CoverDrive Updates His Q3 Forecast
It’s no secret that one of my favorite Seeking Alpha members is CoverDrive. I appreciate his deep knowledge of the auto industry and enjoy his wry sense of humor.
What I like most, though, is that he systematically compiles data, goes where that data takes him, and is afflicted with few of the cognitive biases that blind many of us.
In early September, CoverDrive shared his tentative earnings forecast for Q3. Laying out his assumptions in an admirably clear fashion, CoverDrive penciled in a GAAP operating loss of $ 543 million.
Eight weeks have passed, Tesla (NASDAQ:TSLA) has revised its sales strategy (with more price cuts and model shifts), and more data has become available. In the spirit of Keynes, when the facts change, CoverDrive changes his forecasts.
As before, CoverDrive assumes that in most respects, Q2 will look exactly like Q3. As before, he sees a 5% increase in SG&A expenses even though Tesla guided for them to remain flat.
And, as before, CoverDrive assumes ZEV credits in Q3 will go to zero, as Tesla will bank the credits instead of selling them.
So, what inputs have changed since the last forecast?
CoverDrive earlier assumed the same number of Q3 Model S and Model X deliveries as Q2 (22,000). However, the significant price cuts since then have prompted him to forecast 14,000 deliveries for the Model S and 12,500 for the Model X.
Yes, 26,500. A new record. And that’s not even counting Model 3 deliveries.
CoverDrive earlier forecast a 3% drop in the average sales price. Now, though, with even more aggressive discounting and a continued shift among Model S buyers to the 75kWh models, he assumes the ASP will decrease by 4%.
These changes ripple through the revenue and cost categories. As we head into the home stretch of Q3, here are the revised numbers:
That’s a better outcome than CoverDrive saw two months ago, when he forecast $ 543 million in Q3 losses (which translated to a GAAP per-share loss of $ 3.29).
The Analysts Play Catch-Up
Will CoverDrive hit the nail on the head with his EPS estimate?
Surely not. But he will have done far better than most of Tesla’s analysts. Their forecasts have been coming down dramatically in recent weeks as they converge with those of CoverDrive.
Interestingly, there is no longer any institutional analyst covering Tesla who forecasts a profit in 2018, never mind 2017, even though only a year ago almost all them saw Tesla becoming profitable next year.
For instance, Goldman Sachs, which last year forecast earnings in 2018 of $ 706 million, now instead sees a 2018 loss of $ 727 million. That’s a swing of more than $ 1.4 billion.
Let that sink in a moment. $ 1.4 billion. In just over a year’s time, Goldman Sachs (a key Tesla underwriter from the beginning) has massively slashed its forecast of Tesla’s prospects.
The bullish Tesla analysts have time after time been wildly optimistic with their forecasts. But even when, as invariably happens, the unfolding of events reveals their expectations to have been exuberantly unrealistic, those analysts remain intensely bullish, with price targets that either hold steady or rise.
(Despair not, Tesla longs. There remains at least one “analyst” who is still forecasting Tesla profitability in 2018. And, for Q3 of this year, that same analyst forecasts Tesla losses as $ 220 million lower than those estimated by CoverDrive.)
The Wild Cards: Regulatory Credits and NCIs
Are there some wild cards here? You bet.
As always, there is the ZEV and other regulatory credit wild card. Last year the ZEV credits totaled $ 215 million and the GHG/CAFE credits (which Elon Musk called “mouse nuts”) totaled another $ 87 million. That adds up to $ 302 million for the year, or about $ 76 million per quarter.
Tesla recorded $ 104 million of such revenue in Q2. But CoverDrive assumes zero ZEV and other regulatory credit revenues in Q3. Why? Because of Tesla’s history of storing up such credits over several quarters and then concentrating the sales in a single quarter.
It’s surely possible, though, that Tesla has sold more regulatory credits in Q3 and thereby reduced the operating loss.
In the opposite direction is the adjustment for “non-controlling interests,” which shifts some of SolarCity’s losses to third parties. In Q2, the loss shift totaled $ 65 million, and CoverDrive, in what he admits is a moment of agnosticism, assumed the same thing would happen in Q3.
Will that happen? Like CoverDrive, I have no idea. Neither of us paid attention to SolarCity’s financial reporting before it was acquired, and both of us find aspects of its accounting utterly inscrutable.
I asked Seeking Alpha Contributor Bill Cunningham, who has spent lots of time puzzling through the SolarCity financials, to weigh in. He believes the loss shifting happens when SolarCity securitizes some of its financial assets, but (much to his credit) acknowledged that he, too, has yet to crack the code of SolarCity’s non-controlling interest loss shifting.
All things considered, the safest course is to assume the loss-shifting will keep on keeping on, and that’s what CoverDrive has done. But to the extent the shift is less than $ 65 million, Tesla’s losses will be correspondingly higher.
