Tesla On The Verge Of Costs & Revenues Breaking Even

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Tesla is Very Close to Break-Even Point — Summary

¤ Tesla’s Model 3 car production is within a few hundred units per week of achieving a break-even level.

¤ Tesla needs to produce over 3,814 Model 3 cars per week for its automotive segment and operating expenses to break even.

» At this level, it covers its cost of revenue from its automotive segment plus operating expenses.
» Tesla requires $5,736,521,611 per quarter or $441,270,893 every week in car sales to break even.
» This includes revenues from the automotive segment.

¤ Tesla needs to produce 5,575 Model 3 cars per week for its automotive segment, operating expenses, and interest expenses to break even.

» At this level, it covers its cost of revenue from its automotive segment, operating expenses, and interest expenses.
» Tesla requires $6,550,829,974 per quarter or $503,909,998 every week in car sales to break even.
» This includes revenues from the automotive segment.

¤ Tesla needs to produce 4,946 Model 3 cars per week for the automotive segment, the leasing segment, operating expenses, and interest expenses to break even.

» At this level, it covers its cost of revenue from its automotive and leasing segments, operating expenses, and interest expenses.
» Tesla requires $6,100,418,549 per quarter or $469,262,965 every week in car sales to break even.
» This includes revenues from the automotive and the leasing segments.

¤ Tesla needs to produce 8,974 Model 3 cars per week to break even with all expenses.

» At this level, it covers its cost of revenue from all segments, operating expenses, and interest expenses.
» Tesla requires $8,982,805,482 per quarter or $690,985,037 every week in car sales to break even.
» This includes revenues from all segments.

¤ Tesla could temporarily increase its production of Model S, Model X, and battery energy products to contribute revenue for reaching a break even level.

¤ The operating expenses: sales, general, administration, research, and development expenses are covered only partially by the current level of sales. Reaching a break-even level will cover these operating expenses.

¤ In the last quarter, cost of goods sold increased faster than sales which made it more difficult to reach a break-even point. It needs to reduce and bring back in line its costs of goods.

¤ Strategically, reaching any break-even level of sales will allow Tesla the opportunity to turn its attention into building up its battery factory, designing and developing the next vehicle models, and expanding its infrastructure for energy storage.

» Covering its automotive revenue cost and operating expenses is critical, and Tesla is about to achieve this.
» The leasing and energy segments’ costs are covered by their revenue.
» The automotive segment and “services and other” costs are not covered by their revenue.
— The size of the automotive segment is so large relative to the other segments that covering its cost of revenue is essential.
» The interest expense is manageable at the moment from available cash.

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What is break even? The Financial Times defines break-even point as:

“the point in a company or product’s development at which revenue equals cost, and neither a profit nor loss is made. Breakeven analysis attempts to locate the breakeven point in a company’s operations and calculate the impact on profit of changes in output, costs and selling price.”

Another useful and straightforward definition is provided by Investopedia, which defines it as such:

“BREAKING DOWN ‘Break-Even Analysis’ —. Break-even analysis is useful in the determination of the level of production or in a targeted desired sales mix. The analysis is for management’s use only as the metric and calculations are often not required to be disclosed to external sources such as investors, regulators or financial institutions. Break-even analysis looks at the level of fixed costs relative to the profit earned by each additional unit produced and sold. In general, a company with lower fixed costs will have a lower break-even point of sale. For example, a company with $0 of fixed costs will automatically have broken even upon the sale of the first product assuming variable costs do not exceed sales revenue. However, the accumulation of variable costs will limit the leverage of the company as these expenses are incurred for each item sold.”

The following table provides a dollar value of the breakeven point of $5,736,621,611. This is Tesla’s required revenue of all cars to reach breakeven, and notice that this narrow definition of breakeven includes covering only the cost of car sales and operating expenses. These by the way are the company wide operating expenses.

The table below shows the latest quarterly income statement for Tesla. As can be seen, using some basic assumptions, the current car sales are less than half of the necessary sales to achieve a break-even point. The revenue includes 8,182 Model 3 cars delivered during the quarter. This is equivalent to delivering about 630 Model 3 cars per calendar week.

However, as will be shown below, the company is currently producing approximately 3,500 Model 3 cars per week. This means that production has increased 4.7 times per week from last quarter. At this rate, it would produce at least 45,500 Model 3 cars per quarter.

This also means that, during the first quarter of 2018, the Model 3 was not really pulling its weight to make up for all the resources committed to its production, but that at a current production rate of 3,500 Models 3 cars per week, it can start making up for this slack, and with a near-term outlook of significantly increasing production each week, this will become even more obvious.

Tesla’s income statement (in thousands in the above table) presented a loss of $784,627,000 (highlighted in yellow) at the end of the first quarter of 2018, and this is a larger loss than the one shown above for operating expenses.

