Perspective on Friday's Events
A robust 24 million shares of TSLA traded hands on Friday. Although some of this trading can be attributable to short-sellers and to delta-hedging by market makers, a good amount was actual selling by longs. I think a big part of that selling was exit now, reenter soon trading by longs, who played the sale when TSLA was down early in the morning, expecting a further decline, and planning to reenter prior to the Q4 ER.
Here's the bear and the bull interpretations of events:
BEAR: Tesla made a profit in 3Q18, will have a smaller profit in 4Q18, and will be lucky to achieve a tiny profit in 1Q19 (according to Musk's letterr). Therefore, as Tesla uses up the orders for more expensive versions of the Model 3, it will continue to see lower profits, and with the additional pressure from subsidies going away, it will eventually run out of profitable options. The 7% Reduction In Force is but a futile step that will harm its ability to expand production.
BULL: Tesla is in the process of constant re-engineering of its Model 3 production process, and when the costs have fallen sufficiently the standard range M3 will be introduced and long-term demand issues will no longer be a concern. Consider the cost and labor savings by introducing the new Grohmann battery module assembly units at the Gigafactory. Consider the cost advantages of introducing faster cell manufacturing machines on the Panasonic side of the Gigafactory. Experts have stated that the standard range Model 3 could be built for $28,000. It's up to Tesla to tweak its assembly methods and reach this price point, and lots of changes are going to happen in Fremont. The changes don't come in even improvements. Instead, we see giant leaps all of a sudden. Did you notice how substantially M3 production picked up towards the end of Q4? This is an example of how uneven the improvement process is. Once Tesla achieves profitable production of the SR M3, the bears will have no leg to stand on and the SP will break out of this long-standing trading range.
Analysis:
A good primer is to review this video of analyst Pierre Ferragu, whose firm has had a longstanding $530 price target for TSLA.
Ferragu states that Tesla is transitioning from a high-priced luxury car manufacturer to a more moderately-priced manufacturer. When moving from a $55K vehicle to a $35K vehicle, demand increases 5X. It's this 5X increase in demand that blows the short-seller arguments right out of the water.
There's one huge competitor for Tesla's current Model 3 offerings, and it's none other than Tesla's Standard Range Model 3. That's the one vehicle that M3 buyers are willing to wait for. The good news for Tesla is that while these SR M3 buyers are waiting for their vehicles to be offered, some will upgrade to the current (more expensive ) Model 3s while waiting. For example, my next door neighbor had a SR M3 on order, but her BMW 325's air conditioner died and BMW wanted $5K to repair it. In Hawaii, AC is important, and so she opted for a MR M3 delivery at end of Q4. Nonetheless, many SR M3 buyers will wait for the less-expensive M3, and so it is critical for Tesla to get its costs low enough to make it profitable.
This cost reduction of M3 is essential for Tesla to make the transition to manufacturing a mainstream vehicle.It has to happen and it's not an easy process. That's the bad news. The good news is that when it does happen, Tesla will have secured its place as the king affordable EVs (as well as King of expensive EVs) and a breakout to new ATHs would be inevitable.The net result for us investors is that the breakout likely gets delayed until this event. Invest accordingly. One exception to this delay in the breakout could be an ER with much higher than expected results. For example, expectations are low for the 1Q19 ER now. If Tesla delivered a profit large enough to trigger S&P500 inclusion, then we could be a breakout.
Tesla has announced its 4Q18 ER for January 30. This is perfect timing because the right words can neutralize the low early February numbers for U.S. deliveries because Elon can explain production numbers and where the vehicles are going.
The big picture is that the bear case has now become "Tesla will run out of high-priced Model 3s to deliver and will see declining profit results each quarter until its clear that the company is in great trouble." The breakout for the bulls will come when results vanquish this argument. It's possible that Elon is doing some sandbagging with his 4Q18 and 1Q19 expectations. If so, we could see some nice rises after those ERs if the numbers surprise to the high side. It's no guarantee, though. The strategy with making money with TSLA is to keep your investments far enough in the future so that you can ride out the short-term turbulence. In the meantime, watch for increases in Model 3 production and word of efficiency improvements because those two issues will show us how well Tesla is doing at making that transition to becoming a mainstream auto manufacturer.
