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Investment Thesis
Going into the Q1 earnings call on April 23rd, I saw expectations as quite low for Tesla, Inc. (NASDAQ:TSLA). Post Q1 earnings, I believe it's clear the company continues to navigate a highly delicate act full of operational challenges while still trying to push the envelope on electric vehicle ("EV") technology and cost reductions, fundamental to their long-term strategy.
With this, and despite the EPS miss, I think the company still rose to the occasion. The first quarter saw Tesla achieving a GAAP net income of $1.1 billion and a non-GAAP net income of $1.5 billion, despite significant external pressures, including geopolitical tensions and supply chain disruptions.
The launch of their "Redwood" model, slated for a more immediate timeline than previously anticipated, is poised to benefit from these advancements, addressing one of the primary criticisms regarding the speculative nature of Tesla's projections.
This new $25,000 vehicle, code-named "Redwood," is expected to significantly expand Tesla's consumer base by targeting a more affordable price point than Tesla's current models. Their lower-cost electric vehicle opens the possibility for Tesla to establish themselves as an even stronger rival of gas-powered cars that dominate many developing markets. Capturing this wider mainstream auto market could greatly increase Tesla's customer base globally.
Tesla is preparing to release this new vehicle in 2025 with industry-leading profit margins from the start, according to CEO Elon Musk.
If Tesla can achieve their current gross margins on a mass-market, affordable EV, it would dramatically increase overall profitability and represent a major accomplishment in auto manufacturing. Maintaining margins has traditionally been very difficult for lower-cost vehicles, making this a challenging but highly rewarding target if Tesla reaches its cost reduction goals.
Combining lower manufacturing costs, greater accessibility for consumers, higher rates of production, and an expansion in their buyer market, I believe Tesla's new $25,000 Model 2 presents Tesla as a strong buying opportunity for investors in the company's stock, especially given post earnings. While Tesla shareholders have been on a ride this year due to lower sales volume and margin compression, I think this new car represents a pivotal moment in the company's trajectory.
Why I Am Doing Follow-Up Coverage
In 2024, Tesla stock - down 34.75% YTD at the time of writing - has been the worst performer in the S&P 500 (SP500). As a Tesla bull (and shareholder myself) this has been frustrating. I saw the Q1 earnings as critical to my thesis. I believe the company is at a juncture (see my section below on current EVs). Tesla, however, has been at many key junctures in their path to where they are today. Most of these previous junctures have been life or death for the company. I don't think this one is, necessarily.
As I wrote about in my previous coverage in December and then in January, Tesla is sowing the seeds to be more than just an EV manufacturer, they are sowing the seeds to be a future EV/mobility ecosystem. This comes together with better charging networks, and better full self-driving ("FSD") software. The missing ingredient was an even more affordable EV (cheaper than the Model 3) to help propel more user adoption. I talk about this below, but I think this is the missing link (and why I think this is their version of the Model T). In essence, like how the Model T made automobiles affordable to the masses in the 20th century, the Model 2 can do that for Tesla (even more so than the Model 3, see my analysis below).
The market has been quite bearish on Tesla recently. I think this earnings call assured investors that the company is on the right track. The purpose of this article is to show how the Model 2 can be the missing link.
Problem With Current EVs
While the goal of being more environmentally friendly is becoming widespread (31% of U.S. adults want to completely phase out internal combustion engine, or ICE, vehicles), the majority of cars on the road are still not electric vehicles. Here's why: one of the most limiting buying factors comes from high upfront costs, with prices averaging $10,000+ higher than comparable gas-powered models in most segments. This price is primarily driven by the battery pack, which can comprise over 30% of the total EV cost. Mainstream EV models currently average around $53,469, pricing out many middle and lower-income demographics. I believe prices will need to approach about $25,000 to drive mass adoption comparable to economy gas vehicles. Consumers aren't only concerned about high up-front costs but also the cost of installation of high-speed, home-based charging. Cost can vary depending on where you live, but in Michigan, it can cost hundreds to thousands of dollars.
Another barrier stems from misconceptions about maintenance expenses. There is a lot of consumer anxiety and misconceptions about the higher maintenance costs of EVs. However, EVs actually require less maintenance than gas-powered vehicles.
Consumers are also concerned about battery range. Despite averages of 250+ miles per charge, fears of running out of power before reaching the destination, or so-called range anxiety, persists, especially on long trips. When comparing the number of charging ports to gas stations, just 100,000 public charging ports exist today in the U.S. compared to gas stations numbering over 150,000. While the number is closer than what I expected when initially researching this, many of these gas stations are more spread out, meaning the network of gas stations in the U.S. covers a wider area than EV charging stations (many are concentrated in cities).
