Edited by Brian Birnbaum.
This an update of my original Tesla deep dive and my Q3 2023 ER digest.
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1.0 FCF / Op. Margin Has Ticked Up QoQ
Tesla’s manufacturing capability has increased massively from Q3 to Q4 2023. Past instances of manufacturing improvements have correlated strongly with significant increases in the stock price.
The market is a voting machine in the short term and a weighing machine in the long term. A thorough fundamental investigation of Tesla reveals that the market’s voting mechanism is hyper-active to the downside, with the company’s core fundamentals showing spectacular progress.
The market is currently wrong about Tesla, which is gearing up to get much stronger, fundamentally speaking.
As I’ve written numerous times, Tesla’s core value driver is its ability to optimize unit economics, which fundamentally involves exponential manufacturing improvements over time. As Tesla’s manufacturing prowess grows, it moves more cars, solar panels, and batteries.
Combined with its software prowess, Tesla’s increased manufacturing capability underpin a platform that promises to bring material abundance to the world–much like the internet has done for information over the past two decades.
In Q4, Tesla’s manufacturing efficiency increased at a pace unseen since 2020. I use two metrics to assess the company’s progress on this front:
Free cash flow / Operating margin: increases in this metric indicate Tesla’s ability to produce more free cash flow with lower margins, meaning more efficient manufacturing (and operational) processes.
Operating cash flow / CapEx: an increase in this metric could denote an increase in automation; holding all else equal, higher rates of return per invested dollar would indicate more efficient operational processes.
In the graph above, notice how the metric has not trended up in this manner since 2020. After the 2020 increment, Tesla proliferated its ability to produce cash, sending the stock up tenfold in a very short period of time, hitting an all time high of ~$400 in late 2021.
You may also notice that the above graph exhibits a cyclical tendency. This is due to Tesla lowering prices every time it reaches a new threshold of efficiency, in order to share economies of scale with customers. This increases customer loyalty and decreases the cost of acquiring new customers.
What is special about this last cycle is that Tesla was forced to cut prices early due to rate hikes. Higher rates make cars far less affordable. Tesla dropped prices to subdue the impact.
However, once again, Tesla’s extraordinary organizational properties have transmuted increased pressure into a leap in manufacturing efficiency. Notice that, although in absolute terms the magnitude of the increase is similar to 2020, the price of money is infinitely higher now than it was back then.
To the extent that cars are less affordable now than in 2020, we can translate this magnitude of manufacturing efficiency increase over the last quarter versus that of Q3-Q4 2020. If the FCF/Op.Margin graph were normalized for the price of money, the spike from Q3 to Q4 2023 would look much larger.
Also notice that increased manufacturing efficiency in 2020 was not a standalone event. Tesla had previously revamped its manufacturing capabilities in 2017 to bring the Model 3 to life, as you may appreciate in the graph below.
Proportional increases in efficiency compound over time, yielding non-linear increases in cash flow production.
The increase in operating cash flow per unit of CapEx is a bit more tepid. CapEx continued to flirt with all time highs in Q4 2023 (see the next graph) because we’re early in the current cycle.
Tesla is currently gearing up for the production of its next-generation vehicles. In the words of CEO Elon Musk, the new manufacturing facilities have a “tremendous amount of new revolutionary manufacturing technology.”
It looks like the optimization of unit economics is set to continue into the future.
I understand that the market is concerned about Tesla’s desirability falling against Chinese electric vehicle OEMs and incumbent European OEMs. But if there’s anything else Tesla does well, it’s creating gravitas. If I had to bet money now (which I am), I would say Tesla’s next generation vehicles will be very appealing.
The above two key metrics are perhaps best summarized in the rapidly declining COGS (cost of goods sold). COGS has decreased 3.5% QoQ, which is a stark acceleration in contrast to previous quarters.
At this pace, Tesla is only a few years away from being able to sell its average car for less than the price of a Toyota Corolla. Tesla is thus geared up to command a considerable cost advantage over the rest of the industry in the decade that lies ahead.
