Tesla (TSLA -2.04%) has been breaking the mold of what a traditional automaker looks like for years. However, it's becoming more apparent that Tesla is slowly drifting toward how its competitors operate, which takes away one of the advantages Tesla holds.
But it's not too late for Tesla to turn it around. This one chart shows what Tesla's current problem is but also pinpoints how the company could fix it. So let's look at this chart and see if Tesla is worth an investment.
Tesla's margins are being placed under the microscope
This infographic perfectly conveys what Tesla's revenue streams are and how it spends them.
Image source: The Motley Fool.
As you can see, nearly all of Tesla's income comes from automotive sales, which grew an incredible 49% in the second quarter year over year. While other business segments may be necessary to fund Tesla, they aren't central to the Tesla investment thesis. Still, there's a bit of a gap here since Tesla's production increased by an astounding 86% in Q2. Ideally, revenue should've closely followed production growth. So what's going on here?
Thanks to Tesla's price cuts, it is no longer generating the same amount of revenue per vehicle. This affects revenue and profit margins, a massive investor-focus point. This shouldn't be surprising to anyone who follows Tesla, as the company adjusted prices on a few vehicle models to remain competitive in the increasingly crowded electric vehicle (EV) space.
However, the problem isn't revenue or production growth, rather, it's Tesla's gross-profit growth. Gross profit only rose 7% in Q2 from the year ago quarter, which is problematic because it restricts revenue growth to trickle down to the bottom line. Once again, this was headlined by the 63% growth in automotive cost of revenue (part of total COGS), significantly outpacing revenue growth by 14 percentage points.
Still, if Tesla gets entangled in a pricing war, it could erode its key advantage over legacy automakers.
TSLA Gross Profit Margin data by YCharts.
While Tesla's gross margins would have to fall significantly to reach the levels of some competitors, it's a growing concern among some investors.
In all, higher costs caused Tesla's operating income to fall by 2.6% despite delivering 83% more vehicles. However, the electric automaker increased its net income by 15% thanks to increased interest income and other non-recurring transactions.
So with Tesla's business still growing its top line rapidly but struggling to get its bottom line to follow suit, what should investors do?
Tesla will likely reverse its price decreases in the future
One of the primary Tesla bear arguments has been its valuation. At 68 times earnings, Tesla is an incredibly expensive stock even if you forget that its primary product is a growing automobile business with a huge market. Tesla has a huge premium compared to legacy automakers that often trade in the single digits to less than 20 times earnings.
Still, the valuation considers that Tesla has a first-mover advantage in the electric vehicle space and market leadership in a technology that will change an aspect of everyday life. But is that worth such a premium? I think so.
Tesla has shown its willingness to adjust prices as the market demands, which it can do thanks to its margin cushion. Legacy automakers are more captive to the market as they don't have the same cushion, so Tesla can continue pulling this lever to capture more market share.
However, don't be surprised if Tesla raises prices once it sees more strength in the EV market. This action can likely be traced to what the Federal Reserve decides to do with interest rates, as it significantly affects the rate consumers can get on a car loan. A lower interest rate gives the consumer more buying power, and Tesla will likely adjust its pricing based on this fact.
As a result, I think this is a relatively short-term trend and will likely reverse itself in the next few years. While Tesla stock is expensive, I still think it is a must-own stock because it is well-positioned in one of the most significant technological shifts many generations have ever seen.
