Why Tesla’s Q3 Profit Margin Isn't What It Seems

Electric-car maker Tesla Motors (NASDAQ: TSLA  ) is growing and changing so quickly, its quarterly numbers are already outdated before the quarter ends! For one thing, a look under Tesla's hood reveals that the electric-car maker's quarterly gross profit margins are actually bigger than you think.

On Nov. 5, Tesla reported its third-quarter results. Adjusted revenue came in at $593 million, excluding zero emission vehicle, or ZEV, credits. Of this amount, adjusted gross profit was $135 million, for a gross margin of 22%. That's up from 14% in the previous quarter, and Tesla wants to boost it to 25% for the upcoming fourth quarter. This is an excellent start -- but the news gets even better.

Previous inventory
Whenever a company begins a quarter, it tends to start off with a batch of inventory from the previous quarter, along with that previous quarter's costs. This has very little meaning for most companies with little cost variance between quarters, such as General Motors (NYSE: GM  ) or Ford (NYSE: F  ) . However, for a company such as Tesla, which has seen massive changes in profit margins over the last few quarters, inventory means everything.

At the end of the second quarter, Tesla had $255 million in inventory, including $78 million in "finished goods" -- completed cars with few or no additional expenses beyond their delivery.

For accounting purposes, Tesla assumes that any vehicle inventory left over from the previous quarter would be first out the door in the new quarter. This means of the $593 million in sales, $78 million of it came from cars fully produced in the second quarter at 14% margins. $11 million of the $125 million third-quarter gross profit actually came from the sale of vehicles in the third quarter, which were physically produced in the second quarter.

New vehicle production and completion in the third quarter accounted for $515 million in sales, with $114 million in gross profit. This comes out to more than a 22% gross profit margin for cars actually produced in the third quarter, compared to the 21% reported.

Tesla guided for a 9% increase in vehicle deliveries compared to the third quarter. If you assume this translates into a 9% increase in adjusted sales (excluding ZEV credits), then you should expect $646 million in sales for the fourth quarter. You should also expect $162 million in gross profit based on the targeted 25% margins.

Tesla began the fourth quarter with $102 million in finished-goods inventory. At last quarter's 21% gross margin, this means around $21 million of the $162 million in expected gross profit will come from previously produced vehicles.

This also means that you should expect $141 million in gross profit on $544 million in sales from vehicles actually produced in the fourth quarter -- which comes out to a 26% margin.

A 26% profit margin compared to 25% may not sound like much of an increase. However, as the top line continues to accelerate, that 1% will make all the difference in the bottom line. This is especially true in the world of automobiles which have a reputation for bad margins and low multiple valuations.

Take General Motors and Ford as examples. For 2013, analysts expect General Motors to make 3% bottom line profit on sales. This means for every $1.00 in sales, it only sees three pennies in profit.  A 1% profit margin increase would mean everything to General Motors.

For Ford, it's a similar situation. Ford is looking at 4.5% to 5% bottom line margins for both 2013 and 2014 based on analyst estimates. While General Motors' percentage is much better than Ford, it's still less than five pennies on the dollar in profit.

Critics of Tesla often compare it to General Motors and Ford. The further Tesla can differentiate itself from the two American automakers from a profitability standpoint, the higher it can ultimately justify larger multiples (such as P/E) in its valuation.

Final foolish thoughts
If Tesla hits its 25% margin target in the fourth quarter, expect an even further improvement in margins the following quarter, even with no change in its production efficiency. Look at each 10-Q and 10-K, under the notes that break down what the inventory consists of. Pay close attention to the "finished goods" component each quarter, since it will tell you how much the previous quarter's margins may influence the new quarter.

Armed with this information, you will have an edge over Wall Street that few others seem to be talking about in regards to Tesla's earnings.  If Tesla's currently calculated margins grow substantially larger than the reported numbers, the company may become a investing opportunity during periods of chaos.


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

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 November 15, 2013, at 10:19 AM, gjsuhr wrote:

    A couple points, if GM had a 1% bottom line margin increase, going from 3% to 4%, that would be huge....that's a 33% increase. For Tesla the difference between 25% and 26% gross profit is only a 4% increase in gross profits. Those would be great margins - sure - and if Tesla made a lot of cars they would make a lot of money....but they don't. They may some day...but they don't today.

    Second..and this is something I really don't know about but struck me as curious. if Tesla has $78 million of finished inventory sitting around, that translates to roughly 1,000 cars or nearly 3 weeks worth of production. I can understand a slower selling vehicle waiting for delivery - I believe normal manufacturers shoot for 8 weeks of inventory as an adequate supply for dealers - but if my cars are built to order from a waiting list, why would I have any sitting around undelivered?

  • Report this Comment On November 15, 2013, at 10:24 AM, nickeyfriedman wrote:

    One word: Europe.

  • Report this Comment On November 15, 2013, at 11:05 AM, trils0n wrote:

    They're not sitting around undelivered. They are on a boat to Europe.

  • Report this Comment On November 15, 2013, at 11:14 AM, Sudre wrote:

    I love the article from my TSLA view but let's not hype things up to much and get people selling off again after Q4.

    I am leaving my expectations at 25% for Q4 only and the 1000 cars on their way to Europe are lower so the total overall might only be 24.xx% for the quarter.

    It will just be a bonus if they do better.

  • Report this Comment On November 15, 2013, at 2:42 PM, jstack6 wrote:

    Nicky , You didn't even mention the best part about Tesla. They are reducing tons of pollution and about $1 Billion a day in imported OIL.

    Imagine what the economy will look like as that $1 Billion a day gets spent here in the USA. Tesla is even exporting vehicles instead of importing. As they get the Gen III ready it will continue to change the world, an EV World.

    Imagine how much better the environment will be as the pollution is reduced. No more LA smog or Phoenix haze! That is priceless.

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