EPS Effectively Missed by 47%: Tesla reported a 6% Q4 2022 GAAP EPS beat, but stripping out a one-off deferred revenue recognition of $0.3bn & a $1.5bn reversal of deferred tax asset (DTA) valuation allowance, Q4 EPS missed by 47% (see Figure-3).
Gross Margins Missed by a Wide Margin: Tesla’s key metric of performance is the automotive gross margin (ex-regulatory credits, which are 100% pure profit). This came in at 24.3% versus expectations of 26.4%, a low not seen since Q1 2021. Excluding the one-off FSD deferred revenue recognition, the auto ex-credit gross margin was only 21.3%, a low not seen since Q4 2020.
Free Cash Flow Missed by 62%: Because of this, Q4 free cash flow (FCF) missed by 62%, as the $1.5bn DTA valuation allowance reversal was likely hidden in “non-current asset changes” within operating cash flow and the $324m of deferred FSD revenue recognition was a non-cash item. The 11% QoQ rise in Accounts Payable & Accrued Liabilities helped soften the blow.
Tesla Hikes their Loan Facility from $2.4bn to $7bn: While many shareholders have pushed Tesla to do a share buyback, any such hopes may have been dashed by Tesla opening up a new credit facility to tap up to $7bn. This helps validate my theory that Tesla doesn’t have that much cash intra-quarter due to huge working capital needs.
Musk’s Deceptive Pump on New Order Flow: While both Musk and Tesla CFO warned about high costs (particularly the rising lithium price), Musk slipped in this comment which got Tesla’s stock to spike in the after hours: “We currently are seeing orders at almost twice the rate of production”. It was a cheeky pump, as Tesla exited 2022 with record high inventory of 70,000 vehicles, or 17% of Q4 deliveries and twice the weekly selling rate in Q4. Production was likely not very high when Musk boasted about orders exceeding output. Five days later, the German factory had a 5-day shutdown for “maintenance” and recent weekly sales data from China (post lunar new year) is 42% lower than last September’s levels, when prices were 22% higher than now.
Cost Cuts May Not Cover 10% Price Reductions: Tesla cut prices globally by roughly 15% in early January. Costs need to come down as much for profits to grow in 2023 based on Tesla’s target of 1.8 million deliveries (+37% YoY). But there were more warnings about lithium costs on the earnings call than there was color on how exactly costs/unit would come down. Raw materials per car are roughly $2,000 per vehicle, but the current lithium spot price indicates $6,100 in just in cell costs for the Model Y (Tesla’s top-selling model and 2/3 of its 2022 global sales). The price of lithium has risen by 758% since 2020 (see figures 5 and 6 below).
$1.9bn in One-Offs only Led to a 7% EPS Beat
Tesla’s Q4 results were poor in quality even before stripping out some monstrous one-offs. To begin with, the $5.1bn in Auto gross profit, ex-regulatory credits—the most critical metric for Tesla’s performance—was 7.7% below consensus of $5.5bn.
And despite 2.7% lower SG&A expenses than expected, operating profit still missed consensus by 1.6%. So how did Tesla manage a beat at the EPS level? Taxes were 45% lower than expected, which led to GAAP net profit being 7.2% above consensus—hardly a “beat” (see Figure-1 below).
Figure-1: Tesla Q4 Results vs Consensus
But there were two significant one-off items, which if stripped out, show that Tesla actually missed operating profit by 9.7% and GAAP net profit by 46.7%.
$324m of Deferred FSD Revenues Recognized: In its Q3 2022 10-Q filing, Tesla said that it planned to recognize $1.1bn in deferred revenues over the “next 12 months” linked mostly to its Full Self-Driving product (a $15,000 ADAS option that is still in development and far from “self driving”).
Tesla had previously said that revenue recognition of FSD would be based on technological milestones (sensible) and the roll-out of beta testing to a wider audience of customers who paid for the option (nonsensical).
This was not factored in by consensus, but the bulls were hoping for around $1bn of recognition in Q4. Tesla only recognized 29% of the $1.1bn in deferred FSD revenues.
This may be due to Tesla’s auditor (PwC) pushing back on 100% recognition as Tesla’s Autopilot/FSD system is currently under investigation by both the Departments of Transportation and Justice as there have been over 19 deaths related to drivers using the product. Cumulative sales of FSD amounted to $3.7bn at the end of Q3 2022, or 29% of Tesla’s 2022 net profit.
Stripping out this $324m of FSD deferred revenue recognition makes Q4 results much worse (refer to Figure-3 for details):
ASPs are Significantly Lower: Q4 average revenues/unit (ex-lease; ex-credits) appear to be down 2.3% QoQ on the surface, but are actually down 3.9% once the FSD recognition is stripped out.
