Margins are particularly important to the TSLA investment case given they’re at the front line of the investment debate: Is Tesla a car company or a tech company?

Expectations for Dec-23 are for margins ex-credits to improve slightly to 17.1%. I see risk to this metric given the ramp in Cybertruck. Overall, I believe margins will end the quarter at 16.7%, compared to 16.3% in the Sep-23 quarter. While this would be below the Street, I see it as a directional positive because it would mark the end of four consecutive quarters of declining margins.  As a point of reference, margins peaked 7 quarters ago at 29%, and even with the decline, Tesla still holds a slight advantage over other carmakers at 10-14% gross margin.

Looking forward to the earnings call and CFO Vaibhav Taneja’s commentary about margins in 2024, I expect the take-away to be to expect margins to remain stable during the year. This may cause a slight downward adjustment for the Street’s full-year ~19% auto margin ex-credit assumption, given I believe the year will end in the 18-19% range. This is based on a belief that Tesla will be in investment mode in the first half of the year with the ramp in production of Cybertruck along with the Model 3 refresh that will likely dampen margins. In the second half of the year, margins should begin to improve with a step down in retooling costs and an increase in production and deliveries. Putting those two forces together yields gross margin ex-credits for the full year between 17-18%, slightly below the current consensus of about 18.5%.

Long term, I believe Tesla will expand operating margins to 25% or greater, while I expect traditional carmakers’ margins to compress over the next 10 years as they feel the financial impact of the transition to EVs.

One of the key topics on the earnings call will be better understanding the ramp of the Cybertruck and the Model 3 refresh.

Cybertruck:

Cybertruck’s November launch came in priced about 25% above most people’s expectations across all configurations. Compared to the industry-leading EV truck, the Ford F-150 Lightning, the Cybertruck is about $10k more expensive for each trim. The company made the right decision to price it above the market given its undeniable wow factor, and early adopters are willing to pay premiums to be in the first 50k deliveries. Musk has recently said there are about 2M people on the waitlist, a number that I expect to decline to sub 500k over the next six months given the reality that this is an expensive vehicle. It’s worth noting, 500k vehicles is still an impressive pre-order number. Elon knows the impact price has on demand and is signaling to the market to be patient when it comes to deliveries ramping. For next year I expect sales of 35k trucks, stepping up to 125k in 2025 and 250k in 2026. These estimates are about 20% below the consensus expectations. My sense is they will not break out Cybertruck units in 2024, but it should be easy to back into the metric. This means that in 2024, Cybertruck will account for just under 2% of deliveries and 5% in 2025. As a point of reference, the Model S and X combined account for about 4% of sales. I believe by the end of 2025, Cybertruck pricing will come down by 25% or more as production efficiency improves. At that point, sales should start to ramp. That means the first big year for Cybertruck will likely be 2026. As a Cybertruck reservation holder, that’s what I’m waiting for.

Model 3 Refresh:

This month in the US, the Model 3 got its first refresh since its launch in 2017. I see it as a measurable but not material improvement. The price, motor, and range all remain essentially the same. Importantly, the new Model 3 does not qualify for the tax credit, so effectively the price of the vehicle will increase by about 15%. Overall, the Model 3 accounts for about 40% of all deliveries. What’s most important is potential Model 3 buyers have been hearing about the refresh since the middle of 2023, and some of those buyers have been holding off. Setting aside the loss of the tax credit, those buyers should return.

On the outside of the vehicle, the refresh brings slimmer and adaptive headlights, better drag coefficient, new taillights, new colors, and new wheel options. On the inside, there is a new backseat display for entertainment (still no Apple CarPlay) and seat controls, the addition of ambient lighting around the car, a better sound system, improved soundproofing, and new seats.

FSD:

In September, Tesla lowered the price of FSD in the US by $3k, from $15k to $12k. Sales of the software have slowed as consumers want to see more substance in the product before buying. That likely has impacted the cumulative FSD miles driven in the September quarter, ending at about 520M, up from 300M in June and 150M in March. I was expecting the number to be above 600M in September. The slight miss is noteworthy, given every mile driven is key to model training to unlock FSD’s full potential. I believe miles driven in December should exceed 720m.

Setting aside miles driven and product milestones, Musk continues to be steadfast in his belief that a polished FSD would see the light of day in part because of his assessment that Tesla has “the best real-world AI team in the world”. I agree. We will see a ChatGPT moment when it comes to FSD, when the product quickly moves from a science product to a must-have mainstream feature. The question is will that happen in three years or a decade?

Timing of New Model:

I’m in the camp that Tesla Robotaxi, or a lower-priced human driver model, will not be announced in 2024, given I believe it’s in Tesla’s best interest to stay quiet on the new models. The new vehicle’s selling “feature” is its price and Tesla showcasing the upcoming vehicle would likely have a cooling effect on current low-priced Model 3 sales, a risk not worth taking in a year where EV sales will continue to be muted. On top of that, the car will likely be produced in Giga Mexico, which we believe won’t be operational until 2027.

Giga Mexico:

Ground has been broken and the factory is expected to be complete by mid 2025.

Optimus:

This is still a science project with the twist that improvements in AI should strengthen the case that the product eventually sees the light of day. My guess is it won’t be ready before 2030.

While most investors expect Tesla to lose share in 2024 given they have just over half of the US EV market share today, I believe the company will maintain share as traditional car makers are slowing their investments in EVs.

In October 2023, by my count, four of the six major automakers announced plans to slow their pursuit of EVs. More recently, Ford announced a production cut on the F-150 Lightning by about 50%. The Cybertruck represents the latest evidence that the distinction between Tesla and its traditional rivals is becoming more clear. Not only is Tesla all-in on EVs, they are all-in on changing how people think about vehicles, including their durability and utility (autonomy, versatility of battery).

The table below outlines the major initiatives of Tesla vs Traditional Auto:

The bottom line is that traditional carmakers have shifted their view and believe it will take 10-20 years for EV adoption to hit its inflection. They have tuned down their investments, appropriately, which has benefitted near-term profitability. On the other hand, Tesla believes the inflection curve will hit in the next five years, and they can use force of will to make this a reality. The output of that force of will is the best EVs for the lowest price that will singlehandedly pull forward the adoption curve. If Tesla is right, traditional carmakers are making a mistake by slowing their investment. If traditional carmakers are right, Tesla is making a mistake by over-investing in a future that will take time.

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