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PROFITABILITY: TAKE II

Tesla turns a profit, again. Now Musk says it’s all about “cost, cost, cost”

Reuters/Lucy Nicholson
We need lower costs, Elon.
  • Michael J. Coren
By Michael J. Coren

Climate and emerging industries editor

Published Last updated This article is more than 2 years old.

With its torturous Model 3 production ramp up behind it, Tesla can expect fewer near-death experiences for the immediate future. Now, it faces an existential struggle to stay profitable as it fights for more of the auto market.

Tesla’s quarterly earnings yesterday (Jan. 30) looked like the beginning of this new future. In a letter to investors (pdf), Tesla highlighted some of its hard-won success: delivering two consecutive profitable quarters, and the crowning of the Model 3 as one of America’s most popular cars.

The automaker reported net income of $139 million and increased its cash position by $718 million, despite a major bond payment, pushing Tesla’s cash reserves up 21% over the last quarter to $4.3 billion. Tesla claims that will allow it to pay off its upcoming $920 million debt obligation in March without raising more money, something analysts have doubted. (Tesla carries $9.4 billion in debt.) Edmunds ranked the Model 3 the best selling luxury vehicle in the fourth quarter, and the fifth best-selling passenger car in America. Tesla accounted for a whopping 77% of all battery-electric vehicles sold in the US in 2018.

“Last year was the most challenging year in Tesla history but also the most successful,” said CEO Elon Musk in a call with investors. “I’m optimistic about being profitable in Q1, and for all quarters going forward.”

Tesla says it now expects “very significant annual growth” in 2019 and beyond. It’s planning to hit its production peak at its Fremont, California, factory this year, and begin manufacturing Model 3 vehicles at its Gigafactory Shanghai plant. Tooling for the Model Y crossover will begin in order to release the car in 2020. likely to be built next to Tesla’s existing Gigafactory for batteries in the Nevada desert.

But Edmunds suggests Tesla’s winning streak will be “virtually impossible” to maintain. Federal tax credits worth $7,500 per car are phasing out. Tesla’s new product lineup is slowing just as Audi, Porsche and Jaguar have begun entering the market with flashy new EVs. “Tesla’s in an awkward purgatory between being a startup and a mainstream automaker, and the biggest open question heading into 2019 is where the company really goes from here,” Jessica Caldwell, Edmunds’ executive director of industry analysis, wrote by email.

Much of the US auto market is operating on razor-thin margins. Morgan Stanley estimates that all of Detroit’s Big 3 profits last year came from pickup trucks and SUVs. Tesla noted that its own operating margins last quarter were 5.7% (slightly betterthan the industry average), with the Model 3’s gross margin exceeding 20%, roughly the same quarter on quarter, and it aims to hit 25% in 2019.

To ensure these margins, Tesla engineers and accountants are pulling out all the stops. Tesla cut the labor hours per Model 3 by 65% in the second half of 2018 and laid off 7% of its workforce. Supercharging perks for customers have been curtailed (no more lifetime charging). Tesla is simplifying its manufacturing process by shipping vehicles with larger standard batteries, but then charging customers more to unlock the full capacity. Tesla is raising the price of its entry-level luxury models—the Model S now sells for $85,000 rather than $76,000 and comes with a bigger battery —while performance options are being unbundled for big spenders. A high-end Model S is now slightly cheaper at $112,000 but you’ll need to drop $20,000 to unlock the “Ludicrous mode” option.

Further, RBC analysts suggest the sky-high demand for Teslas, such as the 350,000 pre-order deposits, will be predicated on lower prices. Right now, writes RBC’s Joseph Spak, ”demand for the Model 3 appears to be coming in at a price point well below TSLA’s cost of vehicles.”

Musk acknowledged on the investor call that the only way forward for Tesla was to continually bring down costs so more people could afford an EV. “It’s cost, cost, cost,” said Musk referring to manufacturing. “I think this past year, while extremely difficult, has driven us to a high level of financial discipline. I think we’re way smarter about how we spend money and we’re getting better with each passing week.”

But much of that cost-cutting and containing task will now fall on Tesla’s newest chief financial officer, Zach Kirkhorn, a nine-year veteran of Tesla’s finance unit. He takes over from Deepak Ahuja, Tesla’s current finance head, who announced his departure at the end of the investor call. Ahuja is leaving Tesla for the second time, having served as its CFO from 2008 to 2015 before reassuming the role in March 2017.  Tesla’s stock fell almost 5% in after-hours trading.

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