Summary
- Tesla, Inc. posted weaker revenues, margins, and free cash flows as there are clear headwinds not just from macro factors, including debates about competition and EV adoption.
- In particular, management's tone was negative during the Q3 2023 earnings call, with a heavy emphasis on the high-interest rate as a significant headwind for its business and consumer sentiment.
- Tesla also lowered expectations for Cybertruck due to difficulties in ramping the Cybertruck as it involves a new design and technology.
- Furthermore, expectations were also managed for its 50% growth target and Mexico factory due to the difficult macroeconomic environment.
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Tesla, Inc. (NASDAQ:TSLA) is seeing some dark clouds ahead for its business as high-interest rates are taking a toll on consumer sentiment, especially for big purchases like that of an electric vehicle ("EV").
Growth seems to be slowing, and there are clear near-term headwinds for Tesla as it navigates through a difficult market environment.
How were the results of Tesla relative to expectations?
In Q3, Tesla's total revenue grew by 9% from the year prior, and fell 6% from the prior quarter to $23.4 billion.
This was 2% below consensus of $23.9 billion.
In particular, automotive revenue was $19.6 billion, 2% below consensus of $20.1 billion.
Auto credits came in at $554 million, almost $250 million above consensus of $306 million.
While gross profit and gross profit margin came in at $4.2 billion and 17.9% margin compared to consensus of 17.8%, automotive gross profit margin ex-credit was the main issue.
Consensus was at 17.6% automotive gross profit margin ex-credit, but it only came in at 16.3%. In general, the investor sentiment around at 16.3% automotive gross profit margin ex-credit was that it is below expectations and relatively weak.
Going down the line, GAAP operating profit was $1.8 billion for a 7.6% margin. Again, this was below consensus of $2.2 billion for a 9.1% margin.
Adjusted EPS was $0.66, 7% below consensus.
Free cash flows came in at $848 million, down 16% from the prior quarter and down 74% from the prior year.
Where were the misses in the quarter?
Firstly, auto gross margin ex-credits at 16.3% was at a lower level since Q1 2019, when deliveries were 86% lower than they currently are.
The reason cited was that the company believes that focusing on investment for future growth while maintaining positive free cash flows is the right approach in the current high interest rate environment.
Secondly, the weakness in revenue will continue to be the debate, in my view.
While there were planned downtimes for its factory upgrades in Q3 2023 for the company to improve production rates, this was already embedded into consensus and the top-line figures were still weaker than expected.
The demand trends for Tesla are clearly weakening, and the questions that will be on investors' minds are whether this is due to competition, macro, EV adoption or is it just Tesla-specific factors.
The current thinking of the market right now is that the price cuts have certainly made the competitive landscape tougher for competitors looking to ramp EVs, but at the same time, it has not yet unlocked significant demand for Tesla.
The macroenvironment and consumer sentiment
Tesla's management team was very cautious about the current interest rate environment, and how the macro environment is affecting the consumer.
Tesla CFO Vaibhav Taneja did mention during the call that consumer sentiment was shifting in his prepared remarks:
As we navigate through a period of economic uncertainty, higher interest rates, and shifting consumer sentiment.
As CEO Elon Musk mentioned in the Q3 2023 earnings call, he has concerns about the high interest rate environment and what it means for the demand environment for Tesla:
I'm worried about the high interest rate environment that we're in. I just can't emphasize this enough that the vast majority of people buying a car is about the monthly payment. And as interest rates rise, the proportion of that monthly payment that is interest increases naturally.
So, if interest rates remain high or if they go even higher, it's that much harder for people to buy the car, they simply cannot afford it.
As a result of the higher interest rate environment which is resulting in weaker demand, Tesla has decided to lower prices through price cuts to ensure that the total cost to the consumer remains the same even though interest costs are now higher.
The direct consequence of these price cuts is, of course, weaker margins for Tesla, even if it can result in improved demand.
50% growth target
There were multiple questions during the call asked on Tesla's 50% long-term growth rate for deliveries that they started to guide in 2021.
While I never understood how a 50% growth rate could be a long-term one, I think in this quarter, the market is starting to realize that this will likely be taking a back seat.
