Tesla might be about to inflict severe pain on some investors. But for the first time in almost two years it is not the bulls that are at the sharp end. In the face of a rally that had seen the electric carmaker’s market value more than double since the start of the year, sceptics have been increasing their bets against the stock.
Short interest now stands at 3.5 per cent of the outstanding share capital, according to data from Factset, up from about 2.7 per cent in January and up to the highest level since October 2021. Doubters might be set for a worse short squeeze if the stock’s momentum extends further. Moves to cover some short positions might explain the outsized reaction to better-than-expected second-quarter delivery numbers. Tesla turned out just over 466,000 vehicles between April and June, 10 per cent higher than the first quarter and 83 per cent above the number delivered over the same period last year.
Against market expectations of 447,000, the increase was a more muted 4 per cent, a difference you could count as a fairly reasonable margin of error for forecasters. It’s been taken as proof that cutting the prices of its vehicles is starting to pay off, which partly explains why the shares rose by the largest amount in almost ten months, up 7 per cent on the day. The relief is understandable — in the first quarter sales rose only 4 per cent quarter over quarter despite price reductions being under way. Tesla is facing heightened scrutiny of its top line. Pressure on consumer spending has been the modest immediate threat to sales, which has pushed the car manufacturer to enact a series of price cuts since the start of this year to stimulate demand for its more affordable Model 3 and Y vehicles.
The reductions mean in the US Tesla has reduced its base price for its Model Y sports utility vehicle by more than 20 per cent so far this year and its Model 3 saloon car by more than 10 per cent. Price cuts have been enacted around the globe, including for the Model Y in China, the largest EV market, this month. True, the markdowns have started to have the desired effect on the top line. Yet it is hardly case closed.
Tesla has yet to prove that it can sustainably push forward sales without slashing prices further and more aggressively. It also leaves investors looking for a reliable floor for margins. Profitability has been the trade-off in reaching for better sales volumes. In the first quarter, cut-prices dragged the gross margin below a previously set threshold of 20 per cent and behind market expectations, set at 19.3 per cent during the first quarter. Analysts at Morgan Stanley think the gross margin will sink further below that golden benchmark, averaging out at 18.5 per cent this financial year and 18.3 per cent next year.
Recognition among investors that Tesla can’t pump up sales and margins at the pace the market once expected is the reason a dramatic fall in the valuation of the EV maker from historic levels is justified. Even after this year’s rally, an enterprise value of 44 times forecast earnings before interest, taxes and other charges is half the level reached during the peak market froth in 2021. But that doesn’t make the shares any bargain, it just brings them back into line with the long-running average valuation. The premium embedded into Tesla’s stock was predicated on the belief that expanding production volumes would steadily beef up margins. The relative simplicity of Tesla’s model compared with those of traditional carmakers — offering only four models, limited colours and direct-to-consumer distribution — enhances that scale benefit. Tesla still thinks it can deliver 1.8 million vehicles this year, which would be 50 per cent ahead of last year.
The strength of demand becomes a more pressing question as rivals have emerged, including the Warren Buffett-backed BYD in China, as well as deep-pocketed, traditional groups such as Toyota looking to challenge Tesla. BYD accounted for 21 per cent of global EV sales in the first quarter of this year, according to analysis by Counterpoint Research, compared with Tesla’s 16 per cent, extending its lead established during the second quarter of last year.
Growth in the absolute size of the electric vehicle market and decline of internal combustion engines will naturally provide a lift to Tesla’s scale. Improving the affordability and reliability of electric vehicles will be key to driving adoption. For Tesla, recent deals with the legacy carmakers Ford and Volkswagen to open up its charging network might not be a sizeable revenue generator for the Elon Musk-led company. But more manufacturers standardising charging kit is another step towards bringing down costs that could be passed on to consumers.
Joe Biden’s Inflation Reduction Act might bring with it more benefits in pushing sales volumes higher. Production tax credits this year, granted on batteries with at least half the materials sourced or assembled in North America, will provide some cushion for Tesla in its price wars. Stepping up production of its own batteries would help it capitalise more effectively on the regulatory incentive. Cooling inflation would also provide a fillip to profitability this year. Logistics costs have come down considerably and inflation in the price of lithium, an all-important part of battery technology, is starting to abate. On commodities, which have provided the “maximum” of pain to the cost structure, the peak in cost rises was in the second half of last year, Tesla told investors on its first-quarter earnings call.
Yet its focus will remain on demand rather than supply. Tesla is now producing more vehicles than it is delivering, the brokerage Jefferies points out. For the core models 3 and Y, the volume of excess deliveries looks to have peaked at just under 31,000 in the final quarter of last year, easing to just over 13,000 in the second quarter. That is above recent historic levels, but Tesla tying up more capital in inventories doesn’t look concerning for cashflows yet.
Free cashflow of $441 million in the first quarter pushed cash and equivalents up to $22.4 billion at the end of March. Analysts think the group will end the year at just over $23 billion. That is plenty to fund the building of its existing production facilities, an increase in its sales teams and the development of the Cybertruck, which is due to begin production this year. But still, Tesla could easily slip in its balancing scale with profitability, allowances for which are not reflected in a swelling market value.
ADVICE Avoid
WHY The shares’ ascending market value does not reflect the risk of margins disappointing again