Pure Automotive Gross Margins Drop by 4.3 Percentage Points: Auto gross margins ex-credits were expected to be 26.4%, but came in at 24.3%. Without the FSD revenue recognition, it falls to 23.1%. On a pure automotive basis (ex-credits and leases), auto gross margin was only 22.5% versus Q3’s 26.3%. This is the lowest level since Q4 2019’s 20.9%, when ASPs were 14% higher. Tesla’s CFO said that pure automotive gross margins would be higher than 20% on the earnings call (more detail on this below).
Reduced Tax Rate Boosted EPS by 101%: Six days after its January 25th earnings results, Tesla released its 10-K which revealed that they had reversed a deferred tax asset (DTA) valuation allowance of $1.53bn (see Figure-2).
Figure-2: Tesla’s $1.53bn of DTA Allowance Reversal
This averted a 19.4% tax rate for the full year in 2022 (actual rate was only 8.3%), as Tesla’s US operations generated their first profit ever, with 13.6% pretax margins (which is quite impressive). Any company of integrity in the S&P 500 would’ve emblazoned this in their initial earnings report, not hide it deep in its annual report released 6 days later. Despite the egregiousness of this, Tesla’s stock continued its rally by 43% post-results.
This is what Tesla’s Q4 results would’ve looked like when adjusting for both the FSD deferred revenue recognition and the reversal of DTA valuation allowance.
Figure-3: Tesla’s Q4 Adjusted Earnings vs Consensus
What’s concerning about this is that valuation allowances are usually reversed after earnings stability has been confirmed. Tesla’s US operations are far from stable with its new Austin plant operating at only 15% of capacity in 2022 and the Biden IRA subsidies leading to increased EV competition.
It also points to higher tax rates for Tesla in 2023 if US operations continue to be profitable. US pretax profits of $5.5bn in 2022 were 40% of global profits, which could impact EPS considerably if profits were to decline and see higher tax rates in 2023.
2023 Headwinds are Strong
Tesla’s situation from a cost perspective is quite dire this year. The key question is whether a 15% price cut can be overcome buy equal cuts in costs.
The simple answer is “not likely” and the main reason is that, aside from steel price declines (for now), not much else is coming down. Among the items that Zach (CFO) said would decline in 2023 are the following:
1) Supply chain costs
2) Logistics & “expedites” (rushed shipments at high rates)
3) Inefficiencies from the ramp up of the new Austin & Berlin factories
Supply Chain Costs: Regarding supply chain costs, there might be lower costs in China now that it’s reopened (parts prices were elevated due to the lockdown). But on the flip side, US parts suppliers are said to be raising wages as they’re all short of workers, which could impact Tesla’s component prices in the US.
Logistics: Logistics includes “expedites” which are basically shipping or air-freighting components at expensive rates due to urgency. While expedites may not be an issue this year, Nissan Motor just said on their earnings call that overall logistics costs will remain a headwind in 2023 due to too few workers in the railway, trucking and container sectors.
Inefficiencies May Fall at New Factories, but Fixed Costs will Rise: While inefficiencies at Tesla’s new factories in Germany and Texas may improve in 2023, fixed costs will definitely rise. Tesla needs to hire roughly 7,000 more workers at factories in Germany and Texas to achieve full production. Then there’s depreciation, which looks set to spike in 2023 as Tesla’s production capacity has nearly doubled with three new factories since 2020, yet depreciation of net property, plant and equipment has only risen by 85% (see figure 4).
Figure-4: Tesla’s PP&E Depreciation Up Less Than Capacity
Depreciation should rise by 54% this year, as Tesla doesn’t depreciate new equipment and tooling until they actually utilize them: The Austin and Berlin plants only ran at 15% of capacity last year, so there’s a lot to utilize with ensuing costs in 2023. The more they ramp, the more fixed costs rise until they reach 80% in capacity utilization (a level above break even for profits).
Lithium Could be a Good Excuse for Profit Declines: Tesla is likely ahead of most carmakers in lithium sourcing and long-term contracts, but their CFO did warn that some contracts are getting reset to current prices. There’s no disclosure on what percentage of Tesla’s lithium contracts will be re-negotiated and what those contracts were priced at up to now. But most of the contracts that have been reported by the press mostly show 2 to 3 year contracts with many set to run out in 2025, when some experts see a massive deficit in lithium supply. That’s bad news for costs as the current price of lithium has already risen by 758% since 2020.
