Are Tesla’s Margins Under Threat?

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Tesla’s (NASDAQ:TSLA) financial performance has been nothing short of stellar over the last couple of quarters. Notably, the company’s gross margins for its automotive business, excluding its regulatory credit sales, rose from just about 22% in  Q1 2021 to 30% in 2022, an increase of about 800 basis points. This is a solid number in the context of the broader automotive industry which sees average gross margins of just about 14%, and also considering the current inflationary environment and supply chain bottlenecks impacting the auto sector. [1] Tesla’s operating margins for Q1 2022 also stood at 19%, roughly 3x the automotive industry average.

A couple of factors are driving the margin gains for Tesla at this point. Firstly, Tesla is seeing better economies of scale, as deliveries have risen by over 60% compared to Q1 2021. The company’s big volume spinners, the Model Y and 3 vehicles, share a common platform and largely utilize similar parts, likely driving down production costs as they scale. Strong demand and supply constraints mean that it’s a seller’s market in the automotive sector, and Tesla, like most other manufacturers, has been prioritizing the production of more expensive trims of its vehicles over basic models. Tesla has also been insulated from the surging material prices to an extent due to its long-term contracts and vertical integration. Tesla’s growing competency in manufacturing and cost management is also getting more apparent, as its margins rise despite industry headwinds, with the company optimizing manufacturing, and proving adept at substituting semiconductor components in short supply.

Now, despite the strong recent progress, Tesla stock has corrected by over 35% year-to-date. However, we think the stock remains a good value at its current market price of about $760 per share, trading at about 60x forward earnings. While this isn’t exactly a low multiple, it is justified by Tesla’s rapid growth and solid execution. For perspective, the company has guided for over 50% delivery growth over a multi-year period while indicating that it could approach 60% growth this year. Tesla’s early mover advantage in the EV market, its solid brand recall, and its growing production capacity should aid its long-term growth. We have a $1,100 per share valuation, which is about 40% ahead of the current market price.

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That said, there are risks as well. The broader U.S. economy appears to be slowing down, with Q1 GDP declining year-over-year. Interest rates have also been on the rise and this could also eventually impact demand for cars and EVs, potentially slowing growth. Moreover, competition in the EV space is also mounting with mainstream automakers doubling down on their EV plans with massive development budgets and investments into production capacity. These developments pose a risk of hurting Tesla’s pricing power, and in turn, proving a risk to its margins. It is also likely that Tesla could eventually feel the impact of the surging spot prices for raw materials as its longer-term contracts expire, given the sheer scale of its requirements.

See our analysis on Tesla Valuation: Is TSLA Stock Expensive Or Cheap? for more details on Tesla’s valuation and how it compares with peers. For more information on Tesla’s business model and revenue trends, check out our dashboard on Tesla Revenue: How TSLA Makes Money.

What if you’re looking for a more balanced portfolio instead? Our high-quality portfolio and multi-strategy portfolio have beaten the market consistently since the end of 2016.

 Returns May 2022
MTD [1]
2022
YTD [1]
2017-22
Total [2]
 TSLA Return -13% -28% 1677%
 S&P 500 Return 1% -13% 86%
 Trefis Multi-Strategy Portfolio 1% -16% 228%

[1] Month-to-date and year-to-date as of 5/30/2022
[2] Cumulative total returns since the end of 2016

 

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Notes:
  1. NYU Stern []