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Something very strange happened with Tesla today. The automaker reported its financial earnings statement for Q3, and despite falling shy of revenue targets, it absolutely obliterated analysts' forecasts on profitability.
- Adjust earnings per share of $1.86 vs. expected losses of 42 cents per share
- Revenue of $6.3 billion, vs. expected $6.33 billion, according to Refinitiv consensus estimates
Wall Street was expecting a loss of around 15 cents per share, yet Tesla (NASDAQ:TSLA) surprised today with profits of $1.91 per share (Non-GAAP). What happened exactly?
Tesla boosts margins while revenue takes a hit due to Model 3 and leased vehicles
Tesla booked $6.3B in revenue during the third quarter, a slight decline of the $6.8B of the same quarter a year ago. This is quite rare for the company, as yearly decreases in revenue haven't happened in quite some time. While profitability has been up and down, Elon Musk and his company have reliably increased its revenue for most quarters during its existence.
Despite the drop in revenue, Tesla booked $1.2B in gross profit.
First, let's discuss why revenue dropped y-o-y. Just as many analysts expected, the Model 3 has begun to dominate the sales mix for the automaker, and as entry-level Model 3s have made their way to virtual showrooms around the world, so too has the average selling price (ASP) declined. In short, Tesla is selling a higher volume of cheaper vehicles which has dragged its ASP down.
Tesla is leasing about three times as many vehicles today as it was a year ago. According to the company's earnings statement, "[the increase in leased vehicles] has impacted revenue by the majority of the YoY decrease."
There you have it, Tesla is leasing more vehicles than before, and the Model 3 is simply a lower cost car and as it begins to sell more of those, its ASP will remain lower.
Model 3 production costs dropped and boosted profitability
While 2018 was the year of the Model 3 ramp, 2019 was the year of Tesla getting its production costs figured out. In other words, Tesla ramped Model 3 in 2018 and then figured out a way to maintain output without burning too much cash.
Margin was impacted in part due to fundamental improvements in our operating efficiency, including higher fixed cost absorption, reductions in manufacturing and material costs and continued improvements in vehicle quality and in part due to Smart Summon-related deferred revenue recognition, FX and other non-recurring items. Improved gross profit combined with a decline in operating expenses resulted in material improvement of GAAP net income.
-Tesla Earnings Statement 10-23-19
Tesla is learning how to be a large-scale automaker. Its building vehicles with fewer defects, and it's doing so with improved operational efficiencies. It's wasting less, both in materials and in labor. While it was all-hands-on-deck (including a massive tent in its parking lot meant to temporarily boost Model 3 production) for quite some time - things have changed these days.
As a result, Tesla's GAAP Automotive gross margin improved (from last quarter) by nearly 4% to 22.8%.
This is exceedingly good news for Tesla faithful and investors alike - efficiency gains are lasting and once achieved shouldn't go away. Elon Musk and his engineers have figured out a way to ramp and sustain volume at a lower cost and that will translate to its future manufacturing plants, which brings us to the Gigafactory 3 in China.
Gigafactory 3 and Model Y both ahead of schedule - and plenty of cash on hand
Today wasn't just about the past quarter, the company also offered some interesting tidbits that will affect upcoming quarters. Tesla was proud to report that the Gigafactory 3 in Shanghai is "ready for production". The facility was completed in 10 months and it was 65% (!) less expensive in terms of CAPEX per unit of capacity compared to Tesla's Model 3 production lines in the U.S.
The Model Y, Tesla's upcoming compact SUV is already entering trial production, and full production is scheduled to commence in the summer of 2020.
Tesla is poised to set new revenue records once its producing vehicles out of its new Shanghai plant, and of course thanks to the addition of the brand new mainline Model Y. The Gigafactory 3 can produce 150,000 Model 3's a year, taking its current ASP that would be an incremental increase of about $6.1B per year, for a start. Shanghai will also crank out Model Ys (unknown capacity at this time) in the future as well.
The company's cash reserve is looking a bit less scary versus recent quarters as Tesla generated $371M in free cash flow in Q3. Tesla believes that it can maintain "positive quarterly free cash flow going forward, with possible temporary exceptions." Tesla now has cash reserves over $5B, and can easily handle the $577M in debt coming due this quarter.
Shares of the automaker skyrocketed in after-hours trading and are currently up over 20% (as of this writing) from the closing bell. $TSLA closed at $254 and could open tomorrow north of $300 per share.
Options traders had priced in a 6% move either up or down, and buyers of call options are looking at a hefty pay-day tomorrow. $270 strike calls could be purchased today for around $3.70 per contract. Should Tesla hold at 20% gain for a share price of around $305, those call options will be worth somewhere north of $30. Good for a 1000% return in less than 24 hours.
Tesla's earnings statement can be found here.