I would like to go into further detail as to how big a deal Tesla's operating leverage
is, as it is not appreciated enough.
I am going to explain how big a deal it actually is, and what it means to Tesla.
At the end of the day net profits are far more important than gross profits.
Yes, Tesla has outstanding gross margins, and they look great on paper, but before they
are brought down to net profits, there is a big hurdle first, known as operating expenses
or OPEX.
How much does it cost to keep the lights on?
ECONOMIES OF SCALE But through economies of scale, as a business
grows, and the gross profits increase then the OPEX becomes relatively smaller, in other
words the operating margin is increasing.
Tesla is still a small company, at least relative to the number of units they produce when compared
to some of the legacy autos.
Tesla still has tons of demand just for the 2 models they sell now, and a lot more demand
when they start releasing more models.
Tesla are working on ways of expanding with more cell and battery production and looking
at new sites for more car factories.
In other words Tesla are still planning on expanding and growing relentlessly, and will
inevitably hit more economies of scale.
I mean Tesla wont even hit 1.5 million cars this year, yet Toyota was hitting around 10
million.
So firstly understand that net profit margin is the important one as that's the profits
that the value of the company is based.
And if we remove tax out of that, then we are pretty much talking about operating margin
anyway.
So to be clear again, the more Tesla grows, the OPEX will become relatively lower, and
a smaller cost relative to revenue or gross profit.
HYPOTHESIS I am actually going to start this with a hypothesis.
I think that even if Tesla lost as much as 5% of their gross margin, as in they go from
around 30% gross margin to around 25% gross margin for autos.
That their operating margin will remain the same if they can double the production number.
Another way to put this is, that if Tesla drop their margins by 5%, and double production,
then operating profits should still be double despite the lower margin.
Tesla gets too much praise about their gross margins, and not enough about their operating
margins.
So lets see what happens.
NUMBERS Well we are just going to need to plug some
numbers in.
But what numbers should we use.
We don't really have an accurate depiction of how successful Tesla are due the past 2
quarters skewing numbers so far.
Therefore I am going to go back all the way to Q1, before the new factories started hurting
margins.
I hope you don't think I am trying to cherry pick a particular quarter here, I think we
can all agree that these new factories were seriously hurting margins, along with the
lock downs we experienced.
We are dealing with an automotive gross margin of 32.9% in Q1.
However, I don't want to make this too easy for myself, as there was a particularly high
regulatory credits that quarter, so we will do this task without regulatory credits.
Which comes to 30%.
And we have an operating margin of 19.2% for the same quarter, which actually comes down
to 15.6% without regulatory credits.
So be clear again, now we have some numbers.
The theory is that if Tesla dropped their gross margin from 30% to 25%, then if they
have managed to double production, that the operating margin should remain at 15.6%, if
they double deliveries.
Deliveries for this quarter was 310,000, therefore we are going to be working with a quarter
that has delivered 620,000 vehicles.
ASPs Alright lets start with ASPs, we have an ASP
of $52,000 for this quarter, excluding regulatory credits.
If this was 30% gross margin, we need to now calculate what the new ASP would be at 25%
gross margin.
The cost of goods sold per vehicle was about $36,500, so if we add a 25% gross margin on
to that, we have a new ASP of $48,700.
Ok so despite a 5% drop in margin, this is closer to a 7% drop in actual price.
So we are dealing with Tesla dropping their prices be 7%.
Of course in this scenario we would be assuming that Tesla has made no improvements on their
cost and have not reaped any benefits of their costs lowering in a deflationary environment.
Both of which we would likely expect in such a scenario.
We are solely focusing on the economies of scale of ramping up production.
Oh also these prices are Q1 prices, which don't include much of the price upgrades in
the first place.
So we are talking about 7% price drop, before Tesla raised prices by about 10%.
However, they also don't include the dollar strengthening either.
But we can go into all those details later.
But a guess we are probably talking about a Model 3 at around $36,000 in the US.
In other words, I think we could safely say we are a price point where there will be enough
demand for 600,000 vehicles in a quarter.
MATH Actually, this was a lot more simple than
I was thinking, I was thinking I would have to calculate the margins of the new factories
and work out the potential production rate there for some reason, but we have all our
numbers, that was it.
Now we can just do the necessary math.
Well aside from other tweak, I know Tesla's OPEX is insanely low and seems to always stay
that way, actually it happens to have reduced about 5% in Q3 even from this Q1 number.
I believe mainly due to moving their headquarters out of palo alto and into Texas.
But let's just raise the OPEX 20% still, as the company would grown a possibly to get
to this next level.
So we will be using OPEX of $2.2 billion for this quarter.
And we know everything else.
When we plug in all the numbers and do the math we get all our answers.
Now although we have twice as many deliveries, due to lowering the prices, we are now hitting
just 86% more revenue, even though twice as many sales.
So that's still a good increase in revenue, but obviously the lower prices are affecting
revenue growth.
On top of that, we are now getting a lower margin on these lower prices, so we get a
lower percentage of margin on a lower revenue figure.
Meaning that despite twice as many deliveries, gross profit is only up 55%.
Ouch!
These price drops have really hurt gross profit.
I am not going to lie, that doesn't feel good if we are selling twice as many cars and only
making 55% more gross profit.
But lets continue on with our theory.
Then we add the other sides of the business, and they don't alter things too much.
Then we increase the OPEX by 10% then we get an operating profit of $5.2 billion, up 84%
from Q1 at $2.9 billion.
Wow, now that's pretty good.
Almost double the profit, despite a 7% reduction in ASP and a 5% reduction in gross margin.
That is not far off double profits despite those reductions.
That is clearly a great sign of Tesla's economies of scale still to come.
And then on to the answer we wanted, operating margin of now 16.3% compared to 15.7%.
The operating margin is actually 4% higher than before.
Tesla reduced their prices and reduced their margin, yet the operating margin actually
increased.
PROFITS Of course in reality it really is the profits
we want to be higher, rather than the margin, but they were still up almost as high.
Except for one thing.
I included the old energy and services side of the business.
Well back then they made a loss, and on now they are profitable.
On top of that, we are not likely to hit a run rate of 600,000 units in a quarter until
perhaps Q2 2023.
Which is perhaps about 5 months time, when Tesla are ramping up their energy side of
the business finally.
So perhaps we should make some tweaks there too.
If add a run rate of more like 3 GWh a quarter in energy and increase services to how it
has been growing steadily, then the numbers change.
We end up with 101% increase in operating profit, and 17% operating profit.
SUMMARY Although this looks really good, I think the
biggest anomaly here is the fact that I used old pricing.
Tesla have increased their prices significantly since this Q1.
The equivalent ASPs in just Q2, accounted for an ASP 7% higher.
So in reality this model is almost as if Tesla lowered their prices by about 14%, not 7%.
Then why are Teslas margins so low the last 2 quarters, well I keep telling you, there
was the lock down and these new factories are still killing margins.
This will not be going on forever.
I think essentially this means there is a bigger buffer in margins than people actually
realize.
And when these new factories actually start generating the highest margins out of all
factories, I think people will be quite surprised as to how profitable Tesla will become.
And I didn't even say a word about subsidies or tax credits.
But remember this is only demonstrating Tesla's economies of scale, they still need to find
ways to increase production, but if they can, then I see this company doing very well.