtracting out regulatory credit sales, which we assume incur no direct costs, from both Automotive Revenues and Gross Profits, we estimate that Gross Margins stood at about 20% in Q1 2020.
• This implies that these credits increased Tesla’s automotive gross profits by 550 bps in Q1 2020.
• Note that regulatory sales do vary considerably from quarter to quarter, and this impacts the variability of Tesla’s gross margins as well.

Will Tesla Continue To Lean On Regulatory Credit Sales To Drive Profits?

• While regulatory credits could remain valuable as new emissions regulations come into play in Europe and states in the U.S. also look to enforce stricter norms, we don’t think Tesla will need to lean on these sales as much to drive profitability going forward.
• Tesla’s deliveries are growing steadily, driven by new launches such as the Model Y and the ramp in production at its Shanghai factory. Higher volumes should help to improve automotive margins.
• More importantly, Tesla’s growing edge in the self-driving software space is likely to be a bigger driver of long-term margins. See our analysis Just How Far Ahead Is Tesla In The Self-Driving Race? for more details.