Firstly, Tesla now is hitting the law of large numbers, which indicates that volume is at a high level today. To continue growing at 50% from a small base was practical, but to grow 50% from the current base is certainly not an easy task.
Secondly, as a result of the law of large numbers, the focus here will be to grow in a cost-efficient manner rather than growing at 50% or at all costs.
Thirdly, focusing on cost efficiency rather than the 50% growth rate is also due to what is happening in the macroeconomic environment and the high-interest rate environment.
As CFO Vaibhav Taneja mentioned in the Q3 2023 earnings call, we will likely get more updates in Q4 2023, but they are focusing on cost efficiency in the current environment
I just talked about what is happening in the macroeconomic environment. So, we're focused on growing our volumes in a very cost efficient manner and are carefully reviewing all our options, and we'll be able to provide a much more meaningful update at our next earnings call.
Conservative on Mexico
Based on the Q3 2023 earnings call, I think management was managing expectations for the Mexico factory buildout, specifically saying that until they get a better sense of the macro environment, they will not be going full-tilt on the Mexico factory buildout.
CEO Elon Musk was clear on the point that they will definitely have a factory in Mexico, but it's more of timing and also the macroeconomic environment or the interest rate environment:
No, we're definitely making the factory in Mexico. We feel very good about that. We put a lot of effort into looking at different locations, and we feel very good about that location, and we are going to build a factory there, and it's going to be great.
The question is really just one of timing. And there's going to be a broken record on the interest front. It's just the interest rates have to come down. Like, if interest rates keep rising, you just fundamentally reduce affordability. It is just the same as increasing the price of the car. So I just don't have visibility into it.
If you can tell me what the interest rates are, I can tell you when we should build the factory. We're going to build it. And I mean think we'll start the initial phases of construction next year. But I am still somewhat scarred by 2009 when General Motors and Chrysler went bankrupt.
Again, the emphasis here on Mexico going full steam is the interest rate environment, as Elon Musk is concerned about the high-interest rate environment that we are in today.
Cybertruck
Cybertruck expectations were lowered for both volume and profitability.
One of the first things that were emphasized about the Cybertruck is how difficult it will be to reach volume production for Cybertruck, and then to make Cybertruck cash flow positive.
The reason for this is that Cybertruck is very different from other vehicles being built, with a lot of new technology, which would have a disproportionately higher number of problems to solve in order for Cybertruck to scale meaningfully.
I will just highlight a part of what CEO Elon Musk said about the Cybertruck in the Q3 earnings call:
So, I just want to emphasize that while I think this is potentially our best product ever and I think it is our best product ever, it is going to be -- require immense work to reach volume production and be cash flow positive at a price that people can afford.
In terms of expectations being lowered, Tesla stated that it will take at least a year to 18 months before it can be a positive cash flow contributor.
Elon Musk did mention an expectation for about 0.25 million rate of output per year for the Cybertruck in 2025, but that's just his best guess and not a guidance.
The positive thing is that the demand for the Cybertruck is strong, with more than 1 million reservations for the car.
Valuation
Tesla is trading at 52x 2024 P/E. Still, while not exactly cheap given that 52x P/E prices in quite a bit of upside, with Tesla, it is always about the long-term opportunity.
I am lowering my financial forecasts for Tesla, Inc. stock given the lower volume expectations for 2024, and also, the higher investment the company needs to make for long-term growth rates.
As a result, the 1-year price target goes down to $257, which once again, is based on a premium 60x 2024 P/E multiple given Tesla's strong leadership position in EVs, AI, and autonomy.
As a result, this near-term price target does suggest that near-term upside remains relatively limited, although I would emphasize that the long-term growth opportunity remains.
Conclusion
I think that investor sentiment will remain under pressure in the near term, as there are clear and increasing headwinds.
The management's negative tone on the Q3 2023 call was very notable, with several uncontrollable headwinds like the macroenvironment, shifting consumer sentiment, and high-interest rates likely to affect business as long as these continue to prevail.
As a result, this has negative implications for demand, Cybertruck ramp, and Mexico expansion.
Market and consensus expectations for 2024 will likely be lowered as a result of these commentaries and outlooks by Tesla.
Likewise, I have also lowered my expectations for the near term given the headwinds and challenges faced by the company and the industry.
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