So Elon says the next 12 months may still be challenging, and then hopefully after that
he expects to see the economy start to recover.
Now you might think that he is more credible than many of you when it comes to predicting
what will happen in the economy, and has a pulse on things on things in real time.
But in reality, not even Elon can tell the future.
We still don't know how the economy will go.
History generally teaches us that an economic slump is often around 2 years, but funny things
can happen.
Anyway, in this video I just wanted to work out how much lower Tesla's car prices could
go, and yet Tesla would still be at break even in earnings.
Although free cash flow would however be negative due to Tesla's substantial CAPEX.
Which we can talk about too.
Now firstly, I am just talking about financials for Tesla over this time.
It's one thing trying to predict whats happening in the economy, or whats going to happen with
Tesla's earnings.
However, those two elements can be irrelevant as to what could happen to the stock price.
If the market feels like Tesla is going to win in AI, or FSD, or EVs, then Tesla's stock
price could still run.
There can still be a total disconnect between them all.
Also in the environment we are going to simulate, where Tesla have to lower their prices again.
Then this will of course be as a result of aggregate demand for autos dropping too.
Which would imply that Tesla's auto market share is increasing during this time too.
If it's bad for Tesla, than its bad for everyone, or potentially worse for everyone else.
Why would it be worse for everyone else?
Because like we said Tesla would have lowered their prices, and thus eating more market
share, taking more sales away from legacy.
Alright, so lets take a look at some numbers, and get an indicative idea of roughly what
sort of price Tesla's cars will be lowered to and still run at break even.
If we take total auto revenue and divide it by deliveries we get an ASP of $46,000, this
doesn't include regulatory credits, but does include leases etc, but like I said, this
is just going to be indicative, and will give us a good enough idea of what we are dealing
with here.
When we take in all the cost, we have a $3.7 billion gross profit with a 19% margin.
Then we look at Tesla's income before taxes and it comes to $2.8 billion.
Therefore if Tesla's gross profit for autos dropped by $2.8 billion, then Tesla would
then be operating at break even.
I think the numbers are that simple, we don't need to factor in the other sides of the business.
Ok sure, we do however expect the other sides of the business to grow in profit and likely
compensate for any further auto losses over time.
But we can't guarantee what that growth will be like.
This would mean that if Tesla lowered their prices all the way to earnings being 0, then
the auto revenue would then become $16.6 billion.
The ASP would then come down to $39,000 from $46,000, which is a 14% drop in price.
So that's the number we wanted.
We would be looking at something like a 14% drop in price for Tesla's cars, and for the
company to still function at break even.
That would mean a Model 3 in the US would start at just under $35,000, and a Model Y
would start at just under $40,000.
And those prices don't even factor in the tax credit.
Which I think we can all agree is a ridiculously low price for a Tesla, and as we know there
is a much larger pool of demand from every incremental price drop at this stage.
For example before when Tesla's prices were higher, and the price dropped 10%, demand
might have increased 20%.
But at this stage if Tesla drops prices by 10% then demand may increase 40%.
For a start the economy would have to be in seriously bad shape for Tesla to drop prices
this much further again.
But it's good to know that even at these prices then Tesla still won't lose money.
Well not lose money on cost of goods sold.
There is still the matter of cash flow.
Tesla is a growth company, and its a growth company that produces cars.
Cars are a very capital intensive industry.
Tesla is trying to grow at rapid rates, and double production rates in the next couple
of years.
The factories are so big, they are literally the biggest factories in the world.
Well these factories cost money.
Last quarter there was over $2 billion on CAPEX, that is not nothing.
Yes, Tesla managed to make enough profit to cover that.
But it only left $441 million of free cash flow for the quarter.
We just worked out how much Tesla could lower prices for break even on earnings, but Tesla
would still need to keep growing and spending money on said growth.
For Tesla to remain cash flow positive, the prices of cars could only drop 2%, any lower
than that, and they would have to dig into reserves.
So if things got really bad and Tesla was operating at break even, there would potentially
be about $2 billion of negative cash flow each quarter.
However, Tesla have the reserves and could still last more than 2 years running at that
state.
Which would make you wonder, if its that bad for Tesla, then surely many of the competition
would not outlast and go under before then, or there would be bailout to go around, of
which Tesla would also likely benefit.
Also some of that CAPEX is going to be moved into cost of goods sold soon, when a lot of
these facilities Tesla are building come online, things like the new cathode factory in Texas.
On top of that the Cybertruck line will also be removed from CAPEX soon, and go into cost
of goods sold, when it starts production.
This actually will affect earnings and margins a noticeable amount, but will actually increase
free cash flow, as there would have been reduce capex as the line is complete, and a little
bit of income from Cybertruck sales too.
Of course there is also a lot more CAPEX to come as well, when Tesla starts Mexico and
Megapack Shanghai, and potentially the Giga Nevada expansion too.
Tesla bears like to bring up the CAPEX issue that Tesla has, but I think Tesla can weather
this still even if the economy makes another turn for the worse.
I don't think Tesla will need to drop prices by as much as we said, and go down to break
even.
They seem ridiculously low, and like I said, if it got that bad in the economy, then there
would be some intervention somewhere to support legacy and Tesla.
Even a further 5% price drop would still mean Tesla can likely last years.
But hopefully there is only about a further 12 months of this to deal with, and we don't
see any major financial crises in the meantime.
Looking at these numbers though, it looks like Tesla will be fine to continue their
growth through struggling economic times.
Anyway, I wanted to entertain this as this is an argument that many bears raise.
But the point is, like I said, Tesla are planning on doubling their growth over the next 2 years
or so.
That does require a lot of CAPEX, but that CAPEX is high relative to where Tesla are
today.
In addition to that, it is high relative to where the economy is today, and with higher
rates eating into profits.
Eventually there will be more economies of scale kicking in, and a lot of these current
CAPEX will be wrapped up, and start producing profits.
Hopefully the likes of 4680 cells too.
And with new manufacturing techniques that we will see come out of Mexico, the margins
will be higher, so we will see a relatively higher return on asset or CAPEX.
It will take time.
But over a couple of years, the CAPEX to earnings ratio will dwindle as Tesla expand more, and
become more profitable with increased efficiencies and new technologies.
And I am not even factoring in FSD or other such technologies, solely EVs and manufacturing.
We can't have massive growth, without high CAPEX, especially with an auto company.
I can't see Tesla running at a loss, but if things do get tight, there may be some quarters
with some negative cash flow, but Tesla have enough of a cash buffer to see that through
for some time.
And remember, eventually CAPEX turns into profits, like we should see sometime next
year with the Cybertruck.
Tesla can survive this storm, and likely any other, it will continue to innovate and grow
and will come out the other side bigger, leaner and stronger.