BYDDF - Tesla Can Win A Price War

2023-03-08 11:38:53 ET

Summary

• Tesla, Inc. can potentially emerge with a net positive benefit in FY23 following a second round of price cuts, even with declines in ASPs and gross margin.
• Tesla recently announced 4% to 9% price cuts to the Model S and X, in an effort to spur demand higher for its lower-volume, higher-priced models.
• Early data from January and February suggests demand is relatively robust and responsive to the price cuts.
• CEO Elon Musk has hinted that 2 million production volume is possible, and strong demand increases confidence in reaching that target.
• At 2 million units in production, Tesla could record both revenue and gross profit growth even if ASPs fall 12% y/y and gross margin declines <6 pp.

Tesla, Inc. ( TSLA ) announced its second price cut Sunday night. This time, it is targeting its higher-end Model S and X with the cuts after slashing Model 3 prices by around 6% and Model Y prices by up to 20% in January. While the first price cut had initially stoked fears of demand deceleration, Musk noted on Tesla's Q4 earnings call less than two weeks later that the OEM "has seen the strongest orders year-to-date in its history" following the cuts.

Tesla is stoking an electric vehicle ("EV") price war -- the second round of price cuts now means all Tesla models have decreased in price since the end of 2022, increasing the stakes for other EV manufacturers to follow suit or be left behind. With its industry-leading EV capacity for 2023, Tesla can win a price war, but the major question here is: will there be enough of a demand surge in response to offset the discounts?

Model S/X Prices Slashed

Tesla cut the two models' prices by 4% to 9% -- the base Model S and X were cut 5% and 9%, respectively, while the S Plaid and X Plaid were cut 4% and 8%. The cuts are another attempt to stir up demand for Tesla's vehicles, even though the two models account for a relatively thin proportion of Tesla's annual volumes.

Musk previously said on the earnings call in late January that the original " price changes really make a difference for the average consumer," with orders coming in nearly double Tesla's production rate. That's a strong positive for driving growth this year via the Model 3 and Y, since excess installed capacity is over 1.8 million units relative to a 1.3 million production volume from FY22 -- however, the impacts from the cuts to the S and X will be more limited, given that installed capacity is limited.

For the S and X, Tesla has installed capacity of approximately 100k units at Fremont -- compare that to FY22's production of 71.2k units, and growth potential looks to be about +40% for FY23, at max capacity. Deliveries for the S and X surged 167% y/y in FY22 to 66.7k units as production ramped +192% y/y -- this suggests that demand for the two models is already quite strong.

Demand Responsive To Cuts

We already have evidence that demand is fairly responsive to the price cuts, aside from Musk's commentary -- sales of China-made vehicles jumped +18% m/m in January with the cuts taking effect, while sales continued accelerating in February, up +12.6% m/m from January and +31.6% y/y.

However, CNBC said last week that the:

"latest weekly data showed [Tesla's] retail sales in China were still running short of the pace seen in the fourth quarter, indicating the bump from discounted prices in its biggest overseas market is waning."

Tesla had been looking to operate Giga Shanghai at a weekly run rate of about 20,000 vehicles, or about 80,000 per month, so there technically is some upside possible from February's 74,402 unit volume.

The key takeaway -- Tesla's price cuts are spurring demand, at least in the short term. Long-term demand effects won't be visible until later in Q2/Q3, but for now, there is evidence that demand in Q1 has jumped.

So what does the latest price cut mean?

Although sales of the Model S and X accounted for just over 5% of total deliveries, strong demand stemming from the price cuts could help push the two models' deliveries up +45% y/y in FY23 -- that would suggest deliveries of around 97k for the year. Boosting Model S/X deliveries to nearly max production capacity increases the confidence that Tesla can surpass a 1.8 million production /1.7 million delivery target.

Musk has said that demand exists to drive production to that 2 million vehicle level in 2023, and bringing production to those levels, to match strong demand, suggests +45% y/y growth for deliveries. Model S/X deliveries could rise towards 95k to 100k, and Model 3/Y deliveries to 1.8 million. Risks to fulfillment from increasingly overextended outbound logistics -- delivering less than 95% of production volume -- will likely persist through the first half of the year, especially as demand rises.

Advantage To Winning The EV Price War

Tesla can win a price war, as it holds a major advantage within its margins that will allow it to cut costs substantially, that other EV startups such as Lucid Group, Inc. ( LCID ) or Rivian Automotive, Inc. ( RIVN ) cannot manage to do.

The two main facets of this price war include:

• can or will Tesla draw buyers away from competitors who are unwilling to engage in price cuts -- General Motors ( GM ), BMW ( BMWYY ), Mercedes ( MBGYY ), Hyundai, for example
• can Tesla boost its delivery figures by attracting extra demand to offset any adverse impacts that the price cuts will have on margins.

Tesla's strong automotive gross margin, which has trended lower from 32.9% in Q1 '22 to 25.9% in Q4 '22, is likely to take a further dent as ASPs fall quicker than production costs are able to come down following the cuts; however, newly-established EV startups such as Lucid, whose Air model is a direct competitor to the Model S, can't afford to take any cuts to production as it is already facing decreasing ASPs and an inability to make positive margin on vehicles as production fails to scale rapidly.

While some major OEMs such as Ford Motor Company ( F ) and BYD ( BYDDY ) are engaging in the price war, others with serious combined volumes -- GM, Mercedes, BMW, and others -- have stood against cutting prices in response. Tesla is attempting to draw demand from competitors by engaging in heavy price cuts, at the cost of consumers who recently purchased at higher prices, but the only way this will work is if production can scale above initial targets of 1.8 million to 2.0 million vehicles.

At Tesla's 1.8 million production target, deliveries would be projected to end FY23 at approximately 1.7 million vehicles, given the state of outbound logistics and vehicles in transit. Assuming a ~10% decline in ASPs to ~$49k in accordance with the first round of cuts leads to a worst-case scenario for growth -- that scenario projects FY23 automotive revenues at $83.47 billion, or about +16.8% y/y growth.

Assuming the second price cut helps spur demand further, and production and deliveries scale to 2.0 million and 1.9 million vehicles, respectively, the net benefit from the surge in deliveries can and likely will offset the revenue loss from declining ASPs. Assuming ASPs fall ~12% in FY23 to ~$48k, the incremental increase in deliveries could boost revenues around +27.5% higher to $91.12 billion. Combined with approximately $12 billion to $14 billion in other revenues, total revenues for FY23 could exceed $104 billion, or +27.7% y/y growth. Even if automotive margins for FY23 fall 6 percentage points to 22.5%, gross profit would be flat y/y, again suggesting that the price cuts can have a net positive benefit on both the top and bottom line.

Outlook

While Tesla, Inc.'s initial price cuts in January sparked fears of a demand slowdown, monthly data for January and February along with commentary on order rates are suggesting that the cuts are boosting demand substantially. Now, following a second round of cuts, this time hitting the higher-priced Model S and X, Tesla is in a pole position in an EV price war -- a war that it can win. Musk has hinted that Tesla can boost production to 2 million vehicle this year, and the early surge in demand in response to the cuts increases confidence that Tesla can reach that figure. Even assuming a 12% decline in ASPs relative to FY22 and a 6 percentage point decline in vehicle gross margin to 22.5%, Tesla, Inc. can emerge with a positive net benefit from the cuts, as peers are either unwilling or unable to engage in this price war.

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