While markets broadly marched higher on Friday, shares of Tesla (NASDAQ:TSLA) headed sharply in the opposite direction. Why? The electric vehicle maker said it will cut about 7% of its workforce due to a combination of depressed profitability this quarter and a desire to keep making money while selling lower-priced vehicles. Following the company’s email announcement, TSLA stock dropped about 13%.
The knee jerk reaction in Tesla stock makes sense. Without a doubt, the company email is a profit warning. Tesla reported a sizable 4% profit margin last quarter, one that was artificially high due to preferential selling of higher-priced Model 3 variants. This one-time margin tailwind won’t persist. Instead, it will turn into a headwind as the company sells cheaper Model 3s in 2019. Tesla can’t make a profit selling those lower-priced cars with its current cost structure, so they are removing costs by cutting jobs.
It’s worth noting that Friday’s decline was the seventh-steepest since the Tesla’s 2010 IPO; the shares sank almost 14% on Sept. 28 after the Securities and Exchange Commission sued CEO Elon Musk for fraud.
None of that is great news. As such, the drop in TSLA stock makes sense on the surface.
But on closer inspection, this dip is a buying opportunity when markets open tomorrow. This isn’t the first time Tesla announced widespread layoffs in an attempt to boost profitability. Prior job cuts boosted profitability without compromising revenue or innovation. The same should happen this time around. Also, net hiring is still up big on a two-year basis. The company simply over-hired in order to boost Model 3 production in late 2018. These firings bring Tesla back to industry normal revenue-per-employee levels.
Overall, the layoff announcement isn’t a big deal. It’s simply normalization, and actually boosts the company’s medium-term profit outlook. As such, the long-term bull thesis remains intact, and investors should consider buying Tesla stock again as it closes in on $300.
Not TSLA’s First Profit Warning
The market is acting like this Tesla company e-mail reveals something new. It doesn’t. Tesla has been beating the “we are going to cut jobs in order to boost profitability because we operate in a tough industry with low margins and want to sell cheaper cars” drum for a long time now.
Last June, CEO Musk sent out a company email revealing that the car maker was going fire 9% of the workforce in order to drive a profit amid the ramp on lower-priced Model 3 production. Over the following months, Model 3 production ramped to mainstream levels, the company sold and delivered a bunch of those cars, and margins roared higher. Tesla ended up reporting a third-quarter profit margin of 4%, the most-impressive profit margin in the company’s 15-year history.
In other words, we’ve seen this rodeo before. The early 2019 version will play out much like the June 2018 one.
Over the next several months, Tesla will pare its workforce by 7%. During that stretch, the company will sell a bunch of higher-priced Model 3 variants in Europe and Asia. That will keep margins in positive territory for the next few months as these layoffs play out. Then, once those folks are off the payroll and the cost structure has been reduced, Tesla will launch lower-priced Model 3 variants in the summer. Revenue will spike, and margins will remain positive, because the cost structure has been appropriately reduced.
As such, by the middle of the year, these job cuts will allow Tesla to report record profits and margins.
Reduction is Normalization Without Value Loss
In the big picture, the workforce reduction at Tesla is simply a normalization in the employee base without a tremendous loss of value.
Consider this: Tesla has about 45,000 employees and revenue of around $20 billion. That means the company’s revenue per employee clocks in around $450,000. Ford (NYSE:F) and General Motors (NYSE:GM) have historically operated around $700,000 to $800,000 in revenue per employee, according to corporate reports. Doing the math, if Tesla reduces its workforce by 7% to ~42,000, and revenue come in around $30 billion next year, then TSLA revenue per employee will be around $700,000, or more of the industry norm.
Moreover, if you consider that Tesla grew its workforce by 30% in 2017 and is now trimming that back by just 7%, the implication is that they are firing people who have been there less than a year, and were just hired to ramp Model 3 production. That isn’t a big long-term value loss.
Bottom Line on TSLA Stock
A close look at Tesla’s layoff announcement doesn’t reveal any red flags that warrant a near-13% sell-off in Tesla stock. As such, this dip is a buying opportunity. Investors should watch the $300 level closely. The TSLA stock price has historically held that level many times before. It should hold again this time.
As of this writing, Luke Lango was long TSLA.