This cost advantage is set to compound with Tesla’s AI and energy capabilities–to effectively produce autonomous vehicles at a scale and quality that will be very hard to match.
It’s one thing to make cars for cheap and another thing entirely to make them at a low cost with the vertically integrated software and hardware stack required for them to function as autonomous robots.
2.0 The Energy and Services Businesses Thrive
While Tesla continues to get better at manufacturing, its strategic business segments continue to evolve well.
Energy storage deployments decreased sequentially in Q4 to 3.2 GWh for a total deployment of 14.7 GWh in 2023, a 125% increase compared to 2022. The dramatic YoY increase in deployments is proportional to Tesla’s improved manufacturing ability across the board.
I suspect that the current manufacturing cycle (as explored in Section 1.0) will likely further exponentiate storage deployments. Tesla is on track to becoming an energy juggernaut by the year 2030.
II also suspect that the current cycle will culminate in a new inflection point in FSD (full self driving) total miles driven. Tesla is currently transitioning from Hardware 3 to Hardware 4, which promises to increase inference performance.
More cars on the road and faster inference should indeed lead to another inflection point a few quarters down the line.
Services gross profit continues progressing, following the NACS (North America Charging Standard) adoption of major OEMs like Ford, GM, Mercedes and others–which, notably, is a charging standard developed by Tesla over a decade ago.
3.0 Financials
At a first glance, Tesla’s financials are getting worse. But free cash flow per share levels, more than earnings per share, drive the stock price over the long term.
Income Statement and Cash Flow Statements
First level financial metrics in the income statement are trending down, in absolute terms. Gross margin came in at 17.63% in Q4 2023, down from 17.89% in Q3 2023. This is a steep decline from the highs of 29.11% in Q1 2022.
Further, operating margin has also been trending down, coming in at 8.20% in Q4 2023, which is nonetheless an increment from 7.55% in Q3 2023. Similar to gross margins, operating margin has declined sharply from a high of 19.21% in Q1 2022.
As I have discussed previously, however, what ultimately drives a stock over the long term is the free cash flow per share levels.
Every additional dollar a company makes in as an added incentive for the market to come in and disrupt it. Dollars captured in absolute terms is therefore not predictive of future returns, but dollars captured in a way that cannot be imitated is.
By constantly growing more efficient and dropping prices, Tesla is making it exponentially harder for competitors to compete. In other words, it is securing higher levels of free cash flow per share in the future than otherwise.
Higher rates have forced Tesla to decrease prices faster than otherwise, but deliveries and manufacturing efficiency continue to push all time highs. Meanwhile, the long term plan is intact with the AI and energy businesses tracking along.
Tesla reported a net income of $7.9 billion. However, a big chunk of that ($5.9 billion) came from a one-time, non-cash tax benefit. Excluding this one-time benefit, Tesla's net income was actually $2.49 billion, which was 39% lower than the same quarter in 2022 and below analyst estimates.
Although disappointing, the decrease in the top line seems natural to me in an environment in which money is exponentially more expensive. However, what’s striking is that Q4 2023 cash flow levels are about on par with Q4 2022.
The financial results therefore confirm that Tesla has quickly adapted to transformational macroeconomic change in a very short period of time. It can now continue growing from here.
Balance Sheet
Tesla ended Q4 2023 with $29.1B in cash and no debt.
4.0 Conclusion
The market is confusing a general decrease in the affordability of cars with consumers losing interest in Tesla specifically. I believe that although Tesla now faces stiffer competition, the company’s ability to produce cars that people want remains intact.
Further and as demonstrated in Section 1.0, Tesla’s ability to profitability produce and deliver cars and increasingly lower prices continues to advance. So long as the desirability of its cars has not faded, this sets the company up for much higher levels of free cash flow per share over the coming years.
Over 50% down from its all time highs, the stock currently presents a compelling buying opportunity.
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Do you happen to know Tesla’s TTM net income ex-auto sales, ex-carbon credits? Not revenues or gross profits, but net income. Sorry if I missed it in your charts.