Tesla has four main revenue segments or divisions. These are automobile sales, automobile leasing, energy generation and storage sales, and services and other sales. Of these four revenue segments, I have chosen to concentrate only on the first one. That is to say, I will examine in the following discussion only the automotive sales segment.

If I examine only the automotive sales segment, then this raises the question: How many Model 3 cars are needed to cover at a minimum its operating expenses?

Based on the most recent financial data released by Tesla, it appears that the company is quite close to achieving a break-even level. The following analyzes this possibility based on the company’s latest financial statements.

Tesla made the following statement:

“Demand for our flagship Model S and Model X vehicles remains very strong. After all-time record orders in Q3 and Q4 2017, we had our highest ever Q1 for orders. With demand exceeding supply, we are making considerable progress with margin improvement. In Q1, we produced 24,728 Model S and X and 9,766 Model 3 vehicles, and delivered 21,815 Model S and Model X vehicles and 8,182 Model 3 vehicles, totaling 29,997 deliveries. Short-term operational and logistical issues led to an increase in the number of Model S and Model X vehicles in transit to customers at the end of Q1. Model 3 net reservations, including configured orders that had not yet been delivered, continued to exceed 450,000 at the end of Q1 even though fewer than 20 stores worldwide had Model 3 on display. We are planning to deploy significantly more Model 3 vehicles in our stores in Q2 this year.”

This statement is actually quite helpful. If I concentrate only on actual production, I know that Tesla produced about 12,364 Model S as well as 12,365 Model X. In addition, it produced 9,766 Model 3. I also know that based on other statements, Tesla does not intend to produce higher numbers of Model S or Model X this year compared to last year.

“Consequently, Model S and X deliveries in Q2 will likely be similar to Q1 but should pick up considerably in Q3 to achieve our goal of 100,000 deliveries for the full year.”

Therefore, the combined number of Model S and Model X vehicles will be about 25,000 cars per quarter, which is quite close to what they produced this last quarter.

From the previous revenue break-even analysis and these two statements from Tesla, it is quite obvious that revenue will have to increase to break even, and the increase in revenue will be dependent on Model 3 production. Moreover, the Model 3 itself will only be available at price points above $35,000 since the standard model is not for sale until late in 2018 or early 2019.

“It appears that an hour after Tesla’s Q4 2017 earnings call ended, the company began notifying Model 3 reservation holders that the entry level version of the car — the one with the ‘standard battery’ and rear wheel drive — won’t be ready for delivery until late this year or early next year.”

To figure out the number of Model 3 cars necessary to break even, this too is helpful since it provides a floor on pricing. The portion referring to production volume,also has a floor of 9,766 Model 3 cars.

The task at hand is to figure out how many Model 3s and at what average sales price will Tesla break even. What is the range of possible prices for a Model 3? The basic model is $35,000, and the most option model is the performance package with Autopilot and full self-driving options for $86,000. However, since the base model is not available, the next lowest available price option is the long range (310 miles) battery trim with the premium package. This is available for $49,000 if you don’t choose a color other than black or the larger tires and rims.

What are the production constraints for the Model 3? Currently, the Model 3 is being produced at a rate of about 500 units per day or 3,500 units per week. However, in about one month, it will be produced at a rate of 5,000 per week, and eventually, 10,000 will be produced per week.

“Once we hit the 5,000 per week milestone, we intend to incorporate our learnings to continue to increase output on our existing manufacturing lines beyond 5,000 units per week, and then in a capital efficient manner to add incremental capacity to ultimately get to a 10,000 unit weekly rate.”

At the current level of production, Tesla can almost (difference between 3,814 and 3,500 — see below) produce enough cars if it can get demand at the required prices. At the expected average sales prices (shown below), Tesla could also temporarily benefit by increasing production (not shown) of Models S & X.

Why is this relevant? Depending on actual delivered volumes and average selling prices, Tesla might be either slightly positive or slightly negative at the end of next quarter (the 2nd quarter). Keep in mind that the scenarios contemplated here mean that revenue is equal to cost. Assuming that the following quarter (the 3rd quarter) Tesla increases production of Model 3 cars to 5,100 cars per week, the average selling prices could be slightly lowered and still break even (covering only operating expenses):

Between the end of the year and next year expected production will expand even further:

Note that at these higher volumes, the price constraint on Model 3 becomes less relevant. In fact, all three models could be sold at the lowest permissible prices, or looked at from another perspective, higher prices will bring in profits.

The Model 3 is a vehicle using more automation than other manufactured cars. This lowers the cost of labor when implemented well. Tesla has a high degree of vertical integration, such as building its own car seats, battery chargers, electric motors, batteries, and battery modules. In addition, it produces the major components of the chassis through stamping processes, it assembles all major car components, it welds major car sections together, and it paints. In addition, it designs and writes most of its own car software.

