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Why the Shanghai Gigafactory Marks a New Era for Tesla

By Pavan Gadiraju – Feb 16, 2020 at 10:00AM

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Despite falling car sales in China and signs of near-term pain for the industry, the new Shanghai Gigafactory is a bullish sign of things to come.

In a testimony to its engineering expertise and experience building electric vehicles (EVs), Tesla (TSLA 2.51%) needed just ten months to get its Shanghai Gigafactory up and running, and a few months more to deliver its first Model 3 vehicles from that facility.

Tesla CEO Elon Musk spent much of 2019 making headlines for various controversies, lending credence to critics' doubts regarding the company's manufacturing prowess and its ability to satiate growing demand for EVs worldwide. But Musk defied the naysayers in Oct. 2019 when the State Grid Corp. of China opened the first transmission line to bring power to the region's Gigafactory. It had taken Tesla a year to break ground on the project, complete construction, and then roll out its first batch of Model 3's.

With this feat, the company started 2020 off with a bang and sent a clear message to investors regarding its ability to stand out in an increasingly crowded EV market.

A red Tesla Model 3 electric vehicle sitting on an empty road

Image source: Tesla

Wait and watch Tesla steal the show

Before Tesla's Gigafactory venture in Shanghai, the traditional carmakers' approach in the region was conservative. The investment and regulatory hurdles required to establish a wholly-owned enterprise in China were significant, and none of them seemed willing to make the first move. Instead, the most common approach was the joint venture (JV) route with domestic companies.

Noteworthy among these JVs was the deal between Volkswagen and JAC Motors, just one of the European carmaker's multiple JVs with Chinese entities. The Volkswagen-JAC partnership was announced in June 2017, and it took almost two years for it to unveil its plans to construct an electric plant in Hefei with a planned investment of approximately $750 million. Meanwhile, Ford and Zotye Auto announced their own joint venture in 2017, but two years later, that effort seems to be going nowhere with stalled negotiations and little progress.

Musk's foresight in quickly opening a factory to manufacture EVs for the Chinese market should be seen as a coup within the industry given the challenges and extended timetables from competing manufacturers. The government is set to mandate increased EV production for automakers in the country, and Tesla is in a position of strength to capture a substantial portion of the Chinese market.

Short-term pain?

Despite this seemingly rosy backdrop, after decades of impressive growth, the Chinese car market is losing steam. It shrunk for the first time in 2018 after three decades of expansion, and car sales have declined year over year for 19 months straight as of Jan. 2020. Making bets on China's EV market looks increasingly risky as multiple domestic auto companies reported double-digit declines in EV sales last month, extending a trend that began in July 2019 after the Chinese government reduced the subsidies it offered for new EV purchases.

As a result, automakers like Tesla face the very real prospect of depressed demand this year. Even if the slump has not been as pronounced in the luxury segment of the market, investors must consider the warnings of a decreased appetite among wealthy Chinese consumers for premium EVs. But these challenges are still short term in nature. The Chinese government has shared goals for EVs to make up one-fifth of annual car sales by 2025, or approximately seven million vehicles. Investors should evaluate the opportunity presented by Tesla's Shanghai Gigafactory from this long-term perspective.

In December, the Shanghai Gigafactory was already producing more than 1,000 Model 3 vehicles every week with plans for run-rate production of 3,000 cars per week. Combined with a strong fourth-quarter earnings report and bullish predictions for the company's growth, Tesla stock is up over 90% year to date.

For years, investors have been asking themselves, "Will Musk's latest gamble pay off?" Well, just 12 years since releasing its first EV, Tesla is now the largest U.S. automaker by market cap. With no signs of slowing down, the market seems perfectly happy betting big on this growth stock.

Pavan Gadiraju 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.

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