In an effort to stimulate purchases and keep demand afloat amid rising interest rates, Tesla (TSLA 0.44%) has implemented a series of price cuts across some of its most popular vehicles. Ranging from 15% to 18%, these lowered prices now appear on Tesla's bottom line as margins narrow.
As evidenced in the automaker's most recent Q2 earnings report, gross profit margins are down from their peak in Q1 2022 and currently hover around 18%. The shrinking margins have been a serious cause for concern among investors, yet this worry is likely misconstrued. Tesla's decision to cut prices is part of its grander vision for the future and makes it a valuable long-term option for investors.
Strengthening its competitive edge
In 2017, electric vehicles (EVs) made up just 1% of new car sales. By 2022, this number grew to 13%.
As demand for EVs picked up, what was once an industry with just a few primary manufacturers now has a multitude of new start-ups and legacy automakers trying to enter the market. Put simply, Tesla's competition has become stiffer.
However, turning a profit in the auto industry is no easy task. And generating net income from EVs is even more difficult. In recognition of this reality, Tesla's price reductions pressure other manufacturers' bottom lines while they operate on much tighter margins.
TSLA Gross Profit Margin (Quarterly) data by YCharts
Take Ford, for example. The company recently announced a projected $4.5 billion loss in its EV division. Rivian, a pure EV maker like Tesla, isn't faring much better as it reported an average loss per vehicle of $32,595.
Although Tesla's recent price cuts may have a short-term impact on its margins, the company is better equipped financially to handle this situation, compared to its competitors. Even with gross profit margins slipping to 18%, Tesla still ranks near the top of the EV industry.
Furthermore, when considering Tesla still has more than $23 billion in cash and equivalents with virtually no burdensome debt, price cuts will likely place more pressure on its competitors.
TSLA Financial Debt to Equity (Quarterly) data by YCharts.
More cars mean improved autonomous driving
Historically, automakers tend to scale back production when economic turbulence hits to maximize profits for every unit sold. But Tesla isn't your traditional automaker. The company recently set new records in production and deliveries, and even though margins are down, it notched a new record in revenue at nearly $25 billion.
The dynamic between record production, deliveries, and revenue amid price cuts is where Tesla truly begins to shine and its long-term vision comes into focus. By getting more vehicles on the road, Tesla becomes closer to achieving fully autonomous driving, which will not only revolutionize commutes for drivers worldwide, but also transform Tesla's revenue and profitability.
With the recent release of its v12 Full Self Driving (FSD) software, the EV maker claims it has developed the infrastructure to train artificial intelligence (AI) to learn how to drive through the use of neural nets. Before v12, Tesla programmers had to preconfigure code so vehicles would respond appropriately in certain situations. But with the help of AI, management believes vehicles now learn how to drive by analyzing video, effectively removing the need for programmers.
The software still needs considerable refinement to account for the inherent randomness that occurs when driving. With v12, however, the only obstacle separating Tesla from obtaining higher levels of autonomy is its ability to gather more video data.
Image source: Getty Images.
Price cuts aren't only a financial strategy but part of the company's pursuit of reaching Level 4 or Level 5 autonomy. At that point, drivers no longer need to monitor the vehicle. If price cuts stimulate demand as it hopes, Tesla can train AI models more efficiently with data from new cars hitting streets.
The ultimate goal of achieving higher levels of autonomy is to create a robotaxi business that could transform Tesla's income and profitability. CEO Elon Musk believes there's "quasi-infinite demand" for such a product, and analysts agree. A recent simulation by Ark Invest hypothesized that the development of a robotaxi fleet could catapult Tesla's revenue by 700% by 2027 and has the potential to make up almost half of its future total revenue.
The bigger picture
Undoubtedly, less-than-ideal economic conditions are making their presence felt in Tesla's operations. However, the company's strategic vision for long-term dominance remains as intact as before rising interest rates and inflation.
While Wall Street focuses on short-term challenges related to tightening margins, now could be an advantageous opportunity to grab Tesla shares at a discount, relative to its long-term potential. Tesla's resilient and robust financial strength will enable it to weather economic turbulence, a luxury almost none of its competitors can afford. Add in the prospects of looming autonomous driving and a highly lucrative robotaxi business, and Tesla could lead portfolios for years to come.
