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KeyBanc Cuts Estimates for Tesla Model 3: What You Need to Know

By Rich Smith - Dec 28, 2017 at 1:50PM

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Tesla could sell only one Model 3 car for every three that Wall Street was expecting.

Every day, Wall Street analysts upgrade some stocks, downgrade others, and "initiate coverage" on a few more. But do these analysts even know what they're talking about? Today, we're taking one high-profile Wall Street pick and putting it under the microscope...

December has been a month of ups and downs for Tesla (TSLA -0.57%) stock. Entering the month at roughly $305 a share, Tesla stock moved up briskly, and seemed in range of reaching $350 two weeks later. The middle of December proved a turning point for Tesla, however, and shares have shed nearly 10% of their value since Dec. 15.

Why? Short attacks are one answer. Last week, noted short-seller Jim Chanos (of Enron fame) warned that Tesla stock "is one of the bad ones," and will disappoint investors in 2018. Yesterday, a more objective source added fuel to the fire, when investment banker KeyBanc (which rates Tesla a hold) announced a big rollback on its estimates for Tesla sales.

Here are three things you need to know about that.

Tesla Model 3

For Tesla investors, it's all about the Model 3. Image source: Tesla.

1. The trouble with Tesla

What is it about Tesla that has KeyBanc worried -- but not quite worried enough to downgrade Tesla stock to sell? Basically, it's the Model 3.

As recently as July, Tesla CEO Elon Musk was promising investors that his company would produce 100 of Tesla's new mass-market Model 3 electric sedans in August, quintuple that output in September, and hit a monthly production rate of 20,000 units by the end of this year.

Last quarter, reality bit when Musk was forced to admit that the company had delivered just 220 Model 3 sedans through the end of September. Then, in November, Tesla pushed back its 5,000-Model 3s-per-week promise to the end of Q1 2018, delaying that production goal by three months.

2. KeyBanc chimes in

But here's the thing: Up until now, analysts seem to have been assuming that Musk was lowballing the market when he said he'd hit 5,000 units per month in Model 3 production only in "late" Q1 2018. KeyBanc in particular appears to have expected the company would produce 15,000 Model 3s in Q4 2017.

Now though, KeyBanc is ratcheting back that target, and warning that "we expect 4Q Model 3 deliveries to come in below expectations" -- the implication being not just its own expectations, but everybody else's as well. As explained in a write-up on (requires subscription), KeyBanc spent last week interviewing workers at 18 Tesla stores around the United States. What it learned from these conversations is that currently, Tesla is on track to sell only about 5,000 Model 3s this quarter -- barely one-third of the 15,000 units the analyst previously anticipated.

3. Low margins, mo' problems

And that's not the only trouble at Tesla. In addition to missing analysts' sales estimate for the Model 3 in Q4, KeyBanc worries that Tesla may not be earning enough profit on the Model 3s it does sell to break even.

As recently as last quarter, Tesla had been telling investors that it expected to achieve "breakeven" gross profit margin on Model 3 sales by the end of this year, and then ramp gross profit margins up toward 25% in 2018. Lower Model 3 sales, however, will deny Tesla the benefit of production efficiencies from operating at scale, imperiling this goal. Combined with Tesla's admission last quarter that it was already suffering lower-than-expected profit margins on its sales of Model S sedans and Model X SUVs, it's starting to look like Tesla's profit margins will take another big hit in Q4 -- driving larger-than-expected losses.

What it all means for investors

Between delayed profitability for the Model 3 line, and "importance of S/X sales, which are not growing, to gross profit" for the company overall, KeyBanc now warns that Tesla's "gross margin will not ramp in line with expectations" in 2018 and indeed, probably won't resume growing before mid-2018.

(Word to the wise: Despite growing sales, Tesla's gross profit margins have actually been declining since about 2014, according to data from S&P Global Market Intelligence.)

What does this mean for investors? In the short term, probably not much. S&P Global figures show that despite overoptimism about the Model 3, few to no analysts were expecting Tesla to turn profitable next year in any case. A bit more negativity in the company's earnings in 2018, therefore, probably won't be seen as a deal breaker for Elon Musk's fan club.

2019, however, could be another story. Analysts have been telling investors to expect Tesla to earn its first GAAP profit in 2019. If gross margins don't even begin inching up until late in 2018, though, that doesn't give Tesla a lot of time.

The more this realization grows in the minds of Tesla investors, the greater the risk for Tesla stock.

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