What About the Model 3?
How many Model 3s will Tesla deliver? As Bill Maurer reminded us this morning, Tesla’s most recent guidance is 1,630 (30 in July, 100 in August, 1,500 in September).
Is Tesla likely to meet this guidance? We can only guess. The early buyers have been Tesla employees or insiders, and their purchases are reportedly subject to non-disclosure agreements. A recent comment by Seeking Alpha member “out for now” details what appear to be concerted efforts by Tesla to keep details of Model 3 problems from being publicly disclosed.
(And, indeed, Model 3 YouTube postings continue to disappear.)
However, the actual number of Model 3 deliveries are of little consequence to CoverDrive’s financial estimates, as he assumes the Model 3 deliveries will be, essentially, “income neutral” (that is, all revenues offset by an approximately equal amount of expenses).
The Model 3 Rollout Is Looking Like a Disaster
Even though it’s impossible to get official information about the Model 3 rollout, there is a new source of anecdotal data: the web forum of the Model 3 Owners Club.
To date, the highest Model 3 VIN reported by club members is No. 250. The low number suggests Tesla is struggling with this launch, just as it struggled with the launches of the Model S and Model X.
The difficulties should surprise no one. Here’s CoverDrive:
I suspect Tesla had to stop the Model 3 production line to address quality issues. It’s an unbelievably poor launch for any modern car company. But for a technology company that skips the Beta (Design Validation) phase, it’s perfectly understandable.
At the risk of repeating myself, skipping the Beta phase is the most foolhardy thing a car company can possibly do. It’s the phase where you discover and address “irreversible corrective action” for all the issues modeling and simulation fail to predict.
At the successful completion of the Beta phase, you can execute a “flawless launch,” which is the expectation of every car manufacturer except Tesla. Tesla expects “manufacturing hell.” Unbelievable!
There is a vast chasm between Tesla’s share price and the company’s fundamentals; a vast chasm between the rhetoric and the reality.
As with so many other risks, Tesla’s share price does not reflect the very real risk of a botched Model 3 rollout resulting from the decision to foreshorten Beta testing.
Will the market remain supine and satisfied, even with a botched Model 3 rollout? Anton Wahlman recently explored that question.
I don’t know the answer. But, I believe, we now have evidence that the Model 3 may be in real trouble. I expect at the next earnings call Musk will do all he can to duck and dodge questions about the exact number of net Model 3 deposits (net of refunds requested but not yet processed).
Is it now safe to short Tesla? No, not quite yet. But the day approaches. In the meantime, proceed with caution.
Let’s Remember the Pie in the Face
We all remember the third quarter a year ago. In July, Elon Musk published his famous “pie-in-the-face” memo, urging Tesla employees to strain every nerve so that Tesla could show a profit and embarrass its critics.
And, indeed, in Q3 2016, Tesla achieved a $ 22 million profit on the strength of 24,821 deliveries.
Here we are, a year later. CoverDrive forecasts Tesla will exceed its deliveries from Q3 2016 by 1,500 or so (excluding the Model 3 deliveries). Should we not then expect an even greater profit than $ 22 million?
And yet, instead, Tesla will set a new quarterly record with some half-billion dollars of losses.
Why has this happened? It’s happened in part because the Q3 2016 profit was artificial to begin with (achieved by cashing in an impressive stock of hoarded regulatory credits). But there are two larger reasons.
First, weakening demand has compelled Tesla to slash prices and thereby reduce margins.
Second, Tesla car buyers, especially Model S buyers, are increasingly opting for lower price, lower performance versions. Here are charts prepared by CoverDrive illustrating what’s happened to Model S purchasing patterns in the first three quarters and what he sees happening in the fourth:
Pie in the face? How about, Pie chart in the face?
Who Killed the S75?
Looking at those pie charts, CoverDrive asks this question, and offers a theory:
Who killed the S75? It’s not being killed because it’s unpopular like the S40 was. In fact, 30% of Model S orders in Q3 were for S75.
Maybe Tesla feels it can convert potential customers to S75Ds. Or maybe Model 3s are soon to be in ample supply? Whatever the case, Tesla surely would not want to disenfranchise 30% of its customers.
I suspect there’s an ulterior motive for killing the S75. I think their CPO and RVG programs are in big, big trouble due to lower residual values. Why would you spend $ 60k on a used car when you could buy a new one for $ 70k and trouser the FIT credit?
By killing the S75, Tesla has essentially just raised residual values by $ 5k. So much of Tesla’s business model relies on high residual values. The good news is that the Model S gross margin should improve even if gross profit is reduced through lower sales.
The good news of higher gross margin despite lower gross profit. As I said at the outset, CoverDrive has a wry sense of humor.
Disclosure: I am/we are short TSLA.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: I am short TSLA via long-dated options