“Tesla’s vehicles are produced at its factory in Fremont, California, where the vast majority of the vehicle’s components are also made.”

In addition, electric cars in general have about 98% fewer moving parts than cars with an internal combustion engine. This lowers the cost to manufacture them. As economies of scale take place, the average sales price of an electric car will come down by 71% by the year 2021 compared to 2016 to around $20,000 per car, some analysts predict.

This can already be seen at Tesla. The previous car sedan had a labor cost of $4,000 per car; whereas the latest model, the Model 3, has a labor cost of $1,000. This is one of the reasons that achieving a 25% profit margin on the Model 3 car is probable.

Tesla also sells directly to the public. Most manufacturers discount the MSRP by about 15%. This in the long run will benefit Tesla’s cost structure. In addition, Tesla does not buy advertising. This further lowers its cost structure.

Automation, vertical manufacturing integration, software design, a lower number of moving parts, direct sales, a policy of no paid advertising, and economies of scale are some of the reasons that the break-even level can be achieved sooner rather than later, and once reached, it allows for profits to accumulate in a rather short period of time.

Tesla’s goal is to reach a weekly production level of 10,000 by the end of 2018 or sometime in 2019. At this level of production, if the average sales price of the Model 3 is reduced to somewhere between $35,000 and $48,000, then the company is producing more than the necessary weekly production to break even, and it is then making profits.

All of this effort will slowly result in competitive economies of scale. This allows selling a product at lower prices while at the same time permitting a company to produce them profitably.

Further down the line, this could open up a new realm of possibilities for Tesla. Namely, given a robust enough level of production, it might allow Tesla at some point in the future to lower the ASP under $35,000 and still maintain an adequate level of profit.

This would allow Tesla to expand its market share by reaching out to customers unable to purchase its more expensive models. It will maintain its market share by creating a barrier to entry for other manufacturers too timid to invest the necessary resources for marketing quality electrical vehicles.

The above discussion should be of interest to different stakeholders. To Tesla’s employees, it should provide confidence in the future of their place of work; to investors, it should provide confidence in holding bonds or shares in the company; to customers, it should provide confidence in obtaining future support for their car; and to local governments, it should provide peace of mind that the local economies where Tesla is based will prosper.

I hope this discussion on Tesla’s break-even level has been of help in providing an evaluation of the current financial situation for Tesla.

Sincerely,
Eric Kosak

Disclaimer: I have, sadly, no positions in the stock of this company.  The above is not a recommendation for investment.  If you seek investment advice consult with a professional, and if you do invest, then do it wisely and without allowing the loss of any of your investments to injure you financially.  Remember that money invested in the stock, bond, option, futures, and real estate markets can and might go to zero.

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Appendix I.

There is a useful formula to figure out break-even units. Investopedia’s formula for breakeven is:

If I had used this formula, ideally, it could have provided a more exact and more convenient way of calculating the number of car units required to achieve break even.

In practice, not enough information is actually known regarding the variable cost per unit or the fixed cost pertaining to the automobile segment. In addition, there is too much uncertainty regarding the average retail price per car. For instance, which are the more popular options requested by a majority of buyers, and how does this affect the average sales price?

This last point requires an estimate of the percent of sales going with the different options available per each of the three car models. Honestly, I did not have a good source of information for all of this. For this reason, this paper is a compromise based on accessible, readily available information to potentially determine the break-even level.

3 possible cases:
Total cost > Total revenue (incurs losses)
Total cost < Total revenue (makes profit)
Total cost = Total revenue @ break even

Definition:

@ break even:

Total cost = Total revenue Why? No profits are being made; however, there are, also, no losses. Revenue equals costs.
Total revenue − Total cost = 0
Total cost − Total revenue = 0

Therefore:

Total revenue = Total variable costs + Total fixed costs
Total revenue − Total variable costs − Total fixed costs = 0

Allow SG&A + R&D from the income statement to be the fixed costs.

Total fixed costs = SG&A + R&D

The main cost of goods sold is due to the Model S, Model X, and Model 3.

Allow the cost of Model S, Model X, and Model 3 to equal to cost of goods sold (0.75 + y).

75% is due to Model S and Model X. The rest is due to Model 3.

