Just to follow up on my reply to
@luvb2b regarding inventory management, I was trying to figure out why my crude
2-component DIO (Days Inventory Outstanding) estimate came so shockingly close to Tesla's reported Q3 inventory numbers.
Here's the main DIO parameters I suggested originally:
- MSX DIO is 45 days
- M3 DIO is 20 days
Here's some new, inventory related disclosures from the Q3 conference call:
"Elon Musk:
Yeah. That is our goal. We do not intend to raise equity or debt. At least that's our intention right now, that may change in the future. But the current operating plan is to pay off our debts not to refinance them, but pay them off and reduce the debt load and overall leverage of the company. But I actually almost forgot one quite important thing. As - and this is quite helpful, it's always helpful to have these sort of crisis situations with logistics, for example.
As I dug into the inventory like basically finished product inventory from factory to the customer, I was quite surprise to see how long that took that took, and that it was quite expensive in a lot of cases to get cars to customers. This was something I didn't fully appreciate before. And we really have a major initiative at Tesla to get the average time from the exiting the factory to receiving the check from the customer, being in the customers hand, if we can only get the check when we give the car to the customer. So getting car from factory to customer to get that to as short as possible.
In August, the average time in North America to get a car from the factory to a customer was 30 days, which is embarrassingly long. By the end of the quarter, we've reduced it to around 20 days. And our goal in Q4 - this is a goal, not a promise. But our goal is to get the average time of the car from factory to customer under 10 days. This is a giant improvement in the capital efficiency of the company, because we're making on the order of $75 million worth of products per day - of cars per day. So every day, it required $75,000 - $75 million with capital, so every 10 days, it's $750 million.
And we - obviously, we have a loan from the bank that we can make use of. But the banks will only loan us 85% of the cost of the vehicle, which translates to about 70% of the price of the vehicle. So - and then we've got this loan outstanding, which effectively increases the COGS of the car. And it dilutes the company to the tune of 30% of one of the inventory - of the finished goods in transit it.
So that this is really like tightening that and getting that below 10 days in North America and then also improving dramatically the time - the transit time to Europe and Asia. It is where like having local factories is actually very important for capital efficiency of the overall system. Because, I think, over time, we want to get the time from a car going from a factory to customer under 7 days worldwide. And then, the terms that we have with from our suppliers are, on average, just over 60 days.
Now, our product inventory management also there's a lot of room for improvement there. We think we can probably cut that down to a few $100 million or so, Deepak, something like that, maybe $200 million or $300 million of COGS at the factory. So effectively, what we're going to go is reverse the working capital requirement for the company quite dramatically, so to a point where the faster we grow the more capital we have. This is incredibly important for capital efficiency of the company. It's night and day.
Deepak, is there anything you would like to…
Deepak Ahuja:
No. I think, you are totally - we are reducing the raw material inventory on one hand by keeping production stable, finding efficiencies and warehouse management and the supply chain. And at the same time, reducing the time to deliver the car and convert that car into a cash. And that significantly improves working capital needs.
Elon Musk:
Yeah, it's really quite dramatic. So, yeah, I think it sure profoundly changes the financial effectiveness of Tesla.
Deepak Ahuja:
Yeah, we reduced our inventory in Q3, which helped. And then, although we had higher payables because - sorry, higher receivables, because the quarter end, the weekend, we won't have that in Q4, so all of this should continue to help us in Q4 and beyond, the working capital again.
Elon Musk:
Yeah, I mean, it occurs to me that, even if the only thing - like even if this was the only thing that Tesla did different was to shorten the time from factory to end customer. In any given company that would outcompete all of the companies over time. It would not be a contest."
So my 20 days DIO for the Model 3 was too optimistic for when I made it, but they actually matched that exact number by the end of September - which with the ASPs and the various probable inventory categories, splits and expected growth I recovered from previous financials gave the right inventory figure with ~90% accuracy. So it's actually a pretty close guess of their real inventory position at the end of Q3, enabled by the fact that their other inventory components (solar, power) did not change much.
(The 45 days DIO for S/X still looks reasonable based on weighing of N.A./EU/APAC and the average shipping time of containers to these destinations from Fremont.)
Note that they also improved some other aspects of their inventory management, better warehousing and it appears from Elon's comments that they are aiming for $200m-$300m of supplies/parts inventory on the automotive side.
So the 20 days DIO was a lucky first principles guess, but it looks like they are aiming for
10 days, which is pretty significant now that the Model 3 is becoming the biggest part of their finished goods inventory in 18'Q4 or in 19'Q1.
Every day improvement of DIO improves their inventory by about $75m, but the Model 3 portion is roughly 40%-50% of that at Q3 levels and Q4 production isn't rising dramatically over that, and they probably cannot improve S/X DIO numbers because they are dominated by the ~30 days shipping times to both APAC and Europe, and some final assembly overhead in Europe.
So every day of DIO reduction for Model 3 North American deliveries should improve inventory by about $30m-$40m in Q4, roughly half of which could be cash improvement - i.e. perhaps $15m-$20m improvement in cash per 1 day of Model 3 DIO reduction.
Their excellent inventory management should also (largely) explain why accounts payable didn't expand nearly as dramatically.
So if we account for Elon time and assume that by end of Q4 they manage to achieve 15 days of DIO for Model 3 deliveries, the cash effect of that could be about $75m-$100m.
Also note the other thing that Deepak said that I highlighted: "because the quarter end, the weekend, we won't have that in Q4": Q3 ended on a weekend (September 30 was a Sunday), which caused banks to not clear two day's worth of customer payments in time and thus certain deliveries were delayed to Q4. This should give a nice start-of-the-quarter boost to Q4. Q4 will end on a Monday which should give time to clear many North American payments at least over the December 29/30 end of Q4 rush that is a Saturday and Sunday.
