1Q17 Results: Buying Opportunity
Disclosure: I am/we are long TSLA. I wrote this article myself, and it expresses my own opinions. I have no business relationship with any company whose stock is mentioned in this article.
Summary
Model 3 ramp-up is on track.
Model S/X combined gross margin is at record high.
Widening moat.
My goal is to cut through the noise, and point out important developments.
Investor Letter
- Model 3 is on track for production start in July and robust ramp-up thereafter. Model 3 timeline and demand are by far the most important factors when estimating Tesla's intrinsic value. Readers should note that July was initially an internal goal and the original externally communicated production start quarter was 4Q17; in other words, Tesla is 3-6 months ahead of its original production timeline for the Model 3. This is very positive.
- Completed transition to internally developed Autopilot software. This is important as Mobileye was a high value-add third party supplier as late as 4Q16. Tesla successfully insourced an important part of its value chain in less than six months. This confirms Tesla's ability to vertically integrate its supply chain, which is a crucial part of its long-term story.
- Repair times declined by 35% this year, with further declines predicted. This is important, because it speaks to the superior reliability of all-electric cars due to their simpler drivetrains, and also because bears predict Tesla will need to spend tons of cash to build out service infrastructure. Higher reliability of all-electric vehicles is also the primary reason why auto parts manufacturers and dealerships (whose profits come from service, not sales) strongly oppose Tesla's growth.
- 150 MW of solar energy generation deployed in Q1. This is lower vs. year-ago quarter, and is in-line with my prediction that SolarCity business will slow down throughout the transition. I expect solar energy generation business to ramp back up throughout 2H17 as Solar Roof is brought to market. I expect solar generation business to be a high-growth low-margin business in the long-term, primarily there to support electricity needs of all-electric vehicle customers. It is an important part of the Tesla growth story, but not a source of long-term profits.
- 60 MWh of energy storage installed in 1Q17, including a 52 MWh storage project in Hawaii. The growth of the stationary battery business is progressing slower than I had expected. Management guided to accelerating growth later this year, and I will be keeping an eye on this.
- Combined, solar generation and energy storage (i.e. Tesla Energy), achieved nearly 30% gross margin, which is very positive. It is important that the gross margin remains high through the expected "super-exponential growth," which is a growth model in which the growth rate itself increases through time as opposed to "exponential growth" in which the growth rate is constant. I have high expectations for Tesla Energy, and I will be keeping a close eye on its growth rate and profitability.
- Automotive gross margin improved significantly in-line with my prediction for 1H17. My preferred measure of gross margin (excluding ZEV credits, which will eventually go away, but including stock-based compensation, which is a real employee expense) improved from 23.0% in 4Q16 to 27.8% in 1Q17. Management commented that part of this increase was due to delayed Autopilot revenue, which has higher margins, and guided automative gross margin to decline by 250 bps in 2Q17. Combined with the recent significant price cut for the Model S, I expect automotive gross margin to come in at 25% in 2Q17, followed by a gradual ramp up to 30% by 4Q17 for Model S/X, as Tesla focuses on manufacturing efficiencies vs. production rate growth throughout 2H17.
- Tesla Energy (generation and storage) gross margin came in at 29%, up from 2% for the previous quarter and 20% in the year-ago quarter. Management attributed this increase to "improved energy storage margins, sale of energy credits and higher production of solar energy due to seasonality." In the longer term, Tesla Energy profitability will be very important to Tesla's intrinsic value, but it's too early at this point to read too much into the data. I will keep a close eye on this metric as Tesla Energy grows throughout 2017.
Earnings Call
- Elon confirmed that Tesla Semi will be able to handle long-haul trucking, which is important because that's where most of trucking industry revenues and profits are. I will explore Tesla Semi's potential in more detail as we get closer to its reveal event in September.
- Option uptake for Model 3, if in-line with Model S and Model X, is expected to be between 20-30% on top of the base price of $35,000. This is in-line with my modeling assumption that the Model 3 average selling price ("ASP") will approximate $45,000.
- In response to a question about Model S/X demand, management noted some impact from the upcoming introduction of the Model 3, but added that they see sufficient demand for the company to achieve its 47,000-50,000 delivery guidance for 2Q17 as well as 100,000/year Model S/X combined deliveries going forward.
- Management noted that the Model 3 production line will be comparable to, or slightly better than, the best volume production line in the world. This is an important milestone for the company as its intrinsic value relies in part to significant improvements in manufacturing speed and quality. Management added that the Model Y (expected in late-2019) production line will see a step change in production speed, meaning there will be nothing close to it among Tesla's competition. Another important tidbit was that the Model 3 production line is expected to achieve 5x the output of the Model S production line with the same hours, so 5x improvement in production efficiency. This means a "step change" for Model Y has the potential to be a game-changer for the automotive industry.
- Management noted that Tesla will be able to fund its ramp-up to 10,000 cars produced per week with internal cash flow. This is in-line with my expectation and contradictory to the primary bear argument that Tesla will continue to dilute existing shareholders with never-ending secondaries.
- In response to an analyst question regarding management's "1 million cars in 2020" prediction, Elon said "a million units is quite likely, combined [all models]. Maybe more." This is in-line with my expectation that Tesla will continuously increase its production guidance for 2020, as I explored in detail in a previous article. Currently, I estimate that the ~$300/share stock price incorporates the overly pessimistic market consensus of 500,000 cars produced in 2020.
- Management guided for SolarCity gross margin to stay very healthy throughout the rest of the year and grow over time. This is very positive for Tesla Energy margins, and above my expectation for 2017.
- Management indicated that Model Y will be produced on a different and improved platform than the Model 3. For example, "the wiring harness on Model S is about 3 kilometers in length. The wire harness on Model 3 is 1.5 kilometers in length. The wiring harness on Model Y will be 100 meters. And that's a redundant wiring harness." This is in-line with earlier commentary that the Model Y production line will be a "step change" from the Model 3 production line, which is expected to be slightly better than the best production line in the world.
- The following management comment is extremely important, so I am including it in full:
The set of steps necessary to achieve [$700 billion market cap by 2025] seems pretty obvious. I am heavily involved in Tesla going – incredibly good at the machine that builds the machine. Which involves, by the way, a tremendous amount of software. This is not just a bunch of robots that are sitting there. It's the programming of robots and how they interact. And it's far more complex than the software in the car. I mean, I think,
this is just going to be a very difficult thing for other manufacturers to copy. I would not know what to do if I were in their position.
I will further explore this in a later article related to Tesla's sustainable competitive advantage.
- Management noted that Tesla Semi will use a lot of the same parts as the Model 3 and will have very good gross margin, which is above my expectation.
Bottom Line: This was positive report on key factors such as the Model 3 progress and Tesla Energy growth and margins. I expect the stock to be volatile in the short-term due to the bottom-line EPS miss, but any short-term decline should be reversed in the coming weeks leading up to the Model 3 final reveal in July.