Total variable costs = Cost of goods sold (0.75 + y)

Total variable costs = Cost of goods sold * 0.75 + Cost of goods sold * y

Total cost = Total variable costs + Total fixed costs

Total revenue = Total variable costs + Total fixed costs

Total revenue = (Cost of goods sold * 0.75 + Cost of goods sold * y) + (SG&A + R&D)

Total revenue — SG&A – R&D — (Cost of goods sold * 0.75 + Cost of goods sold * y) = 0

Also,

Total revenue = Model S sales + Model X sales + Model 3 sales

Therefore,

Model S sales + Model X sales + Model 3 sales — SG&A – R&D — (Cost of goods sold * 0.75 + Cost of goods sold * y) = 0

Model S sales = Model S ASP * Model S volume

Model X sales = Model X ASP * Model X volume

Model 3 sales = Model 3 ASP * Model 3 Volume

Where ASP is the average selling price:

Model S ASP * Model S volume + Model X ASP * Model X volume + Model 3 ASP * Model 3 Volume

Model S ASP * Model S volume + Model X ASP * Model X volume + Model 3 ASP * Model 3 Volume — SG&A – R&D — (Cost
of goods sold * 0.75 + Cost of goods sold * y) = 0

Allow the weighted average sales price of Model S and Model X to be $121,627

Allow the following as well:

(Model S ASP + Model X ASP) = $121,627

Model 3 ASP = $55,045

Model S volume + Model X volume = 24,728

Model 3 Volume = X

Model S ASP * Model S volume + Model X ASP * Model X volume + Model 3 ASP * Model 3 Volume — SG&A – R&D — (Cost
of goods sold * 0.75 + Cost of goods sold * y) = 0

(Model S ASP + Model X ASP) * volume + Model 3 ASP * Model 3 Volume — SG&A – R&D — (Cost of goods sold * 0.75 +
Cost of goods sold * y) = 0

($121,627) * 24,728 + $55,045 * Q — SG&A – R&D — (Cost of goods sold * 0.75 + Cost of goods sold * y) = 0

@ breakeven
Total revenue = Cost of goods sold * 0.75 + Cost of goods sold * y + SG&A + R&D
Total revenue − Cost of goods sold * 0.75 − Cost of goods sold * y − SG&A − R&D = 0

Allow the break even revenue as developed before to be $5,736,521,611.
Allow the automotive cost of revenue to be $2,091,397,000.
Allow the operating expenses to be $1,053,500,000.

Solving for y:

$5,736,521,611 − Cost of goods sold * 0.75 − Cost of goods sold * y − SG&A − R&D = 0
$5,736,521,611 − Cost of goods sold * 0.75 − Cost of goods sold * y − SG&A – R&D = 0
$5,736,521,611 − $2,091,397,000×0.75 − $2,091,397,000 * y − $1,053,500,000 = 0
$5,736,521,611 − $1,568,547,750 − $2,091,397,000 * y — $1,053,500,000 = 0
$5,736,521,611 − $2,622,047,750 — $2,091,397,000 * y = 0
$3,114,473,861 — $2,091,397,000 * y = 0
$3,779,236,224 = $2,091,397,000 * y
1.4892 = y

Solving for X:

($121,627) * 24,728 + $55,045 * X — SG&A – R&D — (Cost of goods sold * 0.75 + Cost of goods sold * 1.807) = 0
($121,627) * 24,728 + $55,045 * X — SG&A – R&D — Cost of goods sold * ( 0.75 + 1.4892) = 0
($121,627) * 24,728 + $55,045 * X — SG&A – R&D — Cost of goods sold * ( 2.2392) = 0
$55,045 * X = —$3,007,592,456 + SG&A + R&D + Cost of goods sold * ( 2.2392)
$55,045 * X = —$3,007,592,456 + $1,053,500,000 + $2,091,397,000 * ( 2.2392)
$55,045 * X = —$3,007,592,456 + $5,736,556,162
$55,045 * Q = $2,728,963,706
Q = 49,577

To cover the costs of revenue and the operating expenses of Tesla, 49,577 Model 3 cars need to be manufactured per quarter. This is equivalent to 3,814 Model 3 cars produced every week for 13-weeks. This is the same as shown before.

Appendix II — What are services and other revenue?

II. What are services and other revenue?

“Services and other revenue consists of repair and maintenance services, service plans, merchandise, sales of used Tesla vehicles, sales of electric vehicle components to other manufacturers and sales of non-Tesla vehicle trade-ins. There were no significant changes to the timing or amount of revenue recognition as a result of our adoption of the new revenue standard.”

• Repair and maintenance services
• Service plans
• Merchandise, sales of used Tesla vehicles
• Sales of electric vehicle components to other manufacturers
• Sales of non-Tesla vehicle trade-ins.

“Revenues related to repair and maintenance services are recognized over time as services are provided and extended service plans are recognized over the performance period of the service contract as the obligation represents a stand-ready obligation to the customer. We sell used vehicles, services, service plans, vehicle components and merchandise separately and thus use standalone selling prices as the basis for revenue allocation to the extent that these items are sold in transactions with other performance obligations. Payment for used vehicles, services, and merchandise are typically received at the point when control transfers to the customer or in accordance with payment terms customary to the business. Payments received for prepaid plans are refundable upon customer cancellation of the related contracts and are included within customer deposits on the consolidated balance sheet. Deferred revenue related to services and other revenue was immaterial as of March 31, 2018 and December 31, 2017.”