Even before would-be consumers had a chance to recover from the sticker shock of a $135,000 price tag for its upcoming Model X “Signature” line of electric vehicles, Tesla Motors (TSLA) raced to the value-end of the spectrum today when the company announced it would be making a $35,000 EV, to be available in a couple of years.
Tesla stock didn’t move much on the news of a lower-end vehicle — the Model 3 — perhaps because the market isn’t quite sure what to think of it. On the one hand, a lower price means sales of more units. On the other hand, a lower-priced model potentially mars some of the mystique of owning a Tesla vehicle.
More than anything though, owners of Tesla stock should be asking if the company is even capable of making any vehicle that inexpensively.
Crunching the Model S Numbers
On the surface, it seems like a brilliant idea to most owners of Tesla stock. A lower-priced electric vehicle that’s priced competitively with new combustion-driven vehicles will allow Tesla Motors to compete in the far bigger mid-priced market where it has no exposure now.
The numbers: The average new car in the United States costs $33,560, and at that mid-range price, Tesla finds itself catering to the biggest sliver of the U.S. auto market. Year-to-date, 2.4 million midsized automobiles have been bought, and 2.9 million so-called “crossover” vehicles (and the Model S will come in a crossover version) have been purchased. Both are the best-selling groups in their respective categories.
But can TSLA build a car anywhere close to that price?
On Aug. 10, Reuters writers Joseph White and Paul Lienert pointed out that, based on the company’s second quarter, Tesla lost $4,000 for every high-end Model S vehicle it sold during Q2. It took less than a day for an army of fan-boys and Tesla supporters (and presumably owners of Tesla stock) to point out the number was misleading, since some of the costs that pulled the company into the red for the quarter weren’t operational expenses, and wouldn’t be expenses fully incurred from here on out as the company grew.
The counter-critics had a good point … sort of. But fans and followers of Tesla stock may want to think realistically about the plausible math of the Model S.
In its second quarter, Tesla drove $955 million in revenue on sales or leases (“deliveries”) of 11,532 vehicles … $83,000 worth of top-line per vehicle. Of that $955 million in revenue, $741 million (77%) of it went toward production costs … which makes $64,400 per vehicle. Another $202 million (21%) went towards selling and administration expenses … $17,500 per vehicle. And last but not least, a total of $182 million (19%) was spent on R&D… $15,800 per vehicle.
What was missing from the equation is scale. The more cars you sell, the cheaper they become to make on a per-car basis, as more costs are shared, price breaks are given for bigger supply orders, etc. The lack of scale has never been denied or disputed regarding TSLA, largely because most of the market has been anticipating greater scale for some time now.
And, the Model 3 will almost certainly give Tesla bigger scale. The question is, to what extent?
Let’s just generously say R&D will eventually be whittled down to nothing. Let’s also say the selling and administration expenses are whittled down to half of what they are now, to only about $9,000 per vehicle. That means for a $35,000 vehicle to be profitable, Tesla must still bring its production cost down from its current level of $64,400 per car to less than $26,000 per unit.
Don’t get the wrong idea. The Model 3 is going to be considerably less car than the Model X or the Model S, so from a production/operational standpoint, nothing is out of the realm of possibility. That’s a huge leap forward in terms of savings, however, and it’s tough to imagine Tesla whittling its production costs down to that degree without yet-another huge investment in its infrastructure.
And even if it does, there’s a new not-so-small matter that surfaces: One of the selling points of high-end Tesla vehicles now is that so few others drivers have one.
Bottom Line for Tesla Stock
Bear in mind the projections associated with greater scale were just that — projections. The second quarter production costs were taken straight from the company’s second quarterly filing, however, and they were pretty typical; Tesla is spending $60,000 or more per vehicle on production alone to make the cars it has made thus far.
It’s going to have to work some serious magic to make the Model S math work. And even then, owners of Tesla stock may see alarmingly thin operating and profit margins on those cars now that it’s chosen to go head-to-head in a price war with a still-cheaper Chevrolet Spark and Nissan LEAF.
In other words, TSLA investors may be sorry they got what they asked for.
As of this writing, James Brumley did not hold a position in any of the aforementioned securities.
