Despite declining profits, Tesla’s business is heavily leveraged compared to the competition

Electric vehicle (EV) maker Tesla (TSLA 0.75%) kicked off its third-quarter earnings last week with a rather mixed report. Elon Musk and his team are fighting intense competition from rival EV manufacturers both at home and abroad. Rivian, Polestar, Nio, BYDand even as old car manufacturers Ford and General Motors. The surge in entrants into the EV landscape, combined with a turbulent macroeconomic environment fueled by inflation and high interest rates, has caused Tesla to take some pretty drastic measures. Namely, the company introduced aggressive price cuts to sell more cars and increase market share.

The problem Tesla faces is that these price cuts are hurting the company’s top-line growth while costs are rising. The result? Tesla makes less profit per car.

While this may sound exciting, there are many variables that investors need to consider. Let’s examine how far Tesla’s earnings have fallen and how it stacks up against the competition. Investors can see that Musk is still running a solid operation, and the recent selloff is an opportunity to buy into the dip in Tesla stock.

A look under the hood

The chart below shows Tesla’s revenue, cost and margin profile per vehicle over the past few quarters.

Item 3rd quarter 2022 4th quarter of 2022 I quarter of 2023 Q2 2023 3rd quarter 2023
Car income $18,692 $21,307 $19,963 $21,268 $19,625
Car expenses $13,480 $15,785 $15,755 $17,179 $15,957
Gross profit of the car 5212 dollars 5522 dollars 4208 dollars 4089 dollars 3668 dollars
Total vehicles delivered 343,830 405,278 422,875 466,140 435,059
Gross profit per vehicle shipped $15,159 $13,625 $9,951 8,772 dollars 8,431 dollars

Data source: Q3 Company Investor Presentation. Revenue, Expenses and Gross Profit are measured in millions.

There’s a lot to unpack in the table above. Investors can clearly see that rising costs are outpacing revenue growth. The net result is a decline in profit per vehicle, with the metric nearly halving over the past year.

My colleague James Brumley provided investors with a fantastic overview of Tesla’s unit-level profitability through 2019. The bottom line is that price cuts, inflation and rising interest rates have become headwinds for Tesla’s profitability.

As a silver lining, Tesla’s gross profit per car in the third quarter was down just 4% from the previous quarter. That doesn’t mean the company has bottomed out, but it’s the smallest decline in a row over the past year. Some factories were also closed for part of the third quarter, further affecting shipments, revenues and profits.

Image source: Getty Images.

Why it’s not the end of the world

Seeing profits at the per-unit level could be sobering for long-time Tesla bulls. However, there is plenty of valuable information for investors to consider when it comes to EV production.

Earlier this year, Ford shared with investors that the company will lose about $4.5 billion on electric vehicles this year — up from previous forecasts of a $3 billion loss. This equates to a loss of $40,000 per unit.

The table below shows Rivian’s profitability profile over the past year:

Item Q2 2022 3rd quarter 2022 4th quarter of 2022 I quarter of 2023 Q2 2023
Gross profit per vehicle shipped ($157,600) ($139,277) ($124,162) ($67,329) ($32,595)

Source: Q2 Company Investor Presentation.

While Rivia’s per-unit losses have narrowed, the company still isn’t close to catching Tesla.

So even though Tesla isn’t generating as much revenue per unit right now, the company is still light years ahead of the competition. Moreover, long-term investors should consider that eventually inflation is expected to normalize and the Federal Reserve will lower interest rates. In a better market environment, Tesla won’t have to keep cutting prices to sell its cars. As costs come down and revenue growth resumes, profitability should not only rise, but return to previous levels.

Should you be investing in Tesla stock right now?

Take a look at the charts below and you’ll see that Tesla stock is trading at its lowest price levels since the company has consistently posted earnings.

TSLA Price to Free Cash Flow Chart

Data by YCharts.

In this context, Tesla stock seems too good to pass up. Musk spent much of his recent earnings call talking about the company’s artificial intelligence (AI) projects, Optimus and Dojo. The results of these efforts are years from now, and even if profits take a near-term hit, the company has plenty of free cash flow to fall back on.

Tesla’s EV business is still ahead of the competition, and with the stock taking a breather, long-term investors have a rare opportunity to cut costs or start a new position in this industry leader.

Adam Spatacco holds positions at Tesla. The Motley Fool owns and recommends positions in BYD, Nio, and Tesla. The Motley Fool recommends General Motors and recommends the following options: January 2025 $25 calls on General Motors. The Motley Fool has a disclosure policy.

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