Tesla's Q1 Profits Could Beat But 2023 EPS Should Plunge by 35%

Consensus is a bit low for Q1, but overly optimistic for the full year as Tesla continues to cut prices and likely won't stop

This is the trickiest quarter to estimate Tesla’s earnings due to so many moving parts and profitability mattering more than actual EPS. Here are the three major factors which need to be nailed down:

• 15% price cuts in January may only lead to 7% sequential declines in average selling prices (ASPs), as Tesla has guided for ASPs to be over $47,000

• Costs per vehicle need to come down but it’s difficult to see significant reductions and Tesla has guided for over 20% in the Automotive gross margin, ex-leases and ex-credits

• How will Tesla book subsidies from America’s new Inflation Reduction Act (IRA) for its battery packs? Given that it’s a subsidy or “credit”, it should be booked along with regulatory credits that Tesla earns. But this would make its target of 20% Automotive gross margin, ex-leases and ex-credits, harder to attain

• The most important metric of Tesla’s Q1 results will not be how much EPS beat or missed consensus estimates. It will be whether Tesla was able to generate over 20% in Automotive gross margins, excluding leases and regulatory credits (it was 23.8% in Q4 2022 prior to the price cuts).

• This is because Tesla’s CFO, Zach Kirkhorn, assured investors on the last earnings call that Tesla could do so. The reason that this guidance is so important is that Tesla had just cut global prices on its line-up by up to 20% prior to the earnings call and investors were worried about profitability.

To soothe these concerns, Kirkhorn hand-picked a question from retail investors, emailed prior to the call, asking if Tesla could actually maintain an Automotive gross margin, ex-leases and credits, above 20% if ASPs were $47,000. He said that Tesla would be “above” both metrics. Whether this goes for Q1 or the full year is ambiguous, especially after Tesla cut prices globally by another 6% or so in mid-April.

Given all the financial levers Tesla has at its disposal, the odds that Tesla pulls off booking higher than $47,000 in ASPs and above 20% pure Automotive gross margins are high, despite further price cuts in Q1 following this commitment. And it’s actually possible due largely to currency tailwinds and low hurdles based on the actual selling price of Tesla cars last year.

ASPs Should be $48,000 in Q1

The weighted average price cut at Tesla—mainly that of the Model Y (68% of sales) and Model 3 (29% of sales)—came to 15% when they were announced on January 13^th. If you reduce Q4 2022’s pure Automotive revenues per unit of $51,305 (ex-credit, ex-lease and ex-FSD revenue recognition) by 15% QoQ in Q1 2023, you get an ASP of $43,609, which is below guidance of “over” $47,000.

Zach said that most of the last year’s deliveries were ordered at much lower prices, i.e., before Tesla raised prices by 7% in March and another 5% in June 2022. So, while the January 13^th price cuts amount to a 15% reduction, the true decline in ASPs may be much smaller.

As of March 25^th, last year, Tesla was showing 11 to 14-month lead times for Model Y deliveries. If you compare the price cuts to January 2022 levels, the weighted average price cut made on January 13^th comes down to only a 7% QoQ decline, which gets you to $47,714 (see Figure-2). Add foreign currency tailwinds of around $250 million and IRA subsidies for battery packs of $322 million (this assumes Tesla books IRA subsidies in Automotive revenues rather than Regulatory Credits) and one can arrive at an ASP of $48,000 in Q1.

Figure-1: Price Declines May Not That Large Yet in Q1

Q1 Costs Per Vehicle: Lithium & Nickel Costs Still Weigh

Tesla’s Largest Cost Factor: Lithium

The largest cost component of Tesla’s cars is lithium. Based on spot prices of South Korean lithium hydroxide in Q4 2022, the cost of lithium per Model Y produced was $4,829. With the recent drop in Korean spot prices, the lithium cost per Model Y is still high at $4,330, albeit down 10% QoQ. Tesla’s CFO said on the January 25^th earnings call that the lithium cost per car would rise in 2023.

