Tesla's Q1 Results Disappoint & Confirm Deteriorating Fundamentals

Elon Musk vowed to sacrifice profitability in order to expand Tesla's Fleet which will benefit once Full Self-Driving is complete. This is a weak argument for further price cuts

Tesla Q1 Earnings Were Weak & Point to Further Downside in 2023

While Tesla printed an adjusted EPS of $0.85 that was in line with consensus, its Q1 results were a huge disappointment, especially the undershooting of Automotive gross margin estimates and the 83% miss of consensus free cash flow (FCF) estimates. Guidance of 1.8 million in production this year is unchanged but, once again, there was no guidance on full-year deliveries, which continue to undershoot production.

Elon Musk emphasized that Tesla will sacrifice profits in order to produce more cars. The general message of the entire earnings call was that short-term pains of lower profitability will lead to future gains, when Tesla solves Full Self-Driving (FSD) and everyone buys FSD. This sounds like a prelude to further price cuts and may not be taken well by the market. Even worse: Musk refused to answer a question on how much the current FSD take rate is.

Below are the highlights of the results and comments Tesla made on the earnings call. Tesla’s Q1 results versus consensus can be seen in Figure-1 below.

Figure-1: Tesla’s Q1 Results Vs Consensus Estimates

• Automotive Gross Margin Miss: The key metric of Automotive gross margin, ex-leases and credits, came in at 18.3% versus guidance of “over 20%” on the last earnings call. Tesla’s CFO explained that half of the shortfall was due to further price cuts in the 2H of Q1, while the other half were one-offs related to increased warranty reserves for older Model S/X and deferred Autopilot revenues. Given that Tesla’s warranty provisions had fallen to a record low of $1,056/unit in 2022 (54% below 2018 levels of $2,315/unit), warranty reserves being a “one-off” headwind is hard to believe, especially given increasing quality problems.

• Gross Margin Target of 20% Removed for the Full Year: In the Q&A, Tesla’s CFO refused to answer a question on full-year Automotive gross margin, ex-leases and credits, saying there are a lot of macro uncertainties, too many macro headwinds & tailwinds, etc. It leaves the impression that Tesla itself doesn’t know how much further they need to cut prices and therefore won’t commit to any margin targets for the full year.

• Ex-Credit FCF Was Negative: Operating cash flow missed consensus estimates by 44%, while capex was 15% higher than expected. This led to a FCF miss of 83%. Excluding regulatory credits of $521 million, Tesla actually had negative FCF of $80 million in Q1. Working capital appears to have halved to -$928 million in Q1, so that may not be the issue. We’ll know more once the 10-Q is released, as today’s numbers don’t give a full breakdown of cash flows.

• Cybertruck Launch Will Be Difficult: While Musk still aims for Cybertruck production to start “later this year” (there will be a “delivery event probably in Q3”, he mentioned), he gave some warning about how the uniqueness of the model might entail complexities in the production ramp. This is most likely because it will be the first time Tesla produces a pick-up truck with rear-wheel steering and also the first time they use stainless steel for the body, which is difficult to use in production. Musk sounded as if he was trying to tame expectations of a smooth ramp by year end.

• Plunge in Lithium Prices Not Much of a Positive for Tesla: While Tesla’s CFO said that the lower lithium price would help lower costs in Q2, all other comments from the supply chain officials on the call confirmed that Tesla won’t benefit that much from the 50%+ drop in the lithium price. This confirms that Tesla is locked into long-term fixed contracts and they admitted they have little exposure to spot prices.

• Megapack Gross Margin Outlook Disappoints: While Tesla said that, in the long term, its Megapack product should see “mid-20%” levels of gross margins, the bulls on Tesla’s Megapack product were expecting 40%-50% gross margins. What’s more is that the Energy division’s revenues grew by 17% QoQ, but the gross margin deteriorated to 11% in Q1 versus 12% in Q4 2022, which isn’t a great sign, given the growth.

• No Mention of IRA Credits for Battery Packs: While I had estimated that Tesla would generate $322 million in IRA credits earmarked for battery packs, there was no disclosure of IRA credits in the Q1 Shareholder Deck or on the conference call. If the 10-Q discloses that Tesla did indeed book IRA credits, it could have a negative impact on the stock, as the results were weak enough and would be even weaker if IRA credits are stripped out. On the Q4 2022 earnings call in January, Tesla’s CFO said he expected these IRA credits to be $150 million to $250 million per quarter.

My estimates were overly optimistic in Q1 due mainly to 3 factors: estimating a $250 million currency tailwind, having ASP assumptions of $47,965 versus the actual Q1 ASP of $47,134 and including $330 million of IRA credits in Automotive revenues, which led to my Automotive revenue estimates being 5% higher than Tesla’s actual result.

Applying the 12% price cuts of the Model Y in the US and 6% in other regions, my current Q2 GAAP net profit estimate is $2.1 billion, which is 25% below consensus estimates of $2.8 billion. After today’s results and earnings call, both Q2 and full-year consensus will undoubtedly come down. And this should weigh on the stock.

Excluding regulatory credits, Tesla only generated a 9.4% operating margin in Q1, which is a low not seen since Q2 2021. It is also half of Porsche’s expected 18% operating margin this year and Porsche only trades at a 20x forward PER. Tesla trades at 92x my 2023 GAAP net profit estimates. And it’s hard to see how earnings grow in 2024 even if the Cybertruck does contribute to profits, as sagging Model 3/Y sales (97% of Q1 deliveries) will likely drag down earnings next year.

None of my views in this report should be taken as investment advice.