Tesla Motors (NASDAQ:TSLA) has an ambitious target for its automotive segment's gross profit margins: 25% by the fourth quarter of this year. Is the goal realistic? Though we'll find out for sure just how close Tesla is to its goal when the company posts third-quarter results today after market close, there's good reason to believe the electric-car maker is getting very close.
Behind the numbers
It's important to keep in mind that whenever Tesla is referring to its goal to reach a gross profit margin of 25% it is talking about its core automotive business, excluding zero emission vehicle, or ZEV, credits (which accounted for approximately 9.3% of Tesla's non-GAAP second-quarter revenue). Tesla doesn't include the benefit of ZEV credits in its target for a 25% gross profit margin because ZEV credits are not sustainable. This makes a 25% gross profit margin all the more impressive.
Notably, Tesla does include "other regulatory credits" in its projection for a 25% gross profit margin, though they only accounted for a paltry 3.2% of second-quarter revenues.
The path to 25%
So can Tesla actually reach a gross profit margin of 25% by the fourth quarter of this year? In Q2, Tesla's automotive business had only reached a gross profit margin of 13%. Is a target of 25% a gamble? Not at all. In fact, it's probably almost certain.
In Tesla's second-quarter conference call CEO Elon Musk explained why Tesla is confident in its ambitious target. We have "visibility into these numbers... ahead of time," he said. He went on that in order for its automotive business to have a 25% gross profit margin in Q4, the factors that affect gross profit margin will have to be in place "about a month before the fourth quarter... So, you know, essentially things need to be in place next month. And so that's not very far away. So that's why we feel confident enough to reaffirm the 25% gross margin guidance... ."
Given Musk's comments, Tesla is likely well on its way to its aggressive gross profit target.
Where should gross margin be in Q3?
A solid estimate for Tesla's Q3 automotive gross profit margin would be right smack in the middle of the 13% automotive gross profit it reported in Q2 and the 25% it projects to reach by Q4. So, 19% is a reasonable expectation for Q3.
Tesla's automotive gross profit margin will almost certainly hit all-time highs when the company reports results today, but to what extent? Can Tesla post an automotive gross profit margin of 19% or greater? To find out, check out Tesla's third-quarter letter to shareholders when the numbers are released after market close and tune into the Tesla's third-quarter conference call.
For more on what metrics to watch when Tesla unveils its third-quarter numbers today, check out this earnings preview.
Fool contributor Daniel Sparks has no position in any stocks mentioned. The Motley Fool recommends and owns shares of Tesla Motors. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.