Since its early days in 2003, Tesla (NASDAQ:TSLA) and its CEO Elon Musk have undeniably played a huge role in helping electric vehicles (EVs) become mainstream. TSLA stock went public in June, 2010, at an opening price of $17. Tesla’s share price is now hovering around $240.
TSLA is expected to report Q3 2019 earnings on Oct. 23. Its usual reaction to earnings reports and other company announcements is a volatile one. Therefore, both Tesla stock bulls and bears are eager to hear the results. At this point, I find the risk-to-reward ratio for the shares of the disruptor of the EV space on the long side inadequate.
Before committing any capital into Tesla shares, I’d like to analyize its next earnings statement.
What Investors Can Expect From Q4
On Oct. 2, Tesla released the numbers for “Q3 2019 Vehicle Production & Deliveries” for the three models currently on the roads:
- Model S (its most expensive model, which it has produced since 2012)
- Model X (its mid-size crossover SUV, which it has produced since 2015)
- Model 3 (its cheapest model, which it has produced since 2017)
Accordingly, Tesla produced a record number of 96,155 EVs in Q3 and also delivered a record number of 97,000 vehicles.
When Tesla’s next earnings hit the wires on Oct. 23, investors are likely to pay attention to total revenue and net loss figures.
On July 24, Q2 total revenue came at $6.35 billion, a 59% increase year-over-year. However, TSLA stock missed analysts’ average top-line estimate of $6.41 billion.
During the second quarter, Tesla had delivered 95,200 vehicles, with the main driver of its revenue growth being a 134% YoY increase in vehicle deliveries.
But regardless of the the quarterly revenue increase, TSLA lost $2.31 per share ($408 million). With these numbers, TSLA failed to match anlysts estimates for the quarter, despite improving over the Q1 results.
In other words, while TSLA sold more cars in Q2, it has not brought in more profits. Therefore, investors may not be forgiving if a similar story develops when Tesla reports Q3 earnings in about two weeks.
TSLA Stock Faces Several Headwinds
Wall Street believes that Tesla faces several short-term important hurdles on the road to profitability as well as higher stock prices. Today, I’d like to discuss two of them in depth:
- Decreasing gross margins, and
- Questions regarding demand.
Tesla’s Q2 results showed that the gross margin of its automotive segment is declining. It now stands at 18.9. In Q1, it was 20.2%. In Q4 and Q3 of 2018, the metric was 24.3% and 25.8%, respectively. In 2014, it was 28%.
In Q2 2017, Tesla management had set the desired gross margin level at 25%. And in Sep. 2017, TSLA stock price had seen an all-time high of $389.61. Is it a coincidence that as margins decline, so does the share price of TSLA?
The main reason behind the decline of the company’s gross margin is that TSLA’s sales mix is increasingly shifting from higher-priced S and X models to the Model 3. Model 3, which is priced at $38,990, is an entry-level car that carries lower margins.
Q3 numbers on Oct. 2, 2018 also showed that the delivery number for Model S/X stood at 17,400. On the other hand, Tesla delivered 79,600 Model 3 numbers.
Wall Street is not exactly convinced that Model 3 is profitable. Can Tesla continue to rely mostly on the sales of Model 3 to drive its growth?
The Demand For Tesla EVs
The demand for the Model S luxury sedan and Model X sport utility vehicle is low. Here the Tesla line-up is aging. Elon Musk has confirmed that the company does not plan to introduce a major refresh for either model. And the demand for Model 3 is not high enough to make up for the margin loss from decreased sales in Model S and Model X.
In September, Gordon Johnson of GLJ Research issued a sell rating on Tesla stock with a price target of $44.52. Mr. Johnson is especially skeptical of Tesla’s sales in China. Another analyst downgrade has followed the recent quarterly production and delivery numbers.
If demand is indeed in decline, Tesla will likely have a hard time surviving such a sales downturn with the low margins that Model 3 offers. And when sales and revenue numbers do not add up, companies need fresh levels of capital. In the long-run, unsustainable levels of borrowing usually kills companies, especially car manufacturers.
Although Q3 numbers were impressive, they fell short of the quarterly 100,000 mark CEO Elon Musk had hoped to achieve. Earlier in the year, TSLA had said that it expected to deliver between 360,000 and 400,000 vehicles in 2019.
However, in the first half of the year, Tesla delivered just 153,700 (90,700 in Q4 2018 plus 63,000 in Q1 2019) vehicles. When you add 97,000 more vehicles in Q3, the number stalls at 250,700.
Can the company’s deliveries in Q4 help Tesla reach even the lower end of its guidance range? If the company’s performance in the rest of 2019 is similar to that of Q4 2018, then TSLA will not even deliver 360,000 vehicles in the second half of 2019.
In such a potentially disappointing scenario, how would the price of TSLA stock react?
So Should You Buy Tesla Stock Now?
In 2019, TSLA has been a battleground between two camps: investors and traders. Year-to-date, TSLA stock is down about 27%. Its 52-week price range has been $176.99 – $387.46.
Investors have been wondering whether the company will be able to work through various production issues and margin and cash worries as it becomes a full-fledged car manufacturer.
Meanwhile, traders are happy to capitalize on the increased daily volatility of Tesla shares. One thing best describes Tesla stock’s daily moves in the markets: roller coaster. It is soaring one day and falling off the cliff the next.
This kind of daily and weekly price choppiness shows me that nervous investors are in general expecting the worst news from TSLA now. In other words, what may be the next shoe to fall? Then these investors get emotional and happy when expectations come true.
Recent research by Nadine Strauss (University of Vienna) and Christopher Holmes Smith (University of Southern California) shows that financial news flow affects the short-term price of Tesla stock and that noise traders aim to take advantage of this volatility.
If you already own Tesla stock, you might want to hold your position. However, within the parameters of your portfolio’s allocation and risk/return profile, you may consider placing a stop loss at about 5-6% below the current price point.
The Bottom Line on Tesla Stock
In addition to TSLA’s falling margins, analysts are concerned that the demand for Tesla cars may also be decreasing. In such a case, could Q4 2019 be the beginning of an unknown period for TSLA stock?
I’d urge long-term investors to exercise caution with Tesla shares. I believe the recent price weakness is a reflection of investor sentiment and major fundamental worries.
Furthermore, Tesla has yet to prove that it can become and stay profitable. If I were a TSLA shareholder, I would not exactly be thrilled when TSLA sells more (Model 3) cars but also incurs further losses with every car sold.
The two important points to remember are that the trend is an investor’s friend and that Tesla is a volatile stock.
As of this writing, Tezcan Gecgil did not hold a position in any of the aforementioned securities.