At the time of the earnings call, USD spot prices of lithium hydroxide in China had fallen by 11% from their December peak, the Korean spot prices had dropped by 6% and the London Metal Exchange (LME)’s price had fallen by 5% from November peaks. Since the earnings call, Chinese spot prices have plunged by 49%, Korean spot prices have fallen another 14% and the LME price is down by 37%.

It’s impossible to estimate how much Tesla’s battery cell suppliers are paying for lithium. Some may think that the massive drop in China’s lithium prices may lead to higher earnings this year, but lithium experts point out that China’s spot prices don’t necessarily reflect the rest of the world’s prices. For example, the current lithium hydroxide spot price in China is $37/kg, while the price in Korea is $66/kg and that of the LME is $51/kg. 

The key point is that Tesla’s CFO said on the earnings call that Tesla is not “fully exposed to lithium prices”, which implies that much of their lithium supplies are in fixed, long-term contracts. There were many cost headwinds for Tesla in 2022, including freight, logistics, losses on in-house battery cell production, as well as currency headwinds. But the fact that Tesla’s COGS/unit in 2022 only rose by 9%, despite the price of lithium having ballooned by 168%, shows that Tesla’s lithium supply was under fixed contract prices. Whatever portion of lithium that Tesla does source in the open market at current levels will certainly lead to cost reductions.

However, this could be offset by multiple long-term contracts that are being re-set this year to current market prices. Any of these contracts that were made before 2022 could actually see the lithium cost per vehicle spike by 395% to 632% versus the low prices Tesla locked into during 2020 and 2021 (note the costs in Q1 of 2020 and 2021 in Figure-3).

Figure-2: Difference in Lithium Prices in China & Korea

Nickel, another key battery material, is possibly the second highest cost component for Tesla and they’ve risen from $1,327 per Model Y in Q3 2022, to $1,413 in Q4 2022 to $1,561 in Q1 2023, based on average quarterly spot prices. This could offset any savings from lower costs of steel, aluminum, logistics and freight, which Tesla said were coming down in Q1 2023.

Based on the above analysis, a generous assumption for Q1 2023 COGS/unit is a 2% QoQ decline to $38,959, which is 7% higher than the average $36,000 of COGS/unit seen between Q3 2021 and Q1 2022.

IRA Credits Will Boost 2023 Profits by $1.4 Billion

Elon Musk said that Tesla and Panasonic would be “sharing” the IRA credits for battery packs, which is strange given the fact that the IRA subsidies for battery cells is $35/kWh and those for the pack are $10/kWh. In other words, Tesla is getting half despite only producing 22% of the content while Panasonic makes 78% of it. We should know more details on the split between the two companies after they report Q1 results.

While there are still questions about whether EV makers will be able to book these credits in Q1, Korean battery cell maker LG Energy Solution already disclosed their booking of IRA credits in Q1. LG booked their IRA subsidies directly to operating profit (not to revenues), but it should be noted that LG uses IFRS accounting standards, unlike Tesla.

As to where in the income statement Tesla books the subsidies, the odds that they book them to Automotive revenues is high, as Tesla’s Q1 commitment was to be “over” 20% Automotive gross margin, ex-leases and ex-credits. If Tesla were to book IRA subsidies in regulatory credits, it would possibly make its 20% margin target harder to attain.

Figure-3 shows estimates for Tesla’s IRA credits booked by US factory sales. It assumes full $45/kWh for the 4680 packs Tesla produces (yields appear to only be 38% as of January) and $22.5/kWh for any packs produced at the Nevada battery plant.

Note that full year IRA credits of $1.39 billion accounts for 17% of my net profit estimate of $8.1 billion, which is 34% of consensus estimates (see Figure-4).

Figure-3: Tesla IRA Credit Estimates for 2023

Q1 Profits Should Beat Consensus Estimates

Excluding leased vehicles, Q1 retail deliveries only grew by 3.3% QoQ. Assuming a 6.5% decline in Q1 ASPs versus Q4 2022 (Tesla has good currency tailwinds from the yuan and the euro) and a 2% decline in COGS/unit, Tesla should see pure Automotive gross margins (ex-leases and credits) of 21.7%.

