Tesla reported Q3 earnings that missed on both the top and bottom lines. Revenue of $23.35 billion missed by $0.79 billion, while non-GAAP EPS of $0.66 missed by $0.07. Margins continued to slide, with gross margin declining ~30 bp QoQ and ~720 bp YoY to 17.9%, and operating margins falling ~210 bp QoQ and ~960 bp YoY to 7.6%. A shift in product mix and price cuts led to a lower ASP during the quarter.
We wrote at the end of August that Tesla’s Q3 operating margins can decline to a level between Honda and VW – between 7.0% to 8.5%, with Q3’s actual 7.6% coming in just shy of the midpoint there. If operating margins were to reach a level closer to 6.0%, like GM, that could be a sign they’re close to the bottom. The continual decline in margins highlights the broader concern for investors that Tesla still not provided any guidance to assess how low margins may fall. The OEM’s Q3 update stated the goal remains unchanged: “reducing cost per vehicle… while maximizing delivery volumes.”
In that regard, Tesla kicked off October with another price cut in the US after Q3 deliveries missed expectations. The cuts, for certain Model 3 and Model Y versions, took the base Model 3 price down approximately -3.1% to $38,990. Another cut to spur demand signals that the bottom still may not be in yet for margins, given that the base Model 3’s latest price point sits just ~4% above Tesla’s average COGS of $37,500 in Q3.
Revenue and EPS:
- Revenue of $23.35 billion missed expectations by (3.3%). This represented YoY growth of +8.9%.
- Automotive revenue of $19.625 billion grew by +5.0% YoY.
- GAAP EPS of $0.53 declined (44.2%) YoY, driven by the decline in gross and operating margins.
- Non-GAAP EPS of $0.66 missed expectations for $0.73, representing a YoY decline of (37.1%).
Margins:
- Gross margin of 17.9% missed expectations for 18.0%.
- Operating margin declined for a fourth straight quarter to 7.6%.
- Automotive margin (excl. leasing & regulatory credits) was 15.75%, declining from 17.52% in Q2 and 26.35% in the year-ago quarter.
- Adjusted EBITDA margin declined ~260 bp QoQ and ~710 bp YoY to 16.1%, as adjusted EBITDA fell (24.2%) YoY.
- GAAP net margin of 7.9% represented a decline of ~290 bp QoQ and ~740 bp YoY.
Cash & Debt:
Tesla’s cash and investments rose by ~$3.0 billion from Q2 to reach $26.08 billion, driven by ~$2.19 billion in net borrowing for vehicle and energy system financing and ~$0.85 billion in free cash flow. Free cash flow declined (74.3%) YoY from $3.30 billion in the same quarter last year, impacted by a $1.79 billion decline in operating cash flow and a $0.66 billion increase in CAPEX. TTM free cash flow of $3.71 billion was at the lowest level since Q4 2020.
Operating cash flow of $3.30 billion declined (35.1%) from $5.10 billion in the same quarter last year but improved +7.9% sequentially from Q2. TTM operating cash flow of $12.16 billion reached the lowest level since Q4 2021.
Tesla reported ~$4.39 billion in total debt and finance leases, up from $2.33 billion in Q2, driven by the $2.19 billion surge in net borrowings under vehicle and energy financing.
Other Key Metrics:
Energy storage revenues increased +39.6% YoY to $1.56 billion as deployments rose +90% YoY to 4.0 GWh, and services and other revenue increased +31.7% to $2.17 billion. Energy storage posted a gross profit margin of 24.4%, while services saw a gross profit margin of 6.0%. Tesla said that “pay-per-use Supercharging remains a profitable business for the company, even as we scale capital expenditures” to expand the network further. Supercharger connector deployments increased +31.4% YoY to 51,105.
Despite the top and bottom-line misses and a miss on Q3 deliveries, Tesla critically kept its 1.8 million delivery target unchanged. That suggests at least 475,000 deliveries in Q4, a new high for Tesla and approximately +1.9% higher than Q2’s 466,140 tally. Tesla has more than 2.23 million installed annual capacity, excluding the Cybertruck in pilot production; there should be no issue on the production side to reach the 1.8 million target. Price cuts continuing already in Q4 suggest that demand may remain weak throughout Q4.
