BYDDY - Tesla Q1 2023 Quick Take: Demand Risks Still A Top Concern

2023-04-19 17:15:57 ET

Summary

• Tesla, Inc. reported disappointing Q1 sales, with a rapid sequential decline to its auto gross margins (ex-credits).
• The results indicate aggressive price cuts implemented this year have been insufficient to stem deteriorating demand across the industry, due to the combination of macro headwinds and stiffening competition.
• While still a cost leader in the industry, the increasingly difficult demand environment, alongside persistent inflationary pressures remain an overhang on Tesla stock.

In our previous coverage on the Tesla, Inc. ( TSLA ) stock, we touched on how the sustainability of Tesla’s recent upsurge remains to be seen despite slight demand improvements based on first quarter delivery results after aggressive price cuts. And today’s Q1 earnings release was a tell-tale on the company’s profitability performance – a key focus area for investors after witnessing multiple pulls by Tesla on its pricing lever over past months. As expected, auto gross margins declined by 5.2 percentage points sequentially to 20.7% (in line with consensus estimate), primarily due to the continued pressure of pricing reductions across the product line-up in core markets, offset by modest improvements to ongoing ramp-up costs pertaining to its new and expanded facilities that likely will not have an evident positive impact on profitability until volumes pick up later in the year.

The stock has slid by almost 4% in post-close trading at the time of writing, underscoring market’s disappointment to the mediocre results despite aggressive price cuts implemented during the first quarter, which have been dialed up a few more notches this month. Demand uncertainties likely remain a prominent overhang on the Tesla stock – especially after its more than 60% upsurge this year prior to the release of its first quarter volumes – and modest delivery improvements from aggressive MRSP cuts that have come at a major cost to profitability, although expected, are unlikely to support a sustained recovery amid the shaky macro backdrop that is expected to deteriorate further in the near-term before secular tailwinds return.

Overview of Tesla Q1 2023 Results

Tesla reported first quarter revenue growth of 24.2% y/y to $23.3 billion, missing the average forecast of $23.5 billion. However, earnings came in at $0.85 per share, which was in line with consensus estimates. Auto gross profit margins, ex-credit sales, came in at 20.7%, which is 520 bps below 25.9% during 4Q22. This is consistent with the burden of ongoing price cuts across its line-up this year that have reduced ASP, alongside an increasing mix of Model Y sales, which “carries a slight cost premium to Model 3.” This was offset by slight improvements to new facility ramp up costs, with the Berlin manufacturing facility now producing at over 5,000 vehicles per week, up from the 3,000-vehicle weekly production run-rate existing 4Q22.

Looking ahead, Tesla has maintained its multi-year 50% CAGR target while clarifying that “in some years [it] may grow faster and some [it] may grow slower.” The company has reiterated its target for 1.8 million deliveries in the current year, a 37% increase from volumes in the prior year.

Faltering U.S. Demand Due to Unfavorable Macros

U.S. retail sales continue to paint a picture of cooling household demand, as surging interest rates and persistent inflation continue to weigh on budgets. March retail sales fell a second consecutive month by 1% y/y , dragged primarily by a slowdown in auto sales which declined by 1.6% y/y. The results underscore renewed challenges to the broader auto industry, with economic deterioration thwarting a long-awaited recovery after acute supply chain constraints, which have only just started easing, upended sales over the past two years. The slowdown in auto sales is consistent with rising interest rates that have put affordability further out of reach – while inflationary pressures in the auto industry have softened as a result of easing supply chain constraints and improving inventory levels, auto financing costs have surged at a relatively faster pace, doing little to assuage affordability concerns while the consumer continues to weaken.

While Tesla has done its fair share in activating aggressive MSRP reductions across its lineup in the U.S., demand looks to be losing charge, nonetheless. Despite record first quarter deliveries , production of 440,808 vehicles over the same period resulted in a net excess of 17,933 vehicles, adding to ballooning inventory levels observed in the second half of 2022. The results also fell short of CEO Elon Musk’s remarks during the previous earnings release, which at the time had implied a returning trend of demand outpacing supply.