Figure-5: China Lithium Hydroxide (USD/MT)
The cost of raw materials for the average car is around $2,000 depending on prices. So, if steel, copper or aluminum prices fall, it’s not a significant boost for Tesla’s profits. What is a big deal, however, is the cost of lithium and the chart below shows why. What used to cost only $584 per Model Y for lithium two years ago is now $6,154, based on current spot prices (see Figure-6).
Figure-6: Cost of Lithium Per Model Y
Tesla’s CFO addressed a question sent in by an investor who asked if Tesla’s hefty price cuts could lead to ASPs of $47,000 and Auto gross margins, ex-credit and leases, below 20%.
Zach CFO said “we believe that we’ll be above both metrics,” so essentially committed to over 20% in gross margins (ex-credit and leases). This is quite a proclamation, given rising costs, the old age of Tesla’s fleet and loads of new EVs hitting the market this year. Figure-7 shows Zach’s full response, which gives details on pricing, but sheds little light on cost cuts. Note the sudden pivot to Tesla’s Energy business growing faster this year, which makes operating margin Tesla’s preferred metric now. It’s as if he is trying to get investors to look away from Tesla’s core business.
Figure-7: Tesla CFO on Prices & Gross Margins in 2023
Price Cuts Need Cost Cuts for Profit Growth
On the face of it, Tesla cut global prices by 15% on average in early January. But Zach (CFO) played this down on the earnings call saying that, long backlogs “for most of 2022 at lower prices”, have already lowered the bar with Q4 ASPs (i.e. prices are already low, so can’t fall by double digits in Q1). But the price cuts in the US and China (67% of global sales) versus prices back in Q4 2021 show that the entry-level Model Y has undergone a 15.9% reduction in price.
To keep Auto gross margins (ex-credits and leases) above 20% on a mere 5% decline in ASPs to $47,600 in Q1 2023, Tesla would need to drop COGS/unit by 2% and grow volumes by 6% QoQ. This is no easy task given the ramp up of two new factories, sluggish demand in China and Europe and rising lithium contract prices. There are three simulations in Figure-9, with COGS/unit falling by 2%, then by 1% and then staying flat with Q4 2022’s level. Note that even if a 2% cut in costs is achieved ub Q1 this year, it would still lead to Auto gross profit (ex-credit and leases) to drop 16% versus Q4. Consensus sees Q1 2023 total Auto gross margins (including credits and leases) to rise 1.2% compared with Q4.
Figure-8: Tesla Needs to Reduce COGS/Unit by 2% in Q1
The Competition Begins to Matter
Finally, there’s the competition, which has not really harmed Tesla’s growth up to now. But the sheer number of new EVs being launched is astounding. By my count, there were 18 new EVs launched in the US last year and they’re all ramping up production this year. Another 31 new EVs are slated to be launched in the US in 2023.
Figure-9: Number of New EVs on US Roads
The timing of this wave of new EVs coincides with the new IRA subsidies for US car buyers and is helped by automotive chip supplies recovering at a faster pace. Since the chip shortage began in 2020, Tesla has been very nimble at using repurposed chips from appliances to keep production running (rivals had to wait over a year for quality/safety validation before following suit). Tesla benefited from rivals having to idle production due to the chip shortage and was able to hike prices by 27% in 2 years.
Larger supply of chips is bad for Tesla because of this. A clear sign that the chip shortage is easing up a bit was January’s US new car sales, which jumped by 18% MoM to a seasonally adjusted annual rate of 15.7m units (full-year 2022 sales amounted to only 13.9m units and anything above 16 million is healthy). Once there’s a full recovery in chip supply (most carmakers assume “by year end”, as they wrongly have every year since 2020), Tesla will face competition not only from rival EVs coming out, but also from regular ICE vehicles, which are seeing pent-up demand.
I’ll end this report with the list of new EV models launched in the US in 2022 and the scheduled introductions in 2023 for reference. Note that while not all of the SUVs listed below will compete with Tesla’s Model Y, there should be 31 new electric SUVs on the market by year end. This could put pressure on Tesla, especially given the decline in favorable views towards the Tesla brand among would-be buyers disgusted by Elon Musk’s political tweets and mass-firings at Twitter.
Thank you, but I accidentally posted the report in its incomplete format, so please take another look, as it includes more charts and tables (especially new EV launches in 2022 & 2023 at the end).
Tesla's warranty provisions in 2022 came to $1,052 per delivery, which is down 54% from 2018's level. Its accrued warranty reserves for 4-year cumulative deliveries 30% versus 2018.
This should lead to higher provisions in 2023, but Tesla has so many cost pressures that they might skimp on warranties. They've done it in the past.
Glad to see you transition to longform! I've followed you on Twitter for a while, but this seems a better way to understand all your Tesla writing in it's full context