Consumer Discretionary / Industrials

Henry Kwon

Equity Bottom-Up

<p>As we near Tesla's earnings announcement which has not yet been announced, we took a look at the quarterly sales trend for the company's 3 key products (Models S &amp; X + the Model 3) and offer some thoughts on issues that writings about Tesla in the market generally tend to skip over:</p><ol><li><div class="content-highlight">Ageing Products - The Model S is now it its 6th year on the market and the sales trend shows.  Consensus focus is currently on the Model 3 ramp, so analysts generally do not pay much attention to the fact that the Model S is now becoming overdue for a full model change.</div></li><li><div class="content-highlight">The Model X is now in its 3rd year, which signifies that in automotive product cycle terms it is now fully in mid cycle.</div></li><li><div class="content-highlight"><strong>From a product cycle perspective, this is a point in time when OEMs will have very little pricing power, especially on the Model S. </strong> Tesla management's strategy of maintaining margins on existing products through price increases will likely face headwinds in our view.</div></li><li><div class="content-highlight">In the meantime, Tesla has not discussed full model change plans for the Model S&amp;X (<em>upgrading battery packs do not count, in our view</em>), but has engaged the market in discussing the Model Y and the Semi development/commercialization.  This is a risk factor that we believe investors should pay attention to.</div></li><li><div class="content-highlight">Model 3 ramp seems to be taking place, according to Tesla's Q1 sales figures released on April 3, but against the backdrop of the ageing products, ASP shrinkage seems inevitable in 2H18.</div></li></ol><p>Analysts like to point to the Model 3 ramp as the beginning of the end of Tesla's external funding needs.  However, Free Cash Flow is composed basically of EBITDA + changes in net working capital, and battery costs for models S, X and 3 should be similar.  If there is margin contraction as a result of ASP erosion from mix shift and pricing power erosion, Tesla could be facing another headwind in our view, since it is not gross margin that will be contributing to cash flow but the company's operating margin.  We maintain our view that despite technical brilliance, Tesla management is green when it comes to the automotive world and how it works.</p>

As we near Tesla's earnings announcement which has not yet been announced, we took a look at the quarterly sales trend for the company's 3 key products (Models S &amp; X + the Model 3) and offer some thoughts on issues that writings about Tesla in the market generally tend to skip over:Ageing Products - The Model S is now it its 6th year on the market and the sales trend shows.  Consensus focus is currently on the Model 3 ramp, so analysts generally do not pay much attention to the fact that the Model S is now becoming overdue for a full model change.The Model X is now in its 3rd year, which signifies that in automotive product cycle terms it is now fully in mid cycle.From a product cycle perspective, this is a point in time when OEMs will have very little pricing power, especially on the Model S.  Tesla management's strategy of maintaining margins on existing products through price increases will likely face headwinds in our view.In the meantime, Tesla has not discussed full model change plans for the Model S&amp;X (upgrading battery packs do not count, in our view), but has engaged the market in discussing the Model Y and the Semi development/commercialization.  This is a risk factor that we believe investors should pay attention to.Model 3 ramp seems to be taking place, according to Tesla's Q1 sales figures released on April 3, but against the backdrop of the ageing products, ASP shrinkage seems inevitable in 2H18.Analysts like to point to the Model 3 ramp as the beginning of the end of Tesla's external funding needs.  However, Free Cash Flow is composed basically of EBITDA + changes in net working capital, and battery costs for models S, X and 3 should be similar.  If there is margin contraction as a result of ASP erosion from mix shift and pricing power erosion, Tesla could be facing another headwind in our view, since it is not gross margin that will be contributing to cash flow but the company's operating margin.  We maintain our view that despite technical brilliance, Tesla management is green when it comes to the automotive world and how it works.

Tesla: A Few Thoughts on Ageing Products Before 1Q Earnings Announcement