• Tesla will report second quarter earnings on Wednesday, August 1st.
• We are expecting results to be a mixed bag, but remain optimistic regarding the Tesla story.
• June profitability and tariffs could weigh on shares.
• Most importantly, Model 3 demand remains healthy, production is improving, profitability is increasing, and Elon Musk’s behavior is more measured.

Earnings

The Street should ready for an earnings miss, as we are modeling for a non-GAAP loss of $3.09, compared to a consensus loss of $2.81. This is based on a combination of higher component costs due to tariffs along with a surge in variable costs related to the push to 5,000 Model 3s per week exiting June.

Profitability targets

Given Jun-18 will likely be another earnings miss, it will cause investors to question the company’s profitability guidance for Sep-18 and Dec-18. We share the concern around Sep-18 profitability and are modeling for a loss of $3.15 (or $546M). Our expected GAAP loss in Sep-18 reflects a lower gross margin on Model 3 and a more aggressive view on the impact of tariffs. For what it’s worth, on July 2nd, the company reiterated its profitability targets stating, “We also reaffirm our guidance for positive GAAP net income and cash flow in Sep-18 and Dec-18, despite negative pressures from a weaker USD and likely higher tariffs for vehicles imported into China as well as components procured from China.”

Model 3 production

Tesla’s goal is to exit August at a run rate of 6,000 Model 3s per week. We’re expecting the company to hit that mark at the end of September. If the company hits 6,000 at the end of September, that would imply an average of 4,300 vehicles per week, up from an average of 2,400 in Jun-18 and 633 in Mar-18. We believe this 80% q/q production increase will increase profit yields, putting them on track for a near 20% Model 3 gross margin in Dec-18.

Model 3 gross margin

As a reminder, on the Mar-18 earnings call, Tesla reduced its Model 3 gross margin target exiting CY18 from 25% to 20%. We expect the company will reiterate that target on Wednesday’s call, but, once again, we are taking a conservative approach and expect Model 3 gross margin at 17% in Dec-18.

Conversion of Model 3 preorders

It’s highly unlikely the company will give details on the conversion of Model 3 reservations. The last data point we were given was net reservations at the end of Q2, which stood at 420,000. We believe 12-24% of U.S. and Canada Model 3 reservations have converted to actual orders. This is based on the 2-4 month delivery times being quoted and assumes all the current orders come from the reservation queue. Only the U.S. and Canada are eligible to configure, which we believe represents 70% of the reservations (roughly consistent with the reported regional revenue breakdown of 55% in the U.S.). One observation from the conversion estimate: some are holding out for lower-priced configurations, given the average Model 3 selling price is $57,000, and the $35,000 base model likely won’t be available until mid-next year. The high-level takeaway is that we believe the 420,000 reservation number is reflective of eventual sales. Interest level in Model 3 is unprecedented in the world of auto, but given its current high-priced configurations, it may take a year to convert reservations to actual sales.

Expect reservation number to fade away

We don’t anticipate Tesla to report a net reservation number going forward, as a reservation is no longer needed to order a Model 3. People may incorrectly read this as a negative sign for demand, but it’s actually a positive sign for supply.

Tariffs

Tariffs will be an important topic on the call, given last week, all of the Big 3 automakers lowered profit guidance, citing rising commodity costs from the tariffs. The stocks were down on average 10% on the news. Even though Tesla recently reiterated that their guidance reflects these tariffs, we think it’s unlikely they have been fully baked in.

Musk’s behavior on the call

We expect a more measured Elon Musk on the earnings call. The consequences of a Mar-18 repeat would be a material loss of investor confidence.

Disclaimer: We actively write about the themes in which we invest: virtual reality, augmented reality, artificial intelligence, and robotics. From time to time, we will write about companies that are in our portfolio. Content on this site including opinions on specific themes in technology, market estimates, and estimates and commentary regarding publicly traded or private companies is not intended for use in making investment decisions. We hold no obligation to update any of our projections. We express no warranties about any estimates or opinions we make.