Electric-car maker Tesla Motors (NASDAQ:TSLA) reported third-quarter earnings on Tuesday. The market wasn't very impressed, sending the stock down more than 10% on Wednesday morning. There was no particular bad news in the Tesla report, so the market's poor reaction can probably be traced to high expectations coming in.
But the real takeaway from Tesla's earnings report and conference call was that the company is gearing up for an extended period of massive growth. Demand for Tesla's Model S sedan remains overwhelming, despite a limited distribution network and no advertising. The company expects a similar level of demand for its upcoming Model X crossover.
Thus, whereas traditional automakers have to focus on design improvements and marketing to boost demand while also ensuring supply is available, Tesla's task is simpler. If it can build more vehicles, it will sell more vehicles. Tesla is rapidly expanding production capacity to meet this demand, and sales could easily quadruple between now and 2016.
Another solid quarter
In the third quarter, Tesla managed to deliver slightly more than 5,500 Model S sedans to customers. That fell short of some analysts' expectations for 5,700-5,750 deliveries during the quarter. But Tesla also announced that it is currently producing 550 cars per week (which would equate to more than 7,000 per quarter).
The number of deliveries will continue to lag production for a while because Tesla is starting to deliver cars to international markets. This means more time in transit between production and final delivery. Still, Q3 deliveries rose sequentially from around 5,150 in Q2. Furthermore, the production rate increased by more than 10% during the quarter, as Tesla was producing just under 500 vehicles per week at the end of Q2.
Gross margin also continued its trajectory of strong improvement. Automotive gross margin, excluding zero-emission vehicle credits, grew to 21% last quarter, up from 14% in Q2, which puts it on track to reach Tesla's near-term target of 25% by the end of the year. Non-GAAP EPS came in at $0.12, just ahead of the average estimate of $0.11.
Groundwork for growth
Tesla's current production potential and earnings power are far from justifying the company's stock price. Instead, Tesla's medium- to long-term outlook is more important for understanding what the stock is really worth. Here, the news is all good, suggesting that Tesla will maintain its stratospheric growth rate for the next few years.
In the shareholder letter, Tesla revealed that it has revised its agreement with Panasonic, its main battery supplier. Panasonic will now provide 1.8 billion battery cells over four years, which is more than triple the quantity of the previous agreement. Tesla also told investors to look at that figure as a floor more than a ceiling.
Furthermore, at several points during the earnings call, CEO Elon Musk talked about building a battery "giga factory" in the U.S. This is very important because Musk has stated repeatedly that battery cells are the main constraint for Tesla. There is plenty of demand for the Model S to ramp up production further, and other production constraints are less worrisome. (Also, Tesla plans to introduce a high-volume car at a $35,000 price point around 2017, and it needs to ensure that battery production capacity will be sufficient to meet the likely demand.)
Ready for takeoff
While Tesla is on pace to deliver at least 21,500 Model S sedans this year, it expects to reach a production rate of at least 40,000 Model S units annually by the end of 2014. Tesla estimates current demand at around 20,000 units per year in North America, and 10,000 units per year in Europe, and expects to get the balance of sales from Asia. This demand has materialized even though Tesla does not advertise.
Moreover, Tesla's next new model -- the Model X crossover -- is supposed to go into production in late 2014 and reach volume production in 2015. On the conference call, CEO Elon Musk said that the company is making plans based on the assumption that demand for the Model X will be similar to Model S demand. Given the strong global demand for SUVs recently, that's likely to be the case.
As a result, combined production of the Model S and the Model X could reach 80,000 units in 2016, assuming that production tops out at 40,000 units per model. Building in room for some growth -- which seems quite likely based on Tesla's current trajectory -- Tesla could easily sell 100,000 vehicles in 2016, which is more than quadruple the current rate!
Tesla is a momentum stock that comes with plenty of risk for investors. Even after its recent pullback, I am still wary of investing in Tesla, because a lot of things have to go right for the company to meet its full potential.
That said, Tesla has generated enormous demand for its luxury vehicles without doing much to promote them. As a result, Tesla has a clear path to selling 100,000 luxury electric vehicles annually by 2016, which will make it solidly profitable. The affordable price segment is another huge opportunity thereafter. As a result, if the Tesla bubble continues to deflate, long-term growth investors may get a nice buying opportunity.