A Closer Look at Margin Troubles:
Automotive revenues increased +5.0% YoY, as weaker pricing offset a +28% YoY rise in deliveries to 435,059 vehicles. On a sequential basis, automotive revenues declined (7.1%), as deliveries declined (6.7%) from Q2. Weaker ASPs in the quarter, at approximately (3.1%) lower than Q2, contributed to that sequential decline.
A worrisome trend is emerging in both ASPs and automotive gross margins as Tesla continues to cut vehicle prices. Automotive gross margins (excluding vehicles subject to leases) fell below 16% in Q3, dropping from 17.52% in Q2 and down from 28.46% in Q3 2021, with little relief along the way down.
CFO Zachary Kirkhorn stated back in January this year that that “Tesla would not go below margins of 20% [including leasing and regulatory credits] and an average selling price of $47,000 across models.” Automotive gross margin including leasing and credits declined to 18.7% in Q3, down from 19.2% in Q2 and 21.1% in Q1.
ASPs have fallen (16.7%) YoY and (20.1%) from a peak in Q2 2022 at ~$55,690 per vehicle to reach ~$44,493. That represented a decline of ($1,469) from Q2’s ~$45,962, more than offsetting the $421 reduction in COGS per vehicle during the quarter.
Looking forward to Q4, should an improved mix offset price cuts to leave ASPs virtually unchanged, Tesla more than likely will have to bring COGS per vehicle lower by at least ~1.5%, to reach point below $37,000, to bring automotive gross margins back above 17%. If COGS per vehicle does not fall to that degree, ASPs will need to rise by at least 1% in the face of price cuts to bring that inflection in margins.
Earnings Call:
Tesla’s earnings call highlighted the difficulties in finding a concrete bottom for margins, as the OEM continues to “invest significantly in AI,” while noting that “there will be enormous challenges in reaching volume production with the Cybertruck, and then in making a Cybertruck cash flow positive.” Therefore, “R&D expenses continued to rise due to Cybertruck prototype bills and pilot production testing combined with spend on AI technologies like full self-driving, Optimus and Dojo.” Increased CAPEX has been detrimental to free cash flow metrics, while heightened R&D will also drag on operating margins – which Tesla inadvertently signaled have yet to bottom.
Tesla said that its “Q3 operational and financial performance was impacted by planned downtimes for our factory upgrades. This was necessary to allow for further factory improvements and production rate increases. Despite such factory shutdowns, our cost per vehicle decreased to approximately $37,500. We saw sequential decreases in material cost and freight. Reducing the cost of our vehicles is our top priority.”
While cost reductions can help prop up margins, Tesla also signaled that price adjustments may continue over the next months to quarters: “as interest costs in the U.S. have risen substantially, it has required us to adjust the price of our vehicles to keep the monthly cost in parity. We’ve tried to offset such adjustments via focus on reducing costs. However, there is an inherent lag in cost reductions, which in turn impacts margins.” Elon Musk added later in the call, “if interest rates remain high or if they go even higher, it’s that much harder for people to buy the car, they simply cannot afford it.” Rates advancing higher would likely force more price reductions to keep those monthly payments relatively close to parity, while higher rates for longer could keep vehicle prices depressed for longer, thereby weighing down on margins.
Conclusion:
Margins were the major story heading into Q3’s earnings and remain the major story moving forward, as Q3’s weaker operating margin print at 7.6%, combined with declining ASPs and automotive gross margins, signal that Tesla is still not much closer to finding a bottom.
Q3’s earnings call supported that view, as Tesla pointed out that reducing vehicle costs remains a key focus but emphasized that affordability is driving price reductions as interest rates rise. Given that there has been no relief in rates, Q4 started with a ~3.1% price cut to the base Model 3 in the US alongside other price cuts.
Tesla did reiterate its 1.8 million target for the year, pointing to a possible record Q4 for production and deliveries, with more than enough installed capacity to reach that goal. While a resumption of sequential delivery growth will be a positive, the question again comes down to how many price adjustments will occur during Q4 and if margins can withstand such adjustments to find a bottom soon.
Damien Robbins, Equity Analyst for the I/O Fund, contributed to this analysis.
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