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Why Tesla’s Planned China Price Hikes Shouldn’t Worry Investors

Tesla's cars will cost more in China. But that doesn't mean that the company's investors should be worried.

The electric car maker plans to increase prices in China starting on Friday, Reuters reported, citing people familiar with the matter. The move is likely a reaction to the slumping yuan, which has weakened against the U.S. dollar and has made it more difficult for American companies doing business in China to earn the same profit as before.

But it's not only exchange rates that Tesla is concerned about. The company is also deciding whether to raise prices again in China in December, when the country plans to impose a 25% tariff on U.S. cars sold there along with a 5% tariff on U.S. auto parts.

The report didn't say how much Tesla would increase prices in China. Tesla did not respond to a request for comment from Fortune.

Several analysts expect that any price increase would benefit the company.

"We view price increases positively," Robert W. Baird analyst Ben Kallo told Fortune. "Companies don’t typically increase price if there are demand worries."

Jeff Osborne, an analyst at Cowen, agreed, saying that higher prices won't stop many Chinese customers from buying Teslas.

"There is always a core group of buyers that want goods and services immediately that are less price sensitive," Osborne said. "Our view is Tesla feels they can raise the price slightly and not impact elasticity of demand."

Wedbush analyst Daniel Ives called China "a major potential growth area" for Tesla. He said that a price increase makes sense, but he also cautioned that Tesla's China sales could decline 3% to 5%, depending on the size of the price hike.

There are also questions about the future opportunity in China's electric vehicle market. Although it's sizable—Chinese consumers bought 1.3 million electric cars last year, or about 60% of all the electric cars purchased worldwide—China's electric vehicle market has risks.

For one, China's market has grown in part because of strong subsidies the government has used to entice shoppers to buy electric cars. Now, the government has started to place limits on those subsidies, making it more costly for shoppers to buy electric cars.

Tesla also finds itself in an increasingly competitive Chinese market, overrun with competitors from both China and the U.S. The company sells more electric vehicles in China than any other competitor, but local rivals, including state-owned BAIC and BYD, are coming on strong.

Tesla's sales in China are growing rapidly. In the first half of the year, Tesla's U.S. sales were around $5.8 billion, or nearly half of the company's $10.9 billion in overall revenue. China was Tesla's second-largest market with $1.5 billion in sales, up from $1 billion in the same period a year earlier.

That prospect of growth in China has proven increasingly important to Tesla in recent quarters. Despite some growth in sales, Tesla continues to take on massive losses each quarter. In the second quarter, the company's revenue topped $6.4 billion, but it lost $408.3 million.

Those losses, coupled with concerns that Tesla won't find its way to profitability and struggles to reach car-manufacturing milestones, have sent the company's shares down in recent months. At the beginning of 2019, Tesla was trading at $310 a share versus $215.59 on Wednesday.

China, therefore, is all the more important in driving future success.

But there's more to Tesla's China story than the yuan and tariffs. Tesla is building a huge factory in Shanghai, called the Gigafactory 3, that is expected to open by the end of the year.

The plant is supposed to produce up to 150,000 Teslas annually, including the mid-priced Model 3. Tesla hopes the car will dramatically improve its China sales by attracting shoppers who want a Tesla, but who prefer one that is cheaper than the company's luxury models.

"Gigafactory 3 remains the major game changer for Musk & Co.," Ives said.

Ives noted that since Gigafactory 3 is in China, the cars manufactured in it would avoid any of the new tariffs. Tesla would be able to maintain its prices in December or raise them less than it otherwise would.

"Once Gigafactory 3 is up and running, it will enable Tesla to price its cars more effectively," Ives said.

Cowan analyst Osborne says that a tariff-free Gigafactory 3 could positively impact Tesla. He said that while there are plenty of Chinese consumers who would pay more for a new Tesla, there are still other "potential buyers in China who are waiting for a tariff free/lower-priced vehicle to be available."

Whatever the case, China seems to welcome Tesla. Government media reports in January said that the country offered Tesla CEO Elon Musk "permanent residency" when he broke ground on Gigafactory 3. Previously, Chinese Premier Li Keqiang said Musk could act as a "promoter of stable China-U.S. relations."

Musk's response was simple.

"I love China very much," he said.

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