Will Tesla’s China-Made Model 3 Up Its Profit Game?

Tesla (TSLA) is in the process of building its China Gigafactory, its first factory outside the US. It will also be China’s first auto factory solely owned by a foreign automaker. Other automakers, including Ford Motor Company (F) and General Motors (GM), have entered the Chinese market through joint ventures. Through its Gigafactory 3, Tesla will be producing China-made Model 3s and Model Ys. The company and many market participants believe that this factory could make a visible change to Tesla’s profitability profile going forward.

Tesla’s China Gigafactory’s impressive progress

One thing about the China Gigafactory that’s surprised bulls and bears alike is the impressive progress the facility has made. The ground on the facility was broken only in January. During Tesla’s third-quarter earnings call, Elon Musk said, “While a lot of people see the outside show the factory, which is enormous, and it was essentially under water in January.” Going from underwater to production trial runs in about ten months is definitely a big feat.

China’s support for Tesla’s China factory

China’s government has also been supporting the building of Tesla’s Gigafactory. It recently exempted Tesla from a 10% purchase tax restriction. The exemption becomes even more important when we consider that China made an exception for the company. Usually, only domestic carmakers or joint ventures qualify.

China-built Tesla Model 3s ready

Currently, the company imports all the cars it sells in China. With the starting of the Shanghai Gigafactory, the company won’t need to import Model 3s anymore. This is particularly important for the company because of the heated trade war between the US and China. With China-built cars, Tesla will be able to avoid a lot of tariffs. Due to the tariffs and related currency volatility, Tesla had to increase the prices of its cars in China in August.

Tesla’s costs in China: Lower than in the US?

After the full ramp-up of the factory, however, car prices are expected to come down in China. The price fall could be the result of two major factors. Firstly, as we discussed above, Tesla should be able to avoid costly tariffs. Secondly, its China Gigafactory is expected to be cost efficient compared to its US factory. Tesla should, therefore, be able to pass on some cost savings to consumers. Tesla mentioned in a press release in October 2018 that it was “operating at a 55% to 60% cost disadvantage compared to the exact same car locally produced in China.”

China cost advantage

Baron Capital founder and ardent Tesla bull Ron Baron also noted that Tesla is “building for 70% less than it would cost for the same cars to build in the United States.” Tesla’s manufacturing costs in China will mainly be aided by optimizations and all that the company has learned from its experiences in US manufacturing. Also, supply and labor costs in China are lower than in the US. Teslarati reported that Tesla will produce batteries, do vehicle assembly, and drive units at one site at the Gigafactory 3. This same process is split between its Nevada and Fremont factories in the US. This integration is also expected to drive efficiencies and reduce costs.

China’s auto demand stalling

Investors should note that overall auto demand and demand for EVs in China have been stalling in recent months. Chinese EV markers, including BYD (BYDDF) and NIO (NIO), are reeling from the subsidy rollback and current slowdown. Tesla, however, never got the benefit of subsidies in the first place. If anything, the rollback will be beneficial for Tesla and other foreign EV makers.

Tesla’s China-centric marketing strategy

Tesla is also approaching the Chinese market from a slightly different perspective. While Musk’s disdain for marketing is well known, Tesla is following a marketing strategy of a different kind in China. In contrast to closing retail stores elsewhere, the company is opening stores in China. It’s also organized races and showroom parties to spread awareness about its brand. In the overcrowded EV market in China, it will need to compete on several fronts to grab additional market share.

China-made Model 3 launch

On November 11, Bloomberg reported that Tesla had unveiled its first vehicles built in China. It noted, “The first Model 3 sedans came in blue and were emblazoned with the brand name in Chinese characters.” Steelguru further reported that while the exact launch date of the China-built Model 3 hasn’t yet been confirmed, as per some media reports, the date could be November 11.

As the US auto market is slowing, China’s Gigafactory could be a long-term demand driver for Tesla. While the company plans to produce about 3,000 Model 3s in the initial phases, Musk is expecting demand of nearly 5,000 units per week.

On November 11, Jefferies also raised TSLA’s target price from $300 to $400. The company notes that Tesla’s gross margin level is consistent with sustained profitability.