Over the past several years, Tesla (TSLA +2.08%) has posted massive profit growth. As recently as 2019, the electric vehicle pioneer was unprofitable under generally accepted accounting principles (GAAP) and barely breaking even on an adjusted basis. However, Tesla's operating margin improved to 6.3% in 2020 and 12.1% in 2021, reaching nearly 15% in the second half of last year.
There's a simple reason why Tesla has suddenly leapt toward the top of the auto industry in terms of profitability: the company is selling huge numbers of vehicles built on a single platform at high prices. Yet this fact isn't widely acknowledged as the source of Tesla's improved fortunes. Let's take a look at what this means for Tesla moving forward.
NASDAQ: TSLA
Key Data Points
Production and revenue surge
Tesla delivered over 936,000 vehicles in 2021: up 155% from the 367,656 vehicles it delivered two years earlier. The Model 3 sedan and Model Y crossover, which are built on the same platform, accounted for 97% of Tesla's output last year. Deliveries of the Model S and Model X fell to 24,980 (from a peak of over 100,000 a few years ago), due to a long production shutdown.
While some analysts expected the mix shift away from the Model S and Model X to hurt profitability, that didn't transpire. A big reason is that Tesla's average selling price (ASP) held up quite well.
Excluding vehicles delivered under leases, Tesla's ASP exceeded $50,000 in 2021, down by about $6,000 from 2019, when the mix of pricey Model S and Model X sales was much higher. As a result, automotive sales (again excluding leases) reached $44.1 billion, up from $26.4 billion in 2020 and $19.4 billion in 2019.
A recipe for fat margins
Selling nearly 1 million vehicles in a year at an ASP of more than $50,000 is obviously good for margins. That's especially true because the Model 3 and Model Y are built on the same platform and share many components. This significantly reduces complexity (and costs).
Image source: Tesla.
This isn't specific to Tesla. Legacy automakers General Motors (GM 0.20%) and Ford Motor Company have high-volume businesses selling full-size trucks and SUVs (built on common platforms) at similarly high prices. For example, GM routinely sells over 1 million full-size trucks and SUVs annually in the U.S.
While neither company provides exact details, the GM and Ford full-size truck/SUV franchises appear to routinely generate operating margins in the 20% to 30% range, accounting for the bulk of both automakers' profits.
Indeed, in Q3 2020, when General Motors was operating its full-size truck and SUV plants at maximum capacity to rebuild inventory while not fully restoring production of some less-popular models, GM posted a 15% operating margin in North America. The main reason why its margins are typically lower is that the rest of its business is far less profitable.
What does it mean for Tesla?
Tesla's strong momentum will likely continue in 2022. The company has projected that it will grow sales at a roughly 50% compound annual growth rate for the foreseeable future. Unless supply constraints worsen dramatically, it should have no trouble hitting that growth rate this year. Tesla is quoting long wait times for many models, suggesting that demand continues to exceed supply.
Like most businesses, Tesla faces rising costs. But it has had no trouble raising prices to compensate. The cheapest Model 3 being sold on its website now has a base price of $44,990. The Model Y starts at nearly $60,000, and its price tops out around $80,000 (including the "full self-driving" package). Moreover, only the more expensive models are available for near-term deliveries, with cheaper versions having estimated delivery dates in the fourth quarter. This should support further margin expansion in 2022.
Image source: Tesla.
Looking further ahead, the outlook is cloudier. For now, supply constraints are preventing the auto industry from meeting demand, causing prices to skyrocket. The average transaction price for U.S. auto sales recently surpassed $45,000. In this context, it would be no surprise if Tesla can push its ASP back toward $60,000 this year while growing combined deliveries of the Model 3 and Model Y well beyond 1 million.
As supply constraints ease, auto prices will retreat. Other brands will look to break Tesla's stranglehold on the EV market by offering reasonably capable alternatives at much lower prices. (For example, GM is touting a Chevy Equinox EV starting around $30,000 that will arrive in the fall of 2023.)
To continue growing unit sales rapidly, Tesla will need to expand its vehicle lineup, including the addition of a cheaper entry-level vehicle. But offering a broader choice of models will add costs and complexity, while Tesla's ASP will decline due to competitive forces.
Tesla is still poised for strong earnings growth as it gains scale in the years ahead. However, even after its recent pullback, Tesla stock trades for 77 times forward earnings. Living up to that valuation will be tough, given the margin headwinds it will inevitably face as it broadens its product lineup over time.
