Cracks Appear In Tesla’s Growth Story (NASDAQ:TSLA)

Cracks are beginning to appear in Tesla’s (NASDAQ:TSLA) growth story. After a dismal second quarter when production at the Shanghai factory was limited by China’s covid shutdowns, expectations were set for a sharp rebound in Q3. But even though Tesla achieved a new quarterly record, the sales of 343,000 cars missed analyst expectations by a wide margin. Production growth continued but demand stalled, leaving Tesla with an extra 22,000 cars in inventory at the end of the quarter.

It might seem odd that I am warning about an end to Tesla’s high growth story when they have just issued record delivery numbers. However, there are real signs of a pending demand problem in China and, to a lesser extent, in Europe, two of Tesla’s three key markets, and Tesla cannot maintain its projected 50% growth without both of those markets.

The delivery schedule excuse

Tesla has always organized its deliveries to maximize the impact on quarterly results, delivering early in the quarter to areas more remote from the factory and making local deliveries in the final weeks of the quarter.

If you have a backlog of orders to be delivered across the country, or across the world, shipping the cars that have the longest delivery times early in the quarter and shipping the local cars at the end of the quarter will minimize in-transit inventory, giving the appearance of higher sales and higher operating cash flow at the quarter end when financials are presented.

However, if you don’t have an order backlog, it becomes more difficult. If orders are trickling in during the final month of the quarter, those orders cannot be delivered to far-flung reaches of the world before the end of the quarter, so end-of-quarter