Tesla's 25% Profit Margin Is Basically Already in the Bag

Shorting Tesla Motors (NASDAQ: TSLA  ) ?

I hate to break it to you, but Tesla's aspiration for a 25% gross profit margin, excluding ZEVs, is basically a guarantee. In fact, Tesla is already almost there.

So if your bearish argument includes a bet against Tesla's ability to get its auto business to a 25% gross profit margin by Q4 this year, you might want to apply some whiteout.

The truth about Tesla's margins
"Twenty-five percent? That's a gamble -- Tesla reported a meager 13% profit margin on its auto business in the company's second quarter," uninformed Tesla bears complain.

Let's take this poor argument to the chalkboard and expose it for what it is.

Sure, Tesla's GAAP gross profit margins of 22% provide an unrealistic picture of the company's operational profitability. Sales of ZEVS inflate undoubtedly provide a nice boost. But by no means is the company attempting to cover this up. Four times in the company's second-quarter letter to shareholders management emphasized results excluding ZEVS -- none of which were in fine print.

With that said, here is the company's gross profit margin progress so far in its automotive operations:

Source: Data retrieved from quarterly filings and earnings calls from the first and second quarters of 2013. The gross profit margin reported in the chart refers exclusively to the company's automotive segment, using non-GAAP figures excluding zero-emission vehicle credits.

What about Tesla's path to gross profit margins of 25%? Let's break it down. Ready for the truth?

In the second-quarter earnings call, Musk emphasized that management "has visibility into these numbers ... ahead of time." Even more, he explained that in order for the things that affect gross margin to deliver 25% results on paper, they will need to be in place "about a month before the fourth quarter ... So, you know, essentially things need to be in place next month. And so that's not very far away. So that's why we feel confident enough to reaffirm the 25% gross margin guidance ..."

Fremont factory. Source: Tesla Motors.

In other words, beginning Sept. 1, Tesla is likely already at a 25% gross profit margin, excluding ZEVs. When the company reported second-quarter earnings on Aug. 7, it was already almost halfway through its third quarter. To look just three weeks into the future and be able to reaffirm guidance for that gross margin target is not a gamble.

But, of course, 25% isn't the end goal: Musk has mentioned aspirations to achieve margins that rival those of Porsche.

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Read/Post Comments (7) | Recommend This Article (5)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On September 05, 2013, at 10:22 AM, nonqual wrote:

    GAAP history of Ss sold and S GM:

    3Q12..........148......... -27.1%

    4Q12......2,490............. -8.2%

    1Q13......4,900............... 1.8%

    2Q13......5,150............... 8.6%

    Is the promised 25% GM using GAAP or Teslanian non-GAAP reporting? In the 4Q12 reporting, the 25% was going to be achieved without regulatory credits; stealthily, that has morphed into ZEV credits. Tesla has earned ~$18 million/quarter from GHG/CAFE credits.

    On a GAAP basis Tesla has lost ~$19 million in the first half of 2013. Without the GHG/CAFE credits the loss would be three times higher. Without GHG/CAFE/ZEV credits the 2013 year-to date loss would be NINE times higher.

    Without regulatory credits, Tesla cannot manufacture vehicles profitably enough to cover R&D and S&GA, let alone fund future cars and expand SCs.

  • Report this Comment On September 05, 2013, at 10:34 AM, Mega wrote:

    "Twenty-five percent? That's a gamble -- Tesla reported a meager 13% profit margin on its auto business in the company's second quarter," uninformed Tesla bears complain.

    Nice job attributing your strawman argument to "uninformed bears". 99% of the bear case is about valuation, not margins.

  • Report this Comment On September 05, 2013, at 10:44 AM, TMFDanielSparks wrote:

    "other regulatory credits" (not ZEVs) accounted for 3.2% of revenue during the company's second quarter. And that will continue to shrink: http://www.fool.com/investing/general/2013/08/09/debunking-t...

    If Tesla wasn't making capital investments it could cover expenses and report GAAP gains going forward. But I sure hope they don't do that. They need to make CapEx investments in Superchargers, Service Centers, and new factories to set up the infrastructure for the affordable car.

  • Report this Comment On September 05, 2013, at 10:45 AM, TMFDanielSparks wrote:

    @MegaShort,

    You would be referring to the informed bears :). I have respect for them and they bring up very good points. That's why I specified that I was referring to the "uninformed" ones.

  • Report this Comment On September 05, 2013, at 3:23 PM, damilkman wrote:

    I found the last part of the article interesting. The goal is to achieve margins that rival Porche. Porche has high margins because they have a product that people are willing to pay more for despite equivalents produced by rivals. Porche makes high end sports cars. Rich people buy sports cars and can afford to pay more for what they really want.

    The stated goal of Tesla is produce everyman cars. The everyman is far more biased towards price. If Tesla and a competetor make equivalent products, Tesla has to be able to produce for a lot less or convince everyman that their product is worth the increased cost.

    So the question to the author is Tesla going to sell cars and make money because they can do it cheaper or are they going to have something that will make everyone be willing to buy it for 20% more. I do not see any technology that others cannot implement. Heck Tesla is working with some of the would be competetors.

  • Report this Comment On September 05, 2013, at 3:39 PM, TMFDanielSparks wrote:

    @damilkman,

    The company's mission is clear. It wants to make affordable fully electric cars for the masses. This must mean musk believes the economies the company will be able to achieve will rival those of traditional vehicles. I've wrote some on why Tesla maybe be able to achieve greater economies here: http://www.fool.com/investing/general/2013/08/31/3-reasons-w...

    Thanks for your comment.

  • Report this Comment On September 07, 2013, at 8:36 PM, highgrowthcarson wrote:

    Main difference between gaap and non-gaap is the hyper confusion over the pseudo-lease deals where Tesla guarantees the residual value of cars that are "leased". This is done (I believe) in order that buyers can realize any and all tax credits. The consequences are that Tesla realizes the cash but has a partially offsetting liability for gaap accounting. Most believe that this liability is zero in actuality.

    You can look at John Paterson's articles on Seeking Alpha -- and the, in my opinion, considerably better informed commentary to the latest article -- for a long and sometimes heated discussion on this subject.

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