Tesla’s Expenses: Operating Cost Controls, Improving Gross Margins Will Drive Tesla’s First Annual Profit

Electric vehicle major Tesla (NASDAQ: TSLA) is on track to report its first GAAP Net Profit in 2020, as it continues to reduce its Operating Expenses while benefiting from growing Revenues, driven by soaring vehicle deliveries as well as higher software and regulatory credit sales. Our interactive dashboard analysis on Tesla Expenses: How Does Tesla Spend Its Money? provides a detailed breakdown of Tesla’s various expenses and how they impact the company’s profitability. Parts of the analysis are summarized below.

Cost of Sales: Higher Volumes, Emissions Credits, Software Sales Should Help Gross Margins

Cost of Sales is the biggest driver of Tesla’s expenses, standing at 77% of Revenue in 2016 and rising to 83% of Revenues in 2019, due to the launch of the lower-priced Model 3 sedan. However, as the production scale-up of Model 3 becomes more mature, with Tesla also launching the Model Y, based on a similar platform, Cost of Sales as % of Revenue is likely to decline again to about 78% in 2020, leading to improved Gross Profits (Gross profits are defined as Revenues minus Cost of Sales). Separately, Renewable Energy Credit sales have also been a big driver of its Gross Margins in recent quarters, and Tesla’s growing software sales are also likely to help profitability. (Related: How Do Regulatory Credits Impact Tesla’s Gross Margins?) We expect Gross Margins to grow from 17% in 2019 to 22% in 2020.

Operating Expenses Are Being Kept In Check

Tesla’s Operating Expenses have increased from $2.3 billion in 2016  to $4.4 billion in 2018, driven largely by higher SG&A expenses, although the number declined to about $4 billion in 2019, as Tesla has been scaling back on its selling-related expenses via manpower reductions and a lower store count. Tesla is clearly improving its operating leverage, as Operating Expenses as % of Revenues have declined from 32% in 2016 to about 16% in 2019. We expect Tesla’s Operating Expenses as % of Revenue to decline further to about 13% in 2020, as the company cuts SG&A expenses further while keeping R&D spends in check. For perspective, over the first half of the year, SG&A expenses fell by about 4% year-over-year, while R&D expenses were down by about 9%. We expect Operating Margins to stand at close to 9% in 2020.

Non-Operating Expenses & Net Margins

Tesla’s Non-Operating Expenses, which include Interest Expenses, net of Interest Income and Other Expenses, have increased from about $80 million in 2016 to about $596 million in 2019, driven largely by higher Interest Expenses. We expect Non-Operating Expenses to grow slightly to about $630 million in 2020. Tesla’s Income Tax Expenses have increased from $27 million to $106 million between 2016 and 2019. Despite its past losses, Tesla has been paying taxes in certain foreign jurisdictions. We expect Tax Expenses to stand at about $100 million in 2020.

Tesla’s total expenses have trended higher from $7.8 billion in 2016 to $25.2 billion in 2019, although they have declined, Expenses as a % of Revenues have dipped from 111% to 103%. This has meant that reported Net Income Margins have improved from around -11% in 2016 to  -3% in 2019. We expect Tesla to post Net Margins of about 6% this year, as Total Expenses as a Percentage of Revenues fall to 94%, driven by improvements to both Direct and Operating Expenses and higher Revenues. We expect Revenues to grow to close to $30 billion from about $24.6 billion in 2016, driven by growing deliveries of the Model 3 and Model Y and production in its Shanghai factory.

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