Tesla Model 3...by the numbers.
Here's the type of detailed, by the numbers accounting article the Tesla slappies never read IMO. This is using Tesla's own numbers from their financials. No smoke and mirrors..just simple math.
Tesla: The Model 3 At 5,000/Week Is Not Enough For Profitability
SUMMARY
We have further data on the Tesla Model 3 margins, as well as data-bearing Tesla promises.
This allows us to calculate marginal gross profits for the Tesla Model 3.
Having marginal gross profits for the Model 3 means we can try to establish whether Tesla's promise of profitability for Q3, Q4 2018 is realistic or not. It's not.
In writing this article, I had my own model for how negative Tesla's (TSLA) Model 3 gross margins were during Q1 2018. However, it’s also good practice to build on other’s work instead of introducing noise and new models at every turn (plus my conclusions were very near to those I am about to use).
First, Q2 2018
So, as a starting point for what I am about to describe, I am going to use Marginal Analysis’ work, as described in his article titled “Tesla's Q1 Revenue Beat Driven Largely By Accounting Changes, Model 3 Currently Loses $8K Per Unit”. The datum from that article which concerns us is:
The Model 3 produced ~$68 million in negative gross profit during Q1 2018.
Next, from Tesla’s Q1 2018 investor letter, we have the following promise:
If we execute according to our plans, we will at least achieve positive net income excluding non-cash stock based compensation in Q3 and Q4 and we expect to also achieve full GAAP profitability in each of these quarters. This is primarily based on our ability to reach Model 3 production volume of 5,000 units per week and to grow Model 3 gross margin from slightly negative in Q1 2018 to close to breakeven in Q2 and then to highly positive in Q3 and Q4. Ultimately, the growth of Model 3 and the profit associated with it will help us accelerate the transition to sustainable energy even faster.
We also need a Model 3 production estimate for Q2 2018:
Tesla started the quarter at 2,000/week and claims it’s able to produce that or more by now. Indeed, it says it will ramp to 5,000 by the end of the quarter. Let’s be generous to Tesla, and say that it will actually produce the Model 3 at an average of just 2,000/week over 12 weeks. Or 24,000 Model 3s.
“Generous?”, I hear you saying. “Tesla will be way ahead, and you’re just spreading FUD with your low ball estimate”, you’re certainly thinking.
Yes, generous, because with what I am going to say next, the higher Tesla thinks its Model 3 production during Q2 2018 will be, and which went into its “breakeven” pronouncement, the worse things look for Tesla. So in assuming “just” 2,000/week, I am actually doing Tesla a favor. Let’s see why.
You see, Tesla said it had a negative gross margin on the Model 3 during Q1 2018. It also said that its increased Model 3 production during Q2 2018 will enable it to reach breakeven. What does that mean? It means that the marginal contribution from the Q2 2018 Model 3 production in excess of the Q1 2018 Model 3 production will be enough to erase the entire negative gross margin contribution which the Model 3 had during Q1 2018. Putting it in an equation:
(Q2 2018 Model 3 production – Q1 2018 Model 3 production) * X - $68 million = $0 (breakeven).
X, of course, is the marginal gross margin Tesla expects from each marginal Model 3 unit during Q2. As you can see, the higher the Q2 2018 Model 3 production, the smaller Tesla thinks X is. Hence, above, when I project 24,000 Model 3 units, I’m being generous if Tesla actually thinks it will be producing more (since that would imply a lower marginal contribution per unit).
So, we take the equation above and what we have is:
X = 68 million / (24,000 – 8,180)X = $4,740 per unit, or a marginal gross margin of ~9% on a $52,000 Model 3.
Said another way, if Tesla produces 24,000 Model 3s during Q2 and each has a positive marginal gross margin of ~9%, then Tesla will reach breakeven gross margin on the Model 3 during Q2 2018.
This also has further meaning. 9% is the marginal gross profit rate on each Model 3 after the fixed costs are entirely diluted on the first 8,180 Model 3 units (the loss that the Model 3 produced during Q1 2018). There is no further fixed cost dilution after those first units if we take their loss as the base, so any further gross margin improvement needs to come from actually removing cost from the product and process.
Now, Q3 2018 (And Beyond)
So, let’s say everything went well for Tesla. Tesla produces the 24,000 Model 3s during Q2 2018, and thus reaches gross profit breakeven on the Model 3.
Tesla just erased a $68 million loss right there. Of course, things are still going ugly elsewhere, with Opex (operating expenses) up another $35 million, interest up another $10 million, $50 million in ZEV profits gone, etc, etc. But let’s just consider the gains, $68 million.
Tesla will then supposedly be entering Q3 2018 fully able to make 5,000 Model 3s/week. Let us say 60,000 over 12 weeks.
Tesla also starts from a gross profit breakeven, for which the first 24,000 Model 3s within those 60,000 are enough to achieve.
Now, if Tesla is only able to keep the 9% marginal gross profit on each of the 36,000 Model 3s, that would imply a further $170.7 million in gross profit. Versus Q1 2018, that would be a $170.7 million + $68 million = $238.7 million improvement. Let us be generous again and let these flow straight through to “net profit”. Let us be even more generous and compare just to the Q1 2018 non-GAAP net loss (-$567.9 million). Well, it’s easy to see that $238.7 million is not going to erase a $567.9 million loss. So just keeping Q2 2018 Model 3's marginal gross profit implied in Tesla’s guidance is not going to cut it.
Even if Tesla is able to increase the marginal gross profit on those last 36,000 units to double what it achieves during Q2 2018 – and remember, in this model all the fixed costs are already diluted as of the Q1 2018 loss, so improvement has to come from taking costs out of the car – the additional contribution would be $341.8+$68 million = $409.4 million. That would still fall short of Q1 2018’s non-GAAP loss by $158.5 million. The distance to GAAP profitability would be larger still. Again, it’s important to remember that this already implies significant improvement over and beyond the easiest gains from increasing production – which is diluting fixed costs over a larger number of units.
CONCLUSION
Just increasing Model 3 production to 5,000/week doesn’t look like enough to pull Tesla from its tremendous losses.
Of course, it does look like enough to reduce such losses. But then again, that’s only a short-term palliative, because:
By Q4 2018, Tesla will be seeing the $7,500 EV tax credit starting to evaporate. This will either bring an up to $7,500 price increase (with an impact on quantities sold) or up to $7,500 in margin erosion on every car Tesla sells (Model S, X and 3).By Q4 2018, Tesla will already be starting to see the arrival of direct competitors to its higher-margin Model S and X, as well as others trying for lower in the market. And all of those will be enjoying the $7,500 EV tax credit, on top. For instance, the Jaguar I-Pace will be starting at $62,000 after the tax credit. With the Model 3 seeing the tax credit gone, even the I-Pace becomes something of a direct competitor! There is no market for 250,000 Model 3s (5,000/week, 50 weeks) at $50k and beyond. Remember, the Model S60 used to start at roughly $65,000 including a $1,000 referral discount. With the $7,500 tax credit, that meant it was effectively a $57,500 car. The Model S60 never sold more than, say, 20,000-25,000 units per year. Why would the Model 3 at a nearly similar price sell 250,000? No, those kinds of volumes are only possible with the $35,000 Model 3. And the $35,000 Model 3 doesn’t exist because Tesla can’t sell it profitably. Indeed, even the long range Model 3 comes with a $5,000 premium package to create gross margin (and even that looks hard to go away).
Again, to conclude, just producing 5,000 Model 3/week is not enough to bring Tesla out of its loss-making habits.
