It wouldn’t be the end of the road for investors riding all along with Tesla Inc. (TSLA), even if the company remained unprofitable and operating cash flow negative for some extended periods. It’s still less than 10 years since the company’s IPO, while 20-plus years onward, Amazon.com Inc. (AMZN) has yet to make its core e-commerce a dominant profit center, which at the moment seemingly belongs to its more auxiliary cloud computing.
Still a relatively new company by comparison, Tesla remains in a period of heavy investments, with all the innovations and pioneering it’s leading. Competitors are scrambling to react in earnest, kind of a validation for what Tesla is doing. The question is not if Tesla will be ever around to lead, but at what levels of losses before its sales can finally take off and both investment and operating costs over time subside–two basic, opposing elements in the equation for profitability and positive cash flow.
Less Production Means Less Sales and Potentially No Profits: It’s That Simple!
There seem to be an ugly truth here: Tesla has a brilliant product and design without a doubt, but hasn’t had quite the magic to mass produce it as fast as everyone would like to see. Who else has an arguably brilliant product and design but has figured out how to bring it to market in tens or even hundreds of millions of units every year? Apple! But what would have happened if contract manufacturing for the iPhone was not available? Think Apple Inc. (AAPL) could do better than Tesla in the event of a “production hell” when having to mass produce all the iPhones by itself? Who knows!
Well, it may be daring to imagine what kind of manufacturing help Tesla might or should get from the outside, it requires no bravery for investors to just keep a watchful eye on the company’s production targets. Until Tesla can churn out its cars fast and furious, becoming profitable and cash flow positive remains a mathematical challenge. To recoup prior and ongoing capital investments, you need enough sales to offset annual depreciation charges at last. MACRS assigns a relatively shorter class life and recovery period of 7 to 10 years to manufacture of motor vehicles. So, a lot more cars have to be there to allow much higher sales to fully cover the fixed investment costs being allocated in such an accelerated fashion. Only then, Tesla may claim a profit for every car made.
The Math is Adding up in Tesla’s Favor
The following is how the math should work for Tesla, starting with break-even. First, add up the cost of revenue for automotive sales and the portion of operating expenses attributable to automotive sales, including automotive-related depreciation. Next, work backward by using the combined cost of revenue and operating expenses as the reference for break-even sales to derive the correspondent annual production units and a weekly production target based on a preset unit-vehicle sales price. Anything beyond the target numbers of production and sales would potentially lead to profitability.
In 2017, Tesla’s cost of revenue for automotive sales was $6,724,480,000 and automotive-attributable operating expenses were approximated as 72.6% (the percentage of automotive sales over total revenues in 2017) of the total operating expenses of $3,854,573,000, equal to about $2,797,731,000. Thus, Tesla’s combined automotive cost of revenue and operating expenses stood at $9,522,211,000 in 2017. If using Model 3’s base price of $35,000 as the unit-vehicle sales price, just to be on the more conservative side, Tesla would have to produce 272,064 cars a year, or 5,232 a week, before earning a profit.
Investor Note
A weekly production in the 5,000 range around break-even point sounds very familiar, doesn’t it? Now, we can understand why Tesla went all out to try to meet the target of producing 5,000 cars a week: just to set itself up for profitability. Having reached the 5,000 milestone by last quarter end, what the company is thinking that it can achieve next? That’s right, to finally become profitable in the upcoming quarter. Based on the calculations above, you could have predicted this yourself. Any more wonder about Mr. Musk’s words as to Tesla becoming profitable and cash flow positive next quarter?
JW Investments Associates: Research & Management 