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Tesla’s Down but Not Out

Key Takeaways

Tesla has had a horrible four months, highlighted by shares being down about 65%. While several factors played into the stock’s free fall, I believe the biggest reasons were expectations for slowing demand and its negative impact on profits. The phrase down but not out is a boxing reference, where a fighter has been knocked down but is not yet knocked out. For Tesla, I believe 2023 will be a knockdown, a reset year when it comes to growth and profits, and 2024 will mark a return to stability. I counted four changes in the near term, three of which fall into the negative category. One thing has not changed, my belief in the company’s long-term potential.

Change #1:  Tesla’s growth is declining

2022 was a challenging year for auto sales in the US, with total deliveries down 7% from 2021. While Tesla’s delivery growth of 40% in 2022 outpaced the US average, sales of Tesla slowed in the final three months of the year. There were 405k deliveries in the December quarter, up 31% y/y, which missed consensus estimates by about 5%. That 31% growth is down from 68% in March of 2022 and 43% in September of 2022. Adding further concern to the growth numbers, Tesla discounted by an average of 7% for about half of the December quarter, suggesting that if not for the lower prices, deliveries would have been even lower. Something does not feel right.

I believe the biggest reason for slowing growth is cars are expensive and often purchased through financing. As interest rates quickly increased in the back half of 2022, demand for cars declined. Rising interest rates are a gale-force headwind to demand so strong that even sales of EVs feel the pain.

A second factor to the slowing growth may have been a pull forward of near-term demand. This one is hard to quantify, but given some of the Tesla buying frenzy driven by early adopters over the past two years, demand pull forward may be playing a factor in current growth rates.

Change #2: The discounting continues

In a surprise move, Tesla recently announced it will be discounting the price of Tesla sold in China by an average of 13%. This comes after a roughly 7% discount in the December quarter. Discounting means demand has stalled and the company wants to keep production high to gain share which will come at the cost of future profits.

Change #3: Margins are going lower

The margin question is the concerning one. More discounting means higher deliveries and lower profits. The quick math suggests a 13% decline in China pricing would reduce Tesla’s overall profits by 15%. If the discounting expands to other countries, then the negative impact on earnings will expand. My guess is discounting expansion in the US. Investors should anticipate a 25% decline in earnings for the March quarter as a result.

Is Tesla a tech or car company?

Negative changes to earnings would also have a negative impact on TSLA’s multiple. I believe Tesla is a tech company, as evidenced by its margins being about 5x greater than traditional car makers. If margins decline in March, investors will increasingly question if Tesla should be valued as a tech company or just a car company. In the midst of uncertainty, investors will sell first, ask questions later.

Even as shares have declined by 65% over the past four months, Tesla’s market cap still stands at $370B, ahead of Toyota at $224B (USD) and Ford and GM at just under $50B. Based on the current market cap, the camp of “Tesla is a car company” can still stand on the case that there is further downside to TSLA shares.

Change #4: Tesla will talk more about Model 2/Robotaxi

In an effort to calm investors’ nerves, Tesla announced that it will be hosting an investor day on March 1st. One topic of discussion will be the generation 3 platform, which is the code name for what I have called Model 2 and most have called the robotaxi initiative. They will likely stop short of announcing the timing of a new car given to avoid a negative near-term impact on demand, so the discussion may be viewed by investors as classic Tesla hype.

What has not changed: My view on the long term

I view the recent delivery misses and expected gross margin shortfall as a year-long headwind.  I’m still a believer that Tesla will be a winner given over the past three months I didn’t see a competitor (outside of China) gain traction with notable sales or with a new factory that is comparable to Tesla. Nor did I see traditional OEMs advance autonomy at the pace of Tesla.

Late this year Cybertruck will begin production, ramping into 2024. That vehicle alone has the potential to restart overall Tesla delivery growth next year.

Most importantly, I believe the big picture is unchanged: the market for EVs is massive. About 5% of car sales today are EVs and that’s rising to 100% in the next twenty years. Traditional car makers are still in trouble as they try to retrofit EV production atop legacy gas vehicle production. Tesla still offers the best value in an EV and no other car maker has optionality around storage, solar, and robotics.


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