What Tesla’s Present Capital Expenses Tell Us About Future Depreciation

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Tesla Shanghai Gigafactory
Tesla Gigafactory 3 in Shanghai, China. Photo courtesy Tesla.

Two of the big pieces of news on the Tesla 3rd quarter earnings announcement were that margins were up dramatically and the cost to build the new lines to manufacture the Model Y in Fremont is half the cost as the existing Model 3 lines, and that the cost to build the Model 3 line in China is 65% less than the same US Model 3 lines on a capacity basis. This means the cost for the Model Y line might cost half of what an existing Model 3 line costs, or it might mean that it costs the same amount of money but has twice the capacity — or some combination of the two.

Are these two pieces of news related? Yes, but not really in this quarter. The gross margin improvements seemed to be many small improvements in every step of building the Model 3 (and to a lesser extent the other products Tesla makes). Tesla is still using the production lines that it built before it learned how to build lines for much less money. The lower capital expenditure (CapEx) helps Tesla’s balance sheet (because it has saved the company billions of dollars), but it doesn’t change Tesla’s earnings much this quarter. However, it will have a big impact in the future. Why is that?

Because until you start producing cars (trial production probably doesn’t count) on a line, not a penny flows to the expenses of the income statement. Tesla can spend $2 billion or $20 billion on a new factory, but until the company starts using it, it doesn’t affect the income statement. An exception is that it would have to pay interest on any loans if Tesla took out loans. If Tesla paid cash, though, it would no longer earn interest on that cash, so that would slightly reduce earnings.

For example, if Tesla spent $2 billion on Gigafactory 3 and paid 5% on the loans, that would result in a $100 million a year or $25 million a quarter additional charge. (Last quarter, Tesla reported paying $185 million in interest expenses, not just for Gigafactory 3, but for all the debt the company has accumulated). A year ago, the company paid $175 million, so you can see Tesla’s interest expenses are creeping up, even though the company raised a large amount of equity this spring. That isn’t a surprise, because although Tesla has been profitable 3 of the last 5 quarters, it is still not profitable over the last 4 quarters because its small profits during good quarters haven’t been big enough to outweigh its larger losses in its loss-making quarters. If you want to follow along, here is the link to the Q3 2019 Tesla earnings letter.

Depreciation from the Q3 2019 Tesla earnings letter.
Property, plant, and equipment from the Q3 2019 Tesla earnings letter.

To know how property, plant, and equipment convert to depreciation, I would need the useful life of each asset and the accounting method that Tesla is using. I can just assume straight-line depreciation for simplicity and I will divide existing depreciation by the assets to get an idea of useful life.

This shows that the depreciation as a percent of property, plant, and equipment has been fairly constant, but is a little lower than last year. That makes sense, since Tesla has the whole Gigafactory 3 as part of the property, plant, and equipment line but it hasn’t started depreciating it yet. Tesla had no similar factory last year — built but not turned on yet.

On the other hand, Tesla has taken about $2 billion in depreciation over the last 4 quarters, so that reduces the property, plant, and equipment, net line by a similar amount. I believe the existing Model 3 production lines in Fremont and supporting ramp up in Gigafactory 1 in Nevada cost Tesla about $4 billion in CapEx. We can use my figures above to estimate that caused an increase of $200 million (5% of $4 billion) a quarter in depreciation when Tesla started to build the Model 3.

Depreciation from the Q4 2017 Tesla earnings letter.

Checking my thoughts with reality, it looks like quarterly deprecation has increased $255 million a quarter from Q4 2016 (when there was no Model 3 production) to the peak in Q2 2019. Some of that additional depreciation was for equipment to produce other products (either Model S and X or Tesla Energy), but most of it was for the Model 3 ramp. That checks out.

So, if Tesla charges about $200 million a quarter in deprecation related to Model 3 production and it made almost 79,837 Model 3’s in the quarter, we can just divide those two numbers and find that adds ~$2,500 to the cost of each car. The new lines in China when turned on and ramped to capacity should have depreciation costs of 65% lower, or ~$1,600 less per vehicle. This is in addition to the lower costs of labor in China.

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If we speculate that the Chinese production ramp is able to save $130 million (65% of $200 million) in quarterly depreciation charges and the Fremont Model Y production ramp is able to save $100 million (50% of $200 million), we could see $230 million in quarterly savings that would drop right to the bottom line (after an allowance for taxes). This is a nice addition that is already “baked in the cake.” This is in addition to economies of scale (which are very large in a software-oriented company like Tesla), the constant innovation to reduce costs that Tesla is focused on every quarter (or every day), and the huge windfall in valuation Tesla will realize if it is able to get approval for a robotaxi without a safety driver anywhere in the world before any other company.

This does not constitute investment advice. Please talk to an investment adviser that evaluates your individual situation before making any investment decisions.

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Paul Fosse

I have been a software engineer for over 30 years, first developing EDI software, then developing data warehouse systems. Along the way, I've also had the chance to help start a software consulting firm and do portfolio management. In 2010, I took an interest in electric cars because gas was getting expensive. In 2015, I started reading CleanTechnica and took an interest in solar, mainly because it was a threat to my oil and gas investments. Follow me on Twitter @atj721 Tesla investor. Tesla referral code: https://ts.la/paul92237

Paul Fosse has 232 posts and counting. See all posts by Paul Fosse