As a follow up to my Tesla (TSLA -1.08%) article where I outlined how Tesla's fourth-quarter earnings should turn out based on previous company disclosures, there are three additional reasons why Tesla's upcoming earnings report might blow away expectations. The best part is that so few people seem to be talking about them anywhere.
The original reason
To briefly rehash, Tesla dropped clues as to what should be expected regarding its earnings per share. They come out to be much higher than analyst expectations, assuming that Tesla meets all of the projections it outlined for investors.
The company projected the total number of deliveries, revenue per delivery, gross profit per delivery, and total overhead expense consisting of R&D and selling, general, and administrative expenses. Using the same interest expense of last quarter plus the projected total share count, Tesla gave you everything you need to calculate the non-GAAP EPS guess of $0.33.
Now let's take it three steps further. Before I begin, I need to emphasize that this is speculative -- there is no assurance that Tesla will even meet its own projections on all of the various components. Things such as the fire investigations, for example, may have led to higher than expected legal and software expenses. Tesla may have decided to invest in an even higher amount of R&D in response to its increased cash flow. There may be a number of other factors that the company didn't expect at the time as well. Now let's take a peek at what's possible.
The three simple reasons
First, most of us seem to have forgotten that the 25% gross profit margin projection from Tesla wasn't really a flat 25%. The exact reference is, "While we expect to achieve our target of 25% non-GAAP automotive gross margin in Q4 (assuming no contribution from ZEV credits), further progress is likely if customers continue to purchase our vehicles with a high option take rate." This implies that if revenue per vehicle comes in during the fourth quarter at a similar rate as the third quarter, the 25% margin will be exceeded.
CEO Elon Musk has since been on CNBC, where he said, "For us, deliveries and revenue are very, very similar things, there's not a meaningful difference between the two." This implies the revenue from each vehicle delivered was similar to last quarter. If so, that should qualify for "further progress" than the 25% target.
Second, Tesla began the fourth quarter with a lot of leftover finished goods inventory, much of which was in transit for final delivery. These deliveries will count as sales, but at the lower third-quarter margins. Since Tesla no doubt accounted for this in its projections of 25%, it means that sales above and beyond the old inventory are expected to be produced at even better margins than 25% in order to arrive at a full-quarter average of 25%.
I went into detail on this in an article back in November. In short, incremental sales should be at least 26% or more in expected profit margins. Since Tesla delivered an extra 900 vehicles compared to guidance, it's reasonable to expect those sales to be at 26% margins or higher. That extra 1% might not sound like much, but it adds up fast when dealing with such large numbers falling to the bottom line.
Finally, the other reason that Tesla may surprise is simply the old-fashioned economies of scale that come with higher production. It's unlikely that employee counts went up as fast as production during the quarter with those extra 900 deliveries. If the same staff were able to squeeze out an extra 900 vehicles, then the average man hour per vehicle goes down and the profit margin per vehicle goes up. Admittedly, the risk with this assumption is that part of the reason for the production increase was the higher than expected battery supply. It's possible that this caused Tesla to temporarily pay higher prices for other parts or higher wages to staff in the form of overtime while it hires and trains new people.
Foolish final thoughts
While no analysis is perfect, the facts in front of us suggest that the profit margins could be materially higher than expected. As with many companies, each dollar of extra profit squeezed out of a sale tends to fall directly to the bottom line, all other things being equal. As many Fools have repeated, Tesla still has a long way to go to justify its current valuation, but the upcoming report will tell us if it is a step closer.