Over the past several years, Tesla (NASDAQ:TSLA) has posted massive profit growth. As recently as 2019, the electric vehicle pioneer was unprofitable under generally accepted accounting principles (GAAP) and barely breaking even on an adjusted basis. However, Tesla’s operating margin rose to 6.3% in 2020 and 12.1% in 2021, reaching nearly 15% in the second half of last year.
There’s a simple reason why Tesla suddenly jumped to the top of the auto industry in terms of profits: The company is selling a large number of vehicles on a single platform at high prices. Yet this fact is not widely accepted as the source of Tesla’s better fortune. Let’s take a look at what it means for Tesla going forward.
production and revenue growth
Tesla delivered more than 936,000 vehicles in 2021: 155% more than the 367,656 vehicles it delivered two years ago. The Model 3 sedan and Model Y crossover, which are built on the same platform, accounted for 97% of Tesla’s production last year. Deliveries of the Model S and Model X dropped to 24,980 (from a peak of over 100,000 a few years ago) due to prolonged production shutdowns.
Although some analysts expected the mix would hurt profitability by shifting from Model S and Model X, that didn’t happen. One big reason is that Tesla’s average selling price (ASP) has been pretty good.
Excluding vehicles under leases, Tesla’s ASP exceeded $50,000 in 2021, down nearly $6,000 from 2019, when the mix of priced Model S and Model X sales was much higher. As a result, automotive sales (again excluding leases) reached $44.1 billion, up from $26.4 billion in 2020 and $19.4 billion in 2019.
A recipe for fat margin
Selling about 1 million vehicles a year at an ASP of over $50,000 is clearly good for margins. This is especially true because the Model 3 and Model Y are built on the same platform and share many components. This significantly reduces complexity (and cost).
Image source: Tesla.
This is not exclusive to Tesla. heritage vehicle manufacturer General Motors (NYSE:GM) and Ford Motor Company There are high-volume businesses selling full-size trucks and SUVs (built on common platforms) at equally high prices. For example, GM regularly sells more than 1 million full-size trucks and SUVs annually in the US.
While neither company provides exact details, GM and Ford full-size truck/SUV franchises routinely generate operating margins in the 20% to 30% range, accounting for the bulk of both automakers’ profits.
Indeed, in the third quarter of 2020, when General Motors was operating its full-size truck and SUV plants at maximum capacity to rebuild inventory while not fully restocking production of some less popular models, GM Posted a 15% operating margin in North America. The main reason its margins are usually low is because the rest of its business is far less profitable.
What does this mean for Tesla?
Tesla’s strong momentum is likely to continue into 2022. The company forecasts that it will grow sales at a compound annual growth rate of about 50% for the foreseeable future. Unless supply constraints worsen dramatically, it should have no trouble hitting that growth rate this year. Tesla is citing longer wait times for many models, suggesting that demand exceeds supply.
Like most businesses, Tesla faces rising costs. But there has been no problem in raising prices to make up for it. The cheapest Model 3 being sold on its website now has a base price of $44,990. The Model Y starts at around $60,000, and costs upwards of about $80,000 (including the “full self-driving” package). Furthermore, only the more expensive models are available for near-term delivery, with cheaper versions with estimated delivery dates in the fourth quarter. This should support further margin expansion in 2022.
Image source: Tesla.
Looking ahead, the outlook is cloudy. For now, supply constraints are preventing the auto industry from meeting demand, causing prices to skyrocket. The average transaction value for US auto sales recently exceeded $45,000. In this context, it would come as no surprise if Tesla could push its ASP back toward $60,000 this year, while boosting the combined deliveries of the Model 3 and Model Y by more than 1 million.
As supply constraints ease, auto prices will retreat. Other brands will try to break Tesla’s grip on the EV market by offering reasonably capable options at very low prices. (For example, GM is using a Chevy Equinox EV starting at about $30,000 that will arrive in the fall of 2023.)
To continue rapidly growing unit sales, Tesla will need to expand its vehicle lineup, including a cheaper entry-level vehicle. But offering a wider choice of models will add cost and complexity, while competing forces will cause Tesla’s ASP to decline.
Tesla is still poised for strong earnings growth as it achieves massive gains in the years ahead. However, even after its recent pullback, Tesla stock trades for 77 times forward earnings. That valuation will be tough to live up to, given the margin headwinds it will inevitably face as it broadens its product lineup over time.
This article represents the opinion of the author, who may disagree with the Motley Fool Premium Advisory Service’s “official” recommendation status. We are Motivate! Questioning an investment thesis — even our own — helps us all to think critically about investing and make decisions that help us become smart, happy, and wealthy.