This leads to revenue estimates that are 3.4% higher than consensus, with total gross margin of 21.6%, which is only slightly above consensus.  Nevertheless, this leads to an operating profit estimate of $3.3 billion, which is 10% above consensus, and because of higher net non-operating income estimates (higher interest income and currency tailwinds), pretax profit is 11% above consensus. GAAP net profit should be 19% above consensus, while non-GAAP net profit is 18% above the Street’s estimates. This may be due to consensus tax rate being higher than my estimates of 9.5%.

While this sounds like a huge beat, I remain bearish and still own long-dated Tesla puts. These results would still show that profits have declined by 7% YoY and with another 6% price cuts this week, Q2 should be even worse:  my Q2 GAAP net profit estimates are currently 10% below consensus, with full-year estimates 34% below the Street.

I expect the Q1 earnings call to be tough for Musk and his CFO in terms of explaining how Tesla can grow profits this year. And this is what might cause the stock to drop, even if Tesla does produce an earnings beat.

Figure-4: Q1 Earnings Estimates Versus Consensus

2023 Full-Year Outlook: Net Profit Should Miss by 34%

Consensus estimates of $12.2 billion in GAAP net profit assumes only a 3% YoY decline from 2022’s net profit of $12.6 billion. This is absurd given the huge price cuts that have occurred since the start of this year and continued high inventory levels. Tesla’s April 12^th global price cuts of around 6% ensures that ASPs will undershoot Tesla’s guidance of “above $47,000” and pure Automotive gross margin of “above 20%”.

Figure-6 shows full-year earnings estimates and Figure-7 shows cash flow estimates for 2023. The major assumptions behind these estimates are largely as follows:

• Tesla will continue to cut prices each quarter, not only because their model line-up has become stale, but also because most rivals’ new EV launches this year are targeting Tesla’s Model Y, which is now 68% of global deliveries

• Chip supply is gradually increasing, as is reflected in 5 and 8 months of consecutive YoY growth in passenger car sales in both the EU and US, respectively. This means that car buyers will have more alternatives not only when it comes to EVs, but also if ICE vehicle offerings are more affordable or attractive

• Tesla will likely produce 1.83 million vehicles this year, while only being able to sell 1.7 million units. The need to keep Tesla’s two new factories running will create a major drag on free cash flow, which should be negative in Q4, by my estimates. Fully year FCF should decline by 83% to $1.3 billion, as profitability declines while Tesla needs to invest in the Cybertruck ramp of production, as well as multiple new factories.  

• While COGS/unit may come down by 9% YoY, ASPs should fall by 17% YoY which will lead to a high deterioration in profitability. By 2023 end, my estimated operating margin of 9.1% could knock Tesla off its throne of having “industry leading” profitability.

• These assumptions don’t include possibly huge losses on Tesla’s resale value guarantee deals, which could add extra downside to earnings. Used 2021 Model Ys are selling at 29% below what they sold for pre-price cuts. A one-year used Model 3 in the UK has seen price declines of 30%

Figure-5: Tesla 2023 Earnings Estimates

Figure-6: Tesla 2023 Cash Flow Estimates

While Tesla may beat Q1 consensus estimates, much of how the share price reacts depends on the earnings call. There have been many times where Tesla beat estimates, only to have the stock crash the next day due to comments by Elon Musk or more sober outlooks on guidance by Tesla’s CFO.

What is certain is this: No carmaker lowers prices unless there is a demand problem. And through the 5 price cuts enacted during the first 4 months of this year, it is completely clear that Tesla faces a lack of demand for its aging line-up. Next year’s launch of the Cybertruck will be a high-priced, low-volume product that will only have a marginal contribution to profits in its first year due to ramp-up costs.

The question is whether Tesla can survive until its next-generation model announced—but not unveiled even in CGI format—at Tesla’s IR Day on March 1^st. Given the fact that not even clay mockups or CGI pictures of the next-generation model were shown proves that it’s in early stages of development, which means it may not hit the market for another 2 to 3 years. That’s a lot of time when you’re burning cash.

The views expressed in this report are not investment advice.