Electric-car maker Tesla Motors (TSLA -1.11%) is growing and changing so quickly, its quarterly numbers are already outdated before the quarter ends! For one thing, a look under Tesla's hood reveals that the electric-car maker's quarterly gross profit margins are actually bigger than you think.
On Nov. 5, Tesla reported its third-quarter results. Adjusted revenue came in at $593 million, excluding zero emission vehicle, or ZEV, credits. Of this amount, adjusted gross profit was $135 million, for a gross margin of 22%. That's up from 14% in the previous quarter, and Tesla wants to boost it to 25% for the upcoming fourth quarter. This is an excellent start -- but the news gets even better.
Previous inventory
Whenever a company begins a quarter, it tends to start off with a batch of inventory from the previous quarter, along with that previous quarter's costs. This has very little meaning for most companies with little cost variance between quarters, such as General Motors (GM 0.48%) or Ford (F -1.92%). However, for a company such as Tesla, which has seen massive changes in profit margins over the last few quarters, inventory means everything.
At the end of the second quarter, Tesla had $255 million in inventory, including $78 million in "finished goods" -- completed cars with few or no additional expenses beyond their delivery.
For accounting purposes, Tesla assumes that any vehicle inventory left over from the previous quarter would be first out the door in the new quarter. This means of the $593 million in sales, $78 million of it came from cars fully produced in the second quarter at 14% margins. $11 million of the $125 million third-quarter gross profit actually came from the sale of vehicles in the third quarter, which were physically produced in the second quarter.
New vehicle production and completion in the third quarter accounted for $515 million in sales, with $114 million in gross profit. This comes out to more than a 22% gross profit margin for cars actually produced in the third quarter, compared to the 21% reported.
Tesla guided for a 9% increase in vehicle deliveries compared to the third quarter. If you assume this translates into a 9% increase in adjusted sales (excluding ZEV credits), then you should expect $646 million in sales for the fourth quarter. You should also expect $162 million in gross profit based on the targeted 25% margins.
Tesla began the fourth quarter with $102 million in finished-goods inventory. At last quarter's 21% gross margin, this means around $21 million of the $162 million in expected gross profit will come from previously produced vehicles.
This also means that you should expect $141 million in gross profit on $544 million in sales from vehicles actually produced in the fourth quarter -- which comes out to a 26% margin.
A 26% profit margin compared to 25% may not sound like much of an increase. However, as the top line continues to accelerate, that 1% will make all the difference in the bottom line. This is especially true in the world of automobiles which have a reputation for bad margins and low multiple valuations.
Take General Motors and Ford as examples. For 2013, analysts expect General Motors to make 3% bottom line profit on sales. This means for every $1.00 in sales, it only sees three pennies in profit. A 1% profit margin increase would mean everything to General Motors.
For Ford, it's a similar situation. Ford is looking at 4.5% to 5% bottom line margins for both 2013 and 2014 based on analyst estimates. While General Motors' percentage is much better than Ford, it's still less than five pennies on the dollar in profit.
Critics of Tesla often compare it to General Motors and Ford. The further Tesla can differentiate itself from the two American automakers from a profitability standpoint, the higher it can ultimately justify larger multiples (such as P/E) in its valuation.
Final foolish thoughts
If Tesla hits its 25% margin target in the fourth quarter, expect an even further improvement in margins the following quarter, even with no change in its production efficiency. Look at each 10-Q and 10-K, under the notes that break down what the inventory consists of. Pay close attention to the "finished goods" component each quarter, since it will tell you how much the previous quarter's margins may influence the new quarter.
Armed with this information, you will have an edge over Wall Street that few others seem to be talking about in regards to Tesla's earnings. If Tesla's currently calculated margins grow substantially larger than the reported numbers, the company may become a investing opportunity during periods of chaos.