Q1 Review
Tesla's Q1 results reflected what I believe to be a hint of resilience as the company navigated through a competitive (see my risks section) and disruptive market environment. Despite a substantial 9% year-over-year revenue decline to $21.30 billion, Tesla's strong price cut responses and operational advancements helped show the resiliency of their adaptive business model (Q1 Presentation).
CEO Elon Musk candidly addressed these challenges during the earnings call, noting the impact of ongoing global issues and internal operational hurdles. Musk stated, "We think Q2 will be a lot better," acknowledging the difficulties faced (Q1 Call).
Despite missing Wall Street expectations on both top and bottom lines, with earnings per share at 45 cents against an anticipated 51 cents and revenue at $21.3 billion coming in lower than the $22.15 billion estimated, Tesla's stock rose 12.06% on Wednesday. I believe this rise was almost entirely fueled by optimism from Musk's forward-looking statements. He revealed on the call an accelerated timeline for new affordable EV models (the Model 2), stating that production could begin "early 2025, if not late this year," sooner than the previously expected second half of 2025.
Financially, Tesla's operational metrics revealed a mixed picture. While the company's automotive revenue declined 13% year over year to $17.38 billion, this was part of the broader narrative of price adjustments to stimulate demand amid fierce competition and market saturation. I think the price cuts were key to maintaining market share in China, see my risks section.
On the brighter side, Tesla's energy division and services sectors showed robust growth. The energy segment's revenue increased by 7% to $1.64 billion, and services revenue rose by 25% to $2.29 billion compared to the same period last year (Q1 Presentation).
Model 2 Overview
To expand their market presence, Tesla is continuing their transition from the production of luxury models to the creation of a mass-market vehicle. In Elon Musk's recent announcement of the new $25,000 Tesla model, he emphasized that this entry-level model predicted to sell by the millions annually, could "blow people's minds" thanks to a revolutionary manufacturing method. Musk's forecast of the Model is planned to launch as soon as "early 2025, if not late this year."
In the context of Tesla's stock performance and market impact, the company remains a dominant force in the electric car market, owning nearly 20% of the global electric car market and over 50% of the U.S. electric car market.
The key component of this new model for consumers is the projected affordability. To still produce a reasonable profit, Tesla must reduce production costs while still delivering high-quality vehicles. To achieve this, Tesla plans to reduce battery production costs by up to 56% by manufacturing its new 4680 battery cells at scale. These lower costs combined with other manufacturing optimizations could make the $25,000 car profitable on each sale. Drastically reducing costs is key for releasing a mainstream, affordable EV profitably.
More on production plans, Tesla plans to produce 10,000 "Redwood" vehicles per week at their new factories. This new model will be built on an entirely new vehicle platform, incorporating all the advanced manufacturing lessons and vertical integration that Tesla has pioneered over the past 14 years since they started to make the Model S. The highly automated manufacturing line for this car is expected to be an industry leader in available technology, reducing labor costs through increased use of cutting-edge robotics and processes optimized for electric vehicle production.
The Model 2 will also offer the Full Self-Driving technology. Tesla has a multi-year head start in developing industry-leading full self-driving technology, with billions of miles of real-world data from customer vehicles (I talked about their edge in my FSD deep dive article last year). I believe this will also be an incredible value proposition for the lower-end EV market, given that few vehicles at this price point offer such powerful autonomous technology.
Valuation Section: How Will Redwood Impact Tesla's Valuation?
According to Elon Musk, Tesla is targeting 20 million vehicles annually by 2030. If achieved, the high-volume $25,000 "Model 2" would likely be Tesla's best-selling model, eventually capturing millions of customers annually and cementing Tesla's dominance with over 50% share of the total EV market. This new model will appeal to consumers all over the world, therefore allowing Tesla to capture more of the EV market.
New automotive products, including the Tesla Model 2, could boost Tesla's annual sales from under 1.8 million vehicles today to 5-6 million by 2026 by some estimates, a 3 to ~4 times increase largely driven by the high-volume budget EV. On the earnings call, CEO Elon Musk specifically stated that production could ramp to "over 3 million vehicles of capacity when realized to the full extent" for the Model 2.
This sales explosion could make Tesla the world's largest automaker. While a lower-cost EV provides opportunities, previous attempts by other automakers to do the same have struggled. But with Tesla's battery innovations and optimized production, they hope to reach the industry-leading margins they have on their other vehicle lines on the Model 2 as well. If achieved, the vehicle would serve as both an offensive and defensive move - opening new markets while sustaining a dominant share in EVs.
