Lost in the hubbub over Tesla's Model 3 is the continuing decline in sales of the Model S. While the achievement of Elon Musk’s oft-stated goal of 5,000 units of weekly production was celebrated by most, Tesla's shares fell Monday as actual unit deliveries of the Model 3 were 18,440 in the second quarter, a full 10,000 units shy of consensus expectations. Few seemed to notice, though, Tesla's disclosure that it had delivered 10,390 Model S units in the second quarter, an 11.4% decline from the first quarter's level. That represented the lowest quarterly delivery figure for the Model S since the second quarter of 2016. While it is true that Model X deliveries posted a sequential gain in 2Q2018 (11,370 vs 10,070 delivered in the first quarter) that model's quarterly deliveries were also well below the levels Tesla produced in the second half of 2017. Full details are in the table at the end of this article.
While the world's established automakers gifted Tesla an almost unfathomable six-year head start in the high-end battery-electric vehicle (BEV) market, the Model S finally has competition. It just so happens that competition comes from the Model 3.
The styling cues are very similar between the two models, and Tesla's decision to produce high-spec Model 3s first (most of the first Model 3s on the road carry a sticker price of $56,000--far from the $35,000 car that Musk had promised), put it squarely in the range of a consumer who might buy the S. Further, Tesla is now hyping--including in Monday’s press release--the upcoming availability of the high-performance versions of the 3, which will push the model’s average selling price even further out of economy segment territory, Until that unicorn-like $35,000 version appears at Tesla's factory gates, it is clear that the Model 3 is really a premium sedan segment entrant. So is the Model S, and it's unlikely that a Tesla-focused consumer would buy both models.
NANTUCKET, MA - JUNE 24: A view of a Tesla Model S at the 2018 Nantucket Film Festival - Day 5 on June 24, 2018 in Nantucket, Massachusetts. (Photo by Noam Galai/Getty Images for Nantucket Film Festival )
Making profits in the automotive industry is a grab-it-while-you-can enterprise, and when a model enters its golden years, as the Model S has, that is when profitability should be peaking. Even the most devoted Tesla-phile could not argue that Elon Musk initially intended to utilize a tent in the parking lot to maximize Model 3 production. So, for those of us who toil at following the auto industry, product cannibalization is a red flag for margin pressures.
That might not seem to matter if all one follows are Musk's tweets and the media's breathless and unquestioning repetition of Tesla's proclamations. The fact is, however, that every Street analyst following Tesla uses Automotive Gross Margin as the controlling figure for gauging Tesla's future profitability. They all do it; both the bulls and the bears, and, really, having spent the better part of my adult life modeling aurto company earnings, there is no way to avoid it.
So, sacrificing a higher margin product for a lower margin one hampers returns on capital, which should be the controlling figure for the valuation of every company, not just those that make cars. As is its usual practice Tesla has yet to announce a second quarter reporting date, but at some point in early August this company is going to drop a profitability bomb on the Street.
The second quarter was horrible for Tesla from a financial perspective, as my model shows more than $1 billion in negative operating cash flow. The trick will be guessing whether analysts attribute that cash burn to one-off factors--Tesla's press release noted the company plans to keep using the tent to finish Model 3s, so please don't call that a second quarter "one-timer"--or will figure out that the core profitability of Tesla's core model has waned.
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