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Tesla Is Making the Right Decision to Invest in the Business
Tesla's June quarter results were solid, as expected. Shares of TSLA traded down by 4% off management comments that implied auto gross margins will be down slightly in September due to production downtime for retooling and other investments. The hyper focus on near-term margins overlooks the long-term value the company is creating by aggressively investing in new models, production capacity, batteries, and FSD, all of which will lead to increasing margins over time.

Key Takeaways

As auto gross margins drift lower, investors wonder when and by how much they will improve.
Tesla is making investments at levels no other car maker can compete with, which is why traditional auto is in trouble.
The biggest surprise: FSD may be licensed by a major OEM, a significant potential for Tesla to expand its margins.

The margin roadmap

Going into earnings, investors continued to be focused on profitability. The reason is the central profitability metric, auto gross margins ex credits, came in line with expectations for the June quarter (18.2% vs. the Street at 18.0% ), down from 19.3% in March and 23.8% in December 2022.

Similar to last quarter, CFO Zach Kirkhorn declined to give an auto gross margin target for the back half of the year, reiterating for the second straight quarter there are factors outside the company’s control when it comes to margins, notably interest rate impact on demand and materials costs. Additionally, some production will be paused in the September quarter for factory upgrades related to Highland, the Model 3 update. Reading between the lines I expect auto margins to be in the 17-18% range for the September quarter, compared to the just reported 18.2%.

Over the next year and a half, I expect auto gross margin ex credits to inch higher, exiting 2024 around 20%. The one wild card is Cybertruck production. The more they produce next year will likely cap margin upside during the truck’s first year as production will have sub-scale margins.


Aggressively investing in the business

While the trend in auto margins is concerning, the biggest reason driving the decline is for the long term strength of the company. Tesla is aggressively investing in the following areas that set Tesla apart from the rest of the auto industry:

  • Build the razor-razorblade model. Keep prices low to sell units that eventually will be higher margin full self-driving customers.
  • Build new production capacity (ramping Austin, expanding Berlin, and adding Mexico). Tesla is investing in the machine that makes the machines. Eventually, other car makers will need to make these investments.
  • Preparing for the 2024 ramp in Cybertruck. Ford F-150 is the 800-pound gorilla in the light truck market (sells just over 500k of them a year), and their recent F-150 Lightning price cut is an indication they believe Cybertruck will have the potential to reshape the segment.
  • Dojo, the brain for autonomy, will get more than $1B in investment over the next year. As a point of reference, in 2022, Nvidia spent $7B across the entire company on research and development. In other words, spending $1B plus on a single product is aggressive and speaks to Musk’s urgency at making good on this FSD prediction.
  • Ramping 4680 battery production. This should expand Tesla’s lead when it comes to consumer value as measured by range divided by vehicle price.
  • Training FSD. FSD Beta now has over 300 million miles driven and Musk expects that to “soon be billions of miles and tens of billions of miles”. With autonomy (AI), data is the competitive advantage for Tesla.
  • Building out the supercharger network. Other automakers (Ford, GM, Nissan, Mercedes-Benz, Polestar, Rivian, and Volvo) have announced that their cars will be able to use Tesla’s Superchargers starting next year.

Licensing full-self driving software

The biggest surprise on the earnings call was Musk announcing Tesla is “very open to licensing our full-self driving software and hardware to other car companies and we are already in discussions with only just early discussions with a major OEM about using Tesla FSD”.

This is important for two reasons. First, if Tesla is successful at landing one OEM (odds are it’s Ford), the likelihood that other car makers jump on board is high. It would be a similar dynamic we’ve seen over the past month as seven car makers have signed up to use Tesla’s charging network. When it comes to autonomy it’s a race to get there first. In theory, once the problem has been solved most car makers will adopt the first-to-market solution given it won’t make economic sense for them to invest in developing a technology that will be difficult to differentiate.

The financial potential of licensing FSD is significant. Currently, Tesla charges $199 a month for Basic Autopilot to FSD capability. If Tesla would reduce the price by 50% to $100 per month and power autonomy for 25% of new cars and light trucks sold in the US, it would add just under $4B in revenue. By year five FSD licensing would be adding nearly $20B in annual high margin revenue.

Taking a step back: if, in a decade, Tesla has a 10% share of the global auto market (their goal is closer to 20%), the company should be making just over $100B in operating income. In other words, licensing FSD could add an additional 20% to annual operating income. While these targets are many years away, it illustrates the FSD licensing opportunity is meaningful and worth the wait.

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