uploads/2019/10/AdobeStock_279385913_Editorial_Use_Only.jpeg

Tesla’s Profitability, Not Demand, Could Be a Problem

By

Updated

A leaked email from Tesla (TSLA) CEO Elon Musk suggests the company could reach 100,000 deliveries in the third quarter, breaking its previous record of 95,200 deliveries in Q2. However, Tesla’s profitability could continue to haunt its stock in the short-to-medium term.

Musk’s leaked email shows no demand problem for Tesla

Electrek reports Musk’s email said third-quarter net orders were “tracking to reach about 110,000.” During its annual shareholder meeting in June, Musk said, “I want to be clear, there is not a demand problem.” He maintained the company’s challenges are in supply, not demand.

Tesla bears disagree. Business Insider reports Highbridge Capital Management analyst Ed McCabe thinks the Model 3’s declining sales suggest “organic demand is extremely weak.” However, that doesn’t seem to be the case. The company’s target of 100,000 deliveries would mean net order demand is 10% above that.

Tesla’s demand strong in new markets

In August, Tesla’s Model 3 became the UK’s third-bestselling car. Its sales are also strong in Europe and its new markets in Australia and New Zealand. On September 23, Teslarati reported, “Tesla is scheduled to deliver over 2,400 units of its Model 3 to Australia this month, making it one of the top-selling cars for the month of September.”

Moreover, even in markets where EV (electric vehicle) demand isn’t great, Tesla is strong. China’s EV sales dropped in July and August due to subsidies being rolled back. However, Tesla’s Chinese deliveries soared more than 175% year-over-year in the third quarter, according to CNBC. Meanwhile, domestic EV makers such as NIO (NIO) are struggling to survive. After the company reported softer-than-expected Q3 results, NIO stock fell 43% in five days.

Why Tesla stock is weak

If Tesla’s deliveries and demand are strong, why is its stock weak? This year, TSLA stock is down more than 27%, underperforming the S&P 500 (SPY) and the NASDAQ Composite (QQQ), which have risen 18.7% and 22.4%, respectively. Legacy automakers Ford (F) and General Motors (GM) have also outperformed Tesla, with gains of 20% and 12% year-to-date.

Tesla’s problem might be its profitability. In its more than ten years of operations as a public company, it hasn’t reported an annual profit, and it’s had only four quarters of net profit. Even after the company reported record deliveries in the second quarter, Tesla stock fell hard because of higher-than-expected losses.

Profitability a concern for Tesla despite record deliveries

Many analysts are concerned about Tesla’s margins. CNBC reports Credit Suisse has maintained its below-average Q3 target of 84,000 deliveries. Although the bank thinks the company’s deliveries could surprise positively, it’s concerned about Tesla’s Q3 margins. On average, Reuters-surveyed analysts expect Tesla’s adjusted loss per share to shrink sequentially in Q3 to $0.43 from $1.12. Despite Tesla’s expected higher deliveries in Q3, analysts expect its revenue to stay at $6.38 billion.

Tesla’s answer to its non-profitability

Tesla’s non-profitability may be due to its sales mix. The Model 3, its top-selling vehicle, is almost half the price of its Model S and Model X. Margins for the Model 3 are narrower, too.

Tesla and Musk aim to address these concerns by launching wider-margin models. The company’s Model Y and pickup trucks could be the answer that potential TSLA investors are seeking. In fall 2020, the automaker expects to start producing the Model Y. The Model Y is set to have a higher price than the Model 3, but marginally higher production costs thanks to component overlap between the two models.

Selling credits to legacy automakers to meet US and European emission standards could also drive Tesla’s profitability. Its Gigafactory ramp-up in China could be a major driver as well. To learn more, read Tesla Gigafactory 3: A Step Closer to Model 3 Production. As long as Tesla’s profitability concerns remain, its stock will likely be pressured.

More From Market Realist