This potentially suggests that demand had faltered further nearing the end of the first quarter, which was also what had likely incentivized the incremental price cuts in April.

Thus far in January, we've seen the strongest orders year-to-date than ever in our history. We currently are seeing orders at almost twice the rate of production. So it’s hard to say that will continue twice the rate of production, but the orders are high. And we've actually raised the Model Y price a little bit in response to that.

Source: Tesla 4Q22 Earnings Call Transcript .

With “excess production over deliveries” being a consistent trend at Tesla over the past three quarters, the ongoing debate over whether macro headwinds, in addition to rising competition, have fast-tracked structural demand normalization at the EV pioneer remains in focus. And to assuage these concerns that have been weighing on the durability of the stock’s performance, Tesla will need to demonstrate consistency in shoring up delivery volumes in the remainder of the year – a highly difficult endeavor. This is corroborated by the latest round of price cuts across its broader line-up in the U.S. for the third time this year – or second time this month – underscoring anticipation for continued challenges to demand as macroeconomic deterioration is expected to pick up its pace over coming months, alongside stiffening competition – more than 50 new electric vehicle ("EV") models are expected to roll out in the U.S. alone this year, as automakers, old and new alike, rush in on electrification opportunities.

Specifically, Tesla has further reduced the MSRP on the best-selling Model 3 and Model Y by “at least $1,000,” and on the premium Model S and Model X by about $5,000 in early April, and again by $3,000 across the Model 3 and Model Y on the eve of releasing first quarter results. A new base version of the Model Y was also recently introduced at a price tag of $49,990, and now reduced to $46,990 as a result of the latest price cuts with the next long range trim level taking on the $49,990 price tag. Tesla vehicle prices have declined by more than a quarter this year, a pace that is almost unheard of in the industry.

The best-selling Model Y – a beloved SUV in the hottest U.S. vehicle segment – now starts at more than “ $5,300 less than the average price paid for a new vehicle” after accounting for the $7,500 tax credit under the Inflation Reduction Act. Meanwhile, the Model 3 is almost $8,000 cheaper than the average new car price at a base MSRP of $39,990 (or another $3,750 cheaper after accounting for related tax credits under the IRA). While management expects to compensate for margin contraction headwinds from ongoing ASP reductions through “ongoing cost reduction of [its] vehicles, including improved production efficiency at [the] newest factories and lower logistics costs,” they will likely come in at a slower clip than the fast pace of MSRP declines observed so far this year.

Admittedly, the rapid price decline on all models – especially the best-selling Model 3/Y – could be preceding a long-awaited refresh cycle speculated for later this year / early next year, alongside a strategy to mimic federal tax incentives for ineligible Tesla vehicles under the IRA, in addition to broader aims of boosting sales amid a shaky demand environment. Specifically, the Model Y is expected to get an exterior and interior makeover for its first refresh since launch in 2020, with planned start of production expected in October 2024. Meanwhile, the Model 3 is expecting an upgrade later this year with changes that would potentially “improve manufacturing efficiency.”

Yet, related updates will likely weigh on profit margins further, compounding pains of potentially more price cuts to come as urgency grows for Tesla to shore up deliveries ahead. While Tesla still has a competitive advantage or boasting industry-leading auto margins – as corroborated by auto gross profit margins (ex-credit sales) that remain consistently in the 20% range despite recent price cuts and various ramp-up costs – continued pressure expected on the bottom-line, which is expected to be only partially offset by incentives under the IRA (Inflation Reduction Act) later this year, alongside weakening auto demand sentiment at the company, will likely weigh on the durability of the stock’s lofty premium, sowing further risks of volatility in the near-term.

Faltering China Demand Due to Rising Competition

With Tesla’s core U.S. market likely experiencing fast-tracked demand normalization due to ongoing macro headwinds, continued resilience in demand within the fastest-growing Chinese EV market will be critical. But cracks are starting to show in Tesla’s ambitions of becoming a dominant player in the Chinese EV market. In addition to economic challenges and rising competition in the region, Tesla’s brand reputation appears to be weakening in China as well.

