What Did Elon Musk Say About This Key Problem?

What Did Elon Musk Say About This Key Problem?

Tesla CEO Elon Musk Semi

  • Tesla is aggressively cutting its vehicle prices.
  • But growing inventories could become a problem.
  • Lower margins could mean a lower stock valuation.

Is Tesla’s strategy genius or desperation?

Earnings are always a big deal for Wall Street’s biggest companies, and electric vehicle company Tesla (TSLA 1.28%) is always a headliner. The company reported its first-quarter 2023 earnings recently, and investors are grappling with an aggressive price-cut strategy creating waves.

CEO Elon Musk commented on the earnings call about Tesla’s price strategy, noting that the company’s vehicles are a hardware product that will generate recurring revenue across its fleet via autonomous driving.

But the company’s financials also point out some issues that potentially undermine what Musk said. Here is what you need to know and how to make sense of it.

The price cut controversy

Tesla has aggressively cut pricing on its vehicles over the past year, especially the Model 3 and Model Y vehicles. Given Tesla’s history as a battleground stock, investors have fallen into two categories. Some believe that Tesla’s price cuts are to squeeze competitors and take market share, and others think that Tesla’s cutting its prices out of desperation to boost delivery figures and spur demand.

Elon Musk elaborated on Tesla’s strategy during the Q1 earnings call, noting that the company emphasizes selling more vehicles at lower margins because it believes autonomy will eventually create more profitable revenue streams from its fleet. In other words, the vehicles aren’t where the profits are made; the autonomous driving software is.

Wherever you stand on Tesla’s price cuts, investors must watch the company’s continually rising inventory. Inventory has steadily increased, from $6.7 billion in Q1 of 2022 to $14.3 billion in just one year, growing every quarter along the way. Excess inventory can be a problem because it might cause continued price cuts, or force a manufacturing slowdown, which would also pressure profit margins. Musk insisted that affordability due to higher interest rates could be hurting consumer demand. Still, inventory will become harder to ignore if it continues growing in upcoming quarters.

Why is Tesla’s stock going down?

The market has responded to Tesla’s earnings by selling the stock down by about 10 percent. What could be the reason for that? Remember that investors often value companies on profits. Tesla’s price cut strategy may prove a winner in the long run, but it’s notably impacting its bottom line today.

Profit margins fell across the board, including gross margin falling 977 basis points and operating margin falling 779 basis points, to 19.3% and 11.4%, respectively. That trickled down to free cash flow, which declined 80% year over year to $441 million, despite revenue growing 24%.

Tesla’s higher-volume, lower-margin market strategy means (at least for now) that the company isn’t as profitable, which commands a lower valuation premium.

Should you buy the dip?

The market could be repricing the stock to determine where it should trade relative to Tesla’s competitors. For example, companies like Ford and General Motors have operating margins between 6% and 8%, and Tesla’s operating margin once blew them out of the water at 19% in the year-ago quarter. This quarter’s 11% puts it much closer to its competitive counterparts.

It’s only one quarter, so investors should be careful about drawing too much from three months in the business. However, its rising inventory levels are now a trend and a potential problem. Meanwhile, the stock could continue repricing to a lower valuation if margins continue heading lower, especially after announcing another price cut just before the earnings release.

A cautious approach could be warranted. Tesla’s long-term opportunities still exist, and its plan to leverage autonomy for higher margins later could work out well for shareholders. Still, investors should resist the temptation to call Tesla’s stock cheap because of where it once traded –there are reasons why the stock is dropping.

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