After the powerful rally, the market appears to be taking profits based on commentary regarding the margin outlook. Not only were margins lower quarter-over-quarter (QoQ), but Tesla offered no insight into how much lower they can go.
The market dislikes unpredictability. During the call, Musk can speak poetically about the complexities of AI, neural net training, the 6-million-dollar man, and robotic taxis, but he is speechless when it comes to fundamental profitability drivers. The former drove the price following Q123, while the latter is currently driving the price.
Did automotive gross margins reach a low point?
Tesla’s automotive gross margin was 19.2% in Q223 compared to 21.10% in Q123 and 25.90% in Q422. Comparatively, group operating margins for Q223 were 9.6%, compared to 11% for Q123 and 16% for Q422.
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Gross margins and operating margins for the automotive industry crested in Q222 at 32.9% and 19.0%, respectively. Since then, both have been gradually decreasing. Because the market does not know where or when these two metrics will ultimately bottom, the stock price is lower today.
In the future, Tesla will continue to prioritize volume through price reductions at the expense of margins. Here is what CFO Zachary Kirkhorn had to say:
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“Second, we continue to work towards our objectives of maximizing volumes on both our vehicle and energy businesses, and most importantly, doing so in a manner that generates the capital necessary to maintain our R&D and capital investment pace. This requires a firm focus on COGS per unit reductions in each of our key businesses, as well as working capital improvements on raw materials, work-in-process inventory, and customer accounts receivable, which made adequate progress in the second quarter.
Despite measures taken to further improve vehicle affordability at the beginning of the quarter, our automotive division’s gross margin showed a slight decline but remained robust. We realized unit cost reductions in virtually every category, including material and commodity costs, manufacturing costs, and logistics.
Tesla reiterates, in response to a query about pricing, that the company must reduce prices due to the rising interest rate environment.
Question:
“How has the order intake changed in relation to production levels during the second quarter? And how has it trended since the beginning of the quarter? How does Tesla conceptually determine when to reduce prices or offer other sales incentives to increase demand?”
Elon Musk The overwhelming majority of individuals consider the purchase of a new automobile to be a significant decision. Consequently, whenever there is economic unpredictability, people generally hold off on purchasing a new car to at least see what occurs.
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And then, undoubtedly, there is also the interest rate environment to consider. As interest rates increase, debt-financed purchases become less affordable, effectively increasing the price of the automobile.
Therefore, when interest rates increase considerably, we must reduce the price of the vehicle because interest payments increase the cost of the vehicle. I believe that this is the most rapid increase in interest rates in history, at least up until recently. Therefore, we had to do something.
When questioned again about automotive margins, management provided no direct response. For our purposes, we prefer direct answers from management teams, as the lack of visibility into contracting margins increases uncertainty.
Question:
“With the emphasis on price cuts to drive volume growth eating into the gross margin of the automotive industry, can investors expect the gross margin to stabilize or even rise as a result of efficiencies outpacing the price cuts? Moreover, when?”
Elon Musk:
“Where is that crystal orb once more? Permit me to point out that the short-term fluctuations in gross margin and profitability are insignificant in comparison to the big picture. Autonomy will make these numbers appear absurd.
Christopher Kirkhorn
“I completely concur with you. I believe the only thing that matters in the short term is what I mentioned in my opening remarks, namely, whether or not we are generating sufficient funds to continue investing. Intense is the portfolio of products and technologies in which the technical teams are currently investing. It is intensive both in terms of investment and potential.
Conclusion:
The sentiment following Q223 is comparable to that following Q123. As everyone knows, Tesla rallied after the first quarter. Now that the stock is trading at higher levels, there may be less AI sentiment to support it in the near future. The third quarter will not be a catalyst, and analysts will likely reduce their estimates.
While many will contend that Tesla is one of the most advanced AI companies in the world, my response is “absolutely,” but Tesla is also highly reliant on consumer spending, which is completely out of their control.
The comment regarding interest rates is the most significant remark made during the call, as high-interest rates necessitate that Tesla reduces prices. In a sense, management agrees that a significant portion of the current situation is beyond its control. While some will argue that recurring software revenue from Robotaxis is the most important catalyst, the stark reality is that the Federal Reserve’s decision to lower interest rates is the most important catalyst for Tesla today.
Tesla is one of many tech companies whose revenue growth and profitability are on borrowed time until the Federal Reserve implements a more dovish policy.
The Analyst Team for the I/O Fund contributed to this analysis.
The I/O Fund performs research and derives conclusions for the company’s portfolio. We then communicate this information to our readers and provide real-time trade alerts.
This does not constitute a guarantee of a stock’s performance or financial advice. Before purchasing stock in any of the companies mentioned in this analysis, you should consult a financial advisor. At the time of writing, Beth Kindig and the I/O Fund own shares of TSLA and may own securities depicted in the charts.
