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Investing, Stocks  | February 15, 2019

Summary

  • Deliveries of Tesla Model 3 sedans fell badly in January. Big job cuts to Tesla's delivery team in the US suggest the slump is far from a one-off.
  • Deliveries have started in Europe, while vehicles also are being shipped to China.
  • Demand in Europe has so far come in below expectations. Reports indicate extremely low Chinese demand.
  • With the North American backlog exhausted and international markets failing to pick up the slack, Tesla is in for a very nasty Q1.

Tesla (TSLA) is fundamentally a growth stock story. Its huge market capitalization is based upon the premise that it will radically increase the production of its electric vehicles and that it will become wildly profitable in a very short period of time. A key hinge of that narrative was the introduction of the Model 3 sedan, which was supposed to become the company’s first mass-market product. Boosters touted a vast pre-order book as evidence of massive demand, declaring that it would take years to work through the backlog.

That narrative has essentially collapsed. Indeed, the North American reservation book has long been exhausted. Meanwhile, demand in Europe and China appear to be quite sluggish. As the reality of lower demand sets in, expect the promise-driven share price to fall precipitously.

What Reservations?

esla has spent years plugging the narrative that demand for the Model 3 is essentially infinite, repeatedly citing its 450,000-strong pre-order book. Even Bloomberg’s Model 3 Tracker, which purports to model production, claims as much:

“Tesla has accomplished something no other automaker can claim: It's made a relatively affordable electric car, the Model 3, that hundreds of thousands of people are lining up to buy. The only problem is that Elon Musk and company can’t produce enough of them.”

Musk has taken to Twitter on several occasions to reassert the demand story, touting the huge preorder book time and again. These claims have been repeated numerous times in Tesla’s recent quarterly shareholder letters.

Despite these claims, signs have been pointing to slowing demand for some time, with Tesla pulling numerous demand levers in recent months to try to increase sales volume. In Q4 2018, Tesla introduced a cheaper, lower-margin mid-range version of the car that helped boost volume but also cut into margins. Q4 also was the last quarter in which buyers could avail themselves of the full $7,500 federal tax credit, which most analysts agreed would help pull forward demand. Despite those demand tailwinds to Q4, deliveries rose just 13% from the previous quarter.

In January, after months of denial, Tesla finally owned up to the exhausted reservation book. On the Q4 earnings call, Musk and CFO Deepak Ahuja declared that they were not thinking about reservations anymore, pointedly refusing to address a subject once near and dear to their hearts.

North American Demand Collapse

As 2019 wound to a close, a number of Wall Street analysts sounded the alarm. In a December analyst note, Goldman Sachs warned of an imminent “lull in demand.” Tesla’s boosters scoffed at this notion, yet January already has seen signs of rapidly deteriorating demand in the North American market, with estimated deliveries falling massively.

According to estimates from InsideEVs, Tesla delivered just 6,500 Model 3s in the first month of 2019. A visualization of this, courtesy of Twitter’s TeslaCharts, shows just how bad this is:

Things have evidently not picked up since then. Recent reports have revealed that the mass layoffs announced in January essentially “gutted” Tesla’s US delivery team. In Q3 2018, Tesla welcomed scores of volunteers to help it make deliveries. Evidently demand has declined sufficiently that half the professional staff is no longer needed, let alone the amateur delivery aid.

Tesla cut prices on all models by $2,000 in the US at the start of January, but this has apparently failed to juice up demand. Instead, it appears that the pent-up demand has been largely exhausted.

International Markets Offer Little Succor

As the North American demand situation has darkened, Tesla and its supporters have transferred their attention and hopes to the international markets, especially Europe and China.

In its latest deliveries estimate report, InsideEVs editorialized that the January dropoff was likely due in large part to vehicles being made for shipment abroad, rather than to domestic buyers. Of course, that hardly comports with the data showing significant inventory buildups in the US, irrespective of the recent shipments to Europe and China.

But these international destinations appear to be offering little in the way of relief to Tesla’s demand problems. In Europe, only about 20,000 Model 3 orders have been identified, barely a month’s worth of production. That is far from the demand rush Tesla had hoped for.

Adding to the woe is concern among EU regulators about Tesla’s Autopilot driver-assist system. Restrictions remain, and this has likely eaten even further into margins, since the software package offered nearly 100% margin.

The situation is China is even grimmer. Instead of being restricted from selling the full Autopilot and Enhanced Autopilot functionality as has happened in Europe, Tesla appears to be giving the upgrades away. With reports of demand only in the hundreds, there is little hope Chinese demand will be able to pick up much, if any, of the slack.

Investor’s Eye View

Things look set to get increasingly bad for Tesla in 2019. With the U.S. and Canadian order backlog exhausted, the steady-state demand rate is far below the 5,000 units per week Musk has claimed the North American market could absorb. The "gutting" of its US delivery team offers further strong evidence that the recent demand drop is a secular decline, and not merely the result of product being shipped abroad.

At the same time, the relatively soft demand in Europe and China compounds the conclusion that the Model 3 is essentially demand constrained at a volume far below market expectations. That is a big problem for a company priced for huge growth.

As the low demand reality sets in, Tesla’s rarefied stock price will come crashing back to earth.


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