The upcoming generations of car buyers will be a large influence on Tesla's future; studies suggest over 50% of 18-34-year-old U.S. car buyers would consider an EV as their next purchase if options were more affordable. The Model 2 specifically could have strong appeal to capture this key demographic worldwide based on its pricing and brand perception.
With just selling the base vehicle at $25,000 with 400,000 units sold in 2025 alone (estimates are for the automaker to be producing 10,000/week next year, so I assume a ramp up at the beginning of the year), this could represent an additional $10 billion in additional revenue for the EV giant.
Applying a forward price to sales multiple on this revenue of 4.65 (the current price to sales forward multiple, we get a market cap boost of $46.5 billion, or about 10% upside in market cap (and shares) from current levels on this opportunity alone.
Why I Don't Think This Is Priced In (And How This Interacts With My Past Research)
While I have been bullish on Tesla since December, their stock has dropped 31.18%. The stock has dropped as more of these opportunities for Tesla have actually come to fruition.
For example, my previous analysis argued that FSD 12 is worth $76.75 billion and that their EV charging networks could be worth $532 billion to Tesla. I still think both of these opportunities are worth the same amount of money now, given the recent wider rollouts of FSD 12 and Tesla continuing to do well with their charging network.
Adding in this $46.5 billion opportunity to the previous opportunity creates a sum of the parts valuation of $655.25 billion on their own. This implies little to no residual valuation to most of the current business (which on its own is profitable and still has best-in-class automotive margins compared to legacy Auto). This is even after margins came down with this last earnings report.
Risks
With the drastic decline in vehicle sales price, concerns are raised on whether Tesla can sufficiently reduce production and material costs to still earn a reasonable gross profit margin on a $25,000 mass market vehicle while maintaining quality. However, Tesla's battery cost reduction of 56% through manufacturing innovations and economies of scale could be the solution to these concerns. I believe their historical ability to reduce costs on expensive EV parts (like the battery) will come into focus with this new model as well.
When looking into Tesla's past production execution, the EV maker has a history of missing timelines and delaying the launch timing of new products as manufacturing goals are often pushed back, such as the repeated timeline shifts for Cybertruck.
To try to prevent this from occurring with this new model, Tesla management (including Elon Musk) is paying close attention to developments on factory expansions to ensure production timelines can be met here. They know how big this car will be for the company's future. Their earnings call on Tuesday showed how big of a deal this car will be. I believe the company will be just as focused on making sure the Model 2 rollout goes well as they were when they launched the Model 3 back in 2017/2018.
Announcing a future $25,000 EV could slow sales and demand growth for Tesla's current mass-market vehicle, the Model 3. Tesla could attempt to manage this sales cannibalization risk by carefully timing the final announcement, marketing messaging, and actual production launch timing of the future, cheaper EV option once capacity is ready. Clear communication to customers on the differentiation of the vehicles will also be critical. Still, some demand loss for Model 3 in the short term may be inevitable once the next-gen EV is concretely announced to the public on August 8th (the date Elon Musk pegged on the conference call).
Competition Is Real, But The Company Is Navigating It Well
To be clear, making mass market affordable EVs is not only Tesla's idea. Companies such as China's EV maker BYD Company Limited (OTCPK:BYDDF) with their Seagull hatchback are offering cars that start at as low as $10,000. This means consumers have real options in the affordable EV market. This is clearly a real threat to Tesla, but I think the company is navigating well.
First, to note, the firm is actually doing better (sales-wise in China) than some of these peers. Elon Musk noted on the call:
I mean, I don't know what our competitors could do, except we've done relatively better than they have. If you look at the drop in our competitors in China sales versus our drop in sales, our drop was less than theirs.-Q1 Call.
Second, I think the FSD software the firm is investing heavily in will be another strong differentiator. We already went over how this technology will be a part of the Model 2, and since this data (and the billions of miles that are a part of the training set) are proprietary, this is a strong moat. I talked more about their FSD competition in my research from December, but this competition is not an abnormally large concern in my opinion. Tesla has been battling similarly priced EVs at the different price points they have sold at for over 10 years. I am more than confident they will continue to offer a strong value proposition to EV customers in China (and abroad) with the Model 2.
Takeaway
I believe Tesla's Q1 2024 earnings provide substantial evidence supporting the company's necessary focus toward the Model 2 launch which will, I believe, define the future of the company. With these firm statements on the future of the product line, I believe Tesla reinforces its market EV leader status and addresses investor concerns regarding the feasibility of its long-term targets, particularly concerning the Model 2.
Tesla, Inc. making their EVs more accessible through lower prices to a broader audience all over the world addresses multiple barriers in the adoption of EVs. While the stock is down significantly in 2024, I think the stock is more compelling than ever (highly favorable risk/reward). I think continues to be a Strong Buy
Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.
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