Please ensure Javascript is enabled for purposes of website accessibility

Tesla Earnings: Will the Electric-Car Maker Report a Profit?

By Daniel Sparks - Oct 10, 2019 at 10:25AM

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

Will higher Model 3 deliveries help or hurt profitability?

Electric-car company Tesla (TSLA -2.98%) has seen impressive growth in vehicle sales recently. Trailing-12-month deliveries are up 88%, fueled by surging production and deliveries of its lower-cost Model 3. But questions remain about how viable the company's business is as the automaker scales. While its losses have been narrowing and its free cash flow has turned positive, there's still uncertainty about whether this momentum can continue.

Questions linger: With Tesla's growth driven entirely by its lowest-priced vehicle, could the automaker's gross profit margin contract and weigh on profitability? Will spending on more production capacity and new vehicle development hurt free cash flow?

The company's third quarter will provide a timely window into whether or not Tesla's business is showing signs of scalability. When the automaker reports its third-quarter results on Oct. 23, here are two key areas investors will want to look at in order to assess Tesla's business.

A red Tesla Model 3.

Tesla's Model 3. Image source: Tesla.

Automotive gross margin

One of the key bull cases for Tesla stock is that the company will eventually be able to flex its premium brand and consistently command a 25% gross profit margin on its automotive business. Indeed, the company has said it is targeting a non-GAAP (adjusted) gross profit margin of 25% for combined sales of its Model S, Model X, and Model 3. This target is impressive because it's about the same gross profit margin that Tesla had on its higher-priced Model S and X sales before Model 3 production and deliveries ramped up. Achieving and sustaining this target even as Model 3 deliveries grow to account for a larger portion of total sales, therefore, would imply that Model 3 production is seeing improved efficiency.

Unfortunately, this key metric has been moving in the wrong direction recently, suggesting Tesla is having trouble achieving the economies of scale it believed it could. After its automotive gross margin peaked in the third quarter of 2018 at 25.8%, it decreased to 24.3% in Q4, 20.2% in Q1,  and 18.9% in Q2. This means that Tesla's gross margin is moving in the wrong direction as Model 3 deliveries increase.

For this reason, investors should tune in closely to this metric when the automaker reports its third-quarter results. Tesla already announced it delivered a record 97,000 vehicles during the quarter, with nearly 80,000 of these vehicles being Model 3 -- more than any other quarter. Were these increased Model 3 deliveries during the period enough for economies of scale to start materializing, or did the company's automotive gross margin contract once again?

Net income

If Tesla's automotive gross profit margin moves in the wrong direction, the automaker may have trouble meeting its guidance. At the time of the company's second-quarter update, management guided to be profitable in Q3. But the Street seems to have doubts about this target. On average, analysts expect Tesla to report a non-GAAP loss per share of $0.42 in Q3.

If Model 3 gross margin did hit a tipping point of improved efficiency during the quarter, Tesla could surprise investors and report a profit. But given the company's history of losses, there are no guarantees.

Daniel Sparks has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Tesla. The Motley Fool has a disclosure policy.

Invest Smarter with The Motley Fool

Join Over 1 Million Premium Members Receiving…

  • New Stock Picks Each Month
  • Detailed Analysis of Companies
  • Model Portfolios
  • Live Streaming During Market Hours
  • And Much More
Get Started Now

Stocks Mentioned

Tesla, Inc. Stock Quote
Tesla, Inc.
$881.51 (-2.98%) $-27.10

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

Related Articles

Motley Fool Returns

Motley Fool Stock Advisor

Market-beating stocks from our award-winning analyst team.

Stock Advisor Returns
S&P 500 Returns

Calculated by average return of all stock recommendations since inception of the Stock Advisor service in February of 2002. Returns as of 08/19/2022.

Discounted offers are only available to new members. Stock Advisor list price is $199 per year.

Premium Investing Services

Invest better with The Motley Fool. Get stock recommendations, portfolio guidance, and more from The Motley Fool's premium services.