Just as the books begin to close on Tesla’s challenging second quarter, CEO Elon Musk has dropped what seems to be a neutron bomb on the market.
The two new gigafactories in Germany and Texas are “gigantic money furnaces,” he confided in the third installment of a marathon interview with members of the YouTube channels Tesla Owners Silicon Valley and The Kilowatts.
“There should be like a giant roaring sound, which is the sound of money on fire,” he said, adding “Berlin and Austin are losing billions of dollars right now.”
Coming from a company that has spoiled shareholders with automotive gross margins north of 30% for three straight quarters—among the absolute best in the industry—those words are bound to cause investors to worry.
Add to Musk’s words the weeks of lost production in Shanghai owing to COVID lockdowns, which prompted analysts to lower Q2 forecasts to a production of 250,000 vehicles, and it would appear that Tesla’s level of high profitability is simply not sustainable.
Then chuck in a hefty charge for Tesla’s Bitcoin impairment that could easily surpass $400 million, and one can see why bears are licking their lips. Even a bull like Morgan Stanley’s Adam Jonas trimmed his price target.
Not as dramatic as they sound
Before Tesla bears get too excited, however, it is worth noting that the problems in Berlin and Austin need not be as dramatic as they sound—Musk’s colorful description notwithstanding (the Tesla CEO is notorious for being demanding in terms of plant performance).
Adding a new plant will always hit margins, owing to a mismatch between the speed at which early revenue trickles in and hefty upfront investments that are written down over time as fixed costs.
The industry rule of thumb is that a manufacturing plant tends to operate at a decent profitability when it utilizes about 80% of its installed production capacity on a two-shift basis. It’s only when that number falls to 60% that a plant typically loses money.
When a factory just starts production, however, there is invariably a laundry list of teething problems that need to be worked out.
The supply chain needs to function flawlessly; machines need to be calibrated to the micrometer to ensure exterior body panels fit together seamlessly without gaps; and workstations must meet time targets in order not to hold up the assembly line—to name just a few obstacles.
If these issues are not addressed from the outset, mistakes pile up and eventually cost the manufacturer much more to fix down the line—when thousands, rather than hundreds, of cars are built per day.
So, while Berlin’s and Austin’s capacity utilization are both minuscule, Musk has previously said it would take about 12 months to bring them up to a scale where they operate most efficiently.
In fact, rival Volkswagen is trying to emulate the expected productivity of Giga Berlin, which is meant to produce a Model Y crossover every 10 hours. That is twice as fast as most factories thanks to new production techniques like front- and rear-body full castings.
Furthermore, Tesla excels in part because of a very low level of production complexity. Virtually all of its volume comes from the Model 3 and Model Y, which feature minimal choice in trim options such as paint color, rims, and interior.
Slow for now
For the moment, however, Berlin only recently hit the 1,000 vehicle per week mark earlier this month, translating to about 10% of its half-million installed capacity—even after nearly three months of operation.
“There’s a ton of expense and hardly any output,” said Musk.
Still the key is what Musk said next: “This is all going to get fixed real fast, but it requires a lot of attention.”
His team expects to continue ramping up Shanghai, Berlin, and Austin to deliver on a 50% (or higher) increase in sales volume this year. With 2022 earnings per share believed to come out close to $12, the stock trades at a forward multiple of about 60x—lofty for most companies but justified according to bulls given that few companies around can match that kind of growth.
In fact, bears might want to remember that the Q2 figures will almost certainly mark the intrayear low for the company. It’s only if these teething problems at Berlin and Austin continue deep into the fourth quarter that investors will probably need to be concerned.
Indeed shareholders seem to be taking Musk’s warning in stride. The stock is expected to open 1% higher on Thursday.