Specifically, on the economic front, while the PBOC has recently cited that China remains on track towards about 5% GDP growth this year, the post-pandemic recovery remains modest. The country’s CPI increased by 0.7% y/y in March, coming in below the consensus forecast of 1%. The modest uptick in prices indicate that while an “economic recovery is on track, [it has not been] strong enough to push up prices…, [suggesting] the economy is still running below its potential.” Continued momentum in China’s economic recovery will depend on progress in consumption and investments. Yet, retail confidence likely remains weak, given modest spending growth relative to record household savings that have risen by a whopping $4 trillion in 2022. The trends continue to imply a mixed recovery in the near-term, considering the “lingering impact of COVID-induced declines in employment and income” and a tendency to brace for “ unknowns .”

Persistent weakness in China’s post-pandemic recovery is also consistent with our observations during a recent trip to the country. Less populated and lower economic-contribution tier 2 cities continue to reel from primarily empty store fronts with aggressively marketed lease signs. While the larger tier 4 cities with greater economic influence are relatively better, foot traffic in high retail goods/services consumption areas like shopping malls remain weak relative to the pre-pandemic days. Many locals we have conversed with also touted that the impacts of stringent COVID restrictions on mobility in previous years continue to linger with signs of recovery in the early stage still not yet too prominent.

Observations of a slow recovery will likely add incremental pressure on Tesla’s ongoing demand headache, especially as its brand reputation appears to be taking a hit alongside rising competition from local rivals as well. Specifically, observations of Tesla vehicles in the tier 2 city we had visited – which is more affluent and acclimated to EV adoption – appeared sparser than expected. Considering China being the EV pioneer’s second largest market, with robust sales numbers reported by the CPCA on a consistent basis, we were slightly taken back by the relatively similar mix of Tesla vehicles observed compared to other local premium EV brands like NIO Inc. ( NIO ), XPeng Inc. ( XPEV ), and Li Auto Inc. ( LI ) – alongside juggernaut BYD Company Limited ( OTCPK: BYDDF / OTCPK: BYDDY ), which boasts an outsized share of total EVs spotted in almost every parking lot we came across during our visit in the tier 2 city. The observations underscore the rising threat of increased competition from local EV makers to Tesla’s presence in China.

Based on conversations with local gig and personal drivers during our visit earlier this month, it also appears Tesla’s reputation in China has been weakening. Concerns over safety have been a major turnoff for the brand, while others also appreciated more competitive pricing and better quality features offered by domestic EV brands (mostly BYD, which locals view as gradually separating from its mass market past to becoming a quality premium brand ). Recent headlines that show Tesla will be skipping the Shanghai Auto Show this year are furthering angst over related concerns about its brand reputation and reception in the country – especially after the debacle that happened during 2021’s exhibit where “an unhappy customer clambered atop a Tesla being displayed to protest its handling of her complaints about malfunctioning brakes,” which the EV pioneer had to apologize to its Chinese market for after, despite not acknowledging fault regarding the protester’s alleged claim.

Protests by Chinese Tesla owners earlier this year against the EV pioneer’s “surprise price cuts” also appear to be contributing to observations of deteriorating brand sentiment, which drives incremental caution over the company’s near-term demand environment in its second largest market. We are also staying incrementally cautious over the potential for more price cuts across Tesla’s line-up in the region to reinforce demand and remain competitive in the region.

The Bottom Line

Considering Tesla, Inc.’s weak first quarter results and management’s cautious commentary on the company’s near-term performance, there remains much convincing to do to assuage investors’ concerns over demand risks at the company. In addition to mounting macroeconomic uncertainties, rising competition in the EV space will be tough to overcome, although Tesla’s pricing lever remains a competitive advantage.

In the current macroeconomic environment, we see this year as a unique opportunity for Tesla. As many carmakers are working through challenges with the unit economics of their EV programs, we aim to leverage our position as a cost leader.

Source: Tesla 1Q23 Shareholder Deck .

However, that will inevitably come at a greater cost on already-contracting profit margins, which risks denting the durability of Tesla, Inc. stock’s premium in the near-term amid a complex market climate that is still adjusting to fluid global macro challenges.

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