Will Tesla’s Margins Surge In Q3?
Tesla (NASDAQ: TSLA) has become the world’s most valuable automaker by far with a market cap of over $400 billion, as its stock soared by about 5x this year. At current valuations, investors are counting on Tesla to continue robust delivery growth, while eventually posting industry-leading margins driven by higher software sales, improved economies of scale, and lower battery costs. Now, Tesla is mostly delivering on the growth front – deliveries soared by 43% year-over-year in Q3 2020. When the company publishes Q3 results this Wednesday, our focus will be on Tesla’s Operating Margins – which we expect will see considerable improvement, as Revenues continue to scale up with costs largely remaining under control. Below is a bit more on what to expect when the company reports earnings. See our analysis on Tesla Expenses: How Does Tesla Spend Its Money? for a detailed breakdown of Tesla’s costs.
Tesla has already published delivery figures for Q3, indicating that deliveries soared by 43% year-over-year to about 139k units in Q3 2020, likely driven by higher sales of Model 3 in China as Tesla scales up production at its Shanghai factory and by sales of the Model Y compact SUV which was launched earlier this year. While Average Selling Prices of Tesla’s vehicles could trend lower year-over-year, due to price adjustments and a higher mix of lower-priced Model 3 and Y sales, Revenues are still likely to trend significantly higher.
Now Tesla’s Gross Margins – defined as Revenues less direct costs – should benefit from higher software sales, as Tesla raised the price of its autopilot feature by $1,000 to $8,000 at the beginning of this quarter. Secondly, Tesla is likely to continue benefiting from stronger sales of emission credits. The company’s regulatory credit sales soared 4x in Q2 2020 likely driven by Tesla’s deal to sell about $2 billion in credits over 2020 and 2021 to Fiat Chrysler. 
Tesla has also been managing its fixed operating costs well. The company’s Selling, General & Administrative expenses have largely averaged about $650 million each quarter while R&D expenses have been trending lower. With soaring Revenues, the above-mentioned tailwinds for Gross Margins, and solid operating cost controls, Tesla’s Operating Margins should trend higher in Q3. For perspective, Operating Margins expanded from about -3% in Q2 2019 to about 5% in Q2 2020 and we think it’s likely that the metric will see a strong increase this quarter.
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