Tesla will report March quarter results this Wednesday, April 29.

Earlier this month, Tesla released March quarter deliveries of 88.4k vehicles, up 40% year over year compared to the US auto industry (limited comparison) down 29%. We see three areas of focus related to the Mar-20 earnings release:

1. Tesla will likely miss free cash flow street estimates, due to the gap between vehicle production and deliveries combined with shutdowns and program ramps.
2. Tesla will likely not issue June guidance on Q2 vehicle deliveries due to uncertainty surrounding the pandemic.
3. Positive commentary indicating strong demand entering the pandemic along with favorable Model Y order and Cybertruck preorder trends.

We believe the long-term Tesla opportunity is intact and well-positioned when the world returns to “normal.” With an expanding product line, Tesla should continue to gain auto market share, growing 15-25% faster than the overall auto industry for multiple years.

Street Free Cash Flow Too High For March Quarter

We see free cash flow as the March quarter’s focal point and believe Street consensus is too optimistic. We expect a $600m burn compared to Street estimates of negative $527m. Some investors may give Tesla a pass, given the Mar-20 inventory rebuild and the pandemic. This would be a supporting data point for the more skeptical investor and restart the “Tesla continues to burn cash” theme. Our math behind our expectation of a free cash flow miss:

• Applying the Street’s $53k ASP estimate along with our average vehicle cost estimate of $43k. Since the company produced 14k more vehicles than it delivered in Mar-20, along with the $43k average build cost per vehicle, it yields a $602m FCF headwind.
• Factoring in Shanghai and Model Y ramps along with the Fremont shutdown (March 23rd).
• Ironically, if Fremont did not shut down the production/delivery gap would have widened by another ~10k vehicles, and FCF would have swung further negative.

Street Gross Margin Falls in Line With Our View

Three weeks ago, FactSet consensus showed Mar-20 auto gross margin ex-credits at flat quarter over quarter (18.9%), which did not factor in the impact of product ramps. Since then, Street auto gross margin ex-credits estimates have since come down by 2.1% to 16.8%, to a level that should be in line with reported numbers.

• On the Dec-19 earnings call, Tesla CFO Zach Kirkhorn commented: “we are in the process of ramping two major products; Model 3 in Shanghai and Model Y in Fremont, which I expect will temporarily weigh on our margins.”
• In Dec-19, we estimate Tesla produced about 1k Model 3s in China, which were delivered in December (<1% of total deliveries). While only a small portion of overall deliveries, Kirkhorn highlighted “we were negative gross margin on the products that we built in Q4” in Shanghai.
• In Mar-20, made-in-China Model 3 mix increased to ~16k out of 88.4k deliveries (18% of total deliveries). Our math shows Street Shanghai auto gross margin estimates ex-credits increasing from negative in Dec-19 to ~7% in Mar-20.
• Combining Fremont auto gross margin estimates ex-credits of 18.9% (same as December) and Shanghai at 7% yields a 16.8% margin, in line with the Street

Regulatory Credits Are a Wild Card

In Dec-19, Tesla had $133m in regulatory credits on 112k vehicle deliveries. In Mar-20, Street estimates call for $172m on 88k vehicle deliveries, which likely anticipate credit purchases from Fiat Chrysler. We believe Street estimates of $172m are too high, as Fiat Chrysler is incentivized to wait until the second half of this year to purchase credits from Tesla.

• Keep in mind Fiat Chrysler is paying Tesla $2B over three years for credits to offset fleet CO2 emissions and meet EU standards.
• Fiat Chrysler does not know the vehicle emissions profile without knowing the delivery volume per model during the pandemic, so the amount of credits needed is uncertain.
• Fiat Chrysler is already struggling financially and will likely not voluntarily increase cash outflow at this time.

June Deliveries Could Be Flat or Down Slightly

We do not expect Tesla to provide guidance on June deliveries. With Fremont shut down for 33 days, the Street will likely be expecting a sharp decline. In the end, June deliveries may be a positive surprise to the upside and be flattish or down only slightly quarter over quarter due to delivery tailwinds offsetting Fremont shutdown.

Incremental June delivery data points:

• China Passenger Car Association reported Tesla wholesale (i.e. production) of over 10k vehicles in March. We expect Shanghai will ramp from ~16k in Mar-20 to likely over 30k vehicles in Jun-20, providing incremental deliveries of about 14k vehicles.
• Fremont Model Y will likely ramp from ~2k in Mar-20 to over 10k in Jun-20 despite the shutdown, providing incremental deliveries of about 8k vehicles.
• Taking the view that production resumes on May 4^th, the window for Jun-20 European deliveries will only be a few weeks. This tight window incentivizes Tesla to deliver the bulk of limited Fremont production domestically to prevent many vehicles from being on boats at the end of the quarter.
• During Mar-20, Tesla rebuilt inventory levels from ~17k to ~30k. If the company is able to decrease inventory levels by the end of June, it would provide a delivery tailwind.

Factory Shutdowns Have a Silver Lining

Assuming Fremont production resumes on May 4^th, the shutdown will have lasted 41 days. We expect positive commentary from Tesla on taking advantage of the shutdown to upgrade factories in Fremont, Nevada, and Buffalo. Tesla will likely upgrade Fremont production lines, expand Model Y capacity, and improve manufacturing efficiencies. Also, if Tesla is going to “refresh” the Model S and X interior anytime soon, the shutdown would be an ideal time to do so.

Demand and Preorder Commentary

Additionally, management observations related to Model Y orders (began shipping limited numbers in March) along with Cybertruck preorders (scheduled for late 2021) will be essential to gain an underlining view of the business. We believe, in five years, Model Y will account for just over half of Tesla deliveries, and Cybertruck will account for 15% of units

The Long-Term View

Tesla is winning because they have a product that is measurably better than both gas and electric competitors. Looking forward, things will get more difficult for the company along with all automakers in the June quarter.

We believe it will likely get progressively more difficult for traditional auto to catch up to Tesla, as demand is outpacing the broader industry. As the company scales to meet demand, Tesla’s price performance gap versus other car makers will widen. This is because other car markers are producing EVs at subscale, which creates a dilemma:

• If traditional auto releases a car with features and range at parity and sells the car at cost, it will be priced 10-25% higher than a comparable Tesla. This will soften demand and lead to further market share loss.
• If traditional auto subsidizes vehicle cost to gain market share they will lose money with limited margin cushion. The more they sell, the more money they lose. Taking it to the logical end, we believe car companies that have been around for 50 plus years will eventually (10 years from now) be forced to restructure or go out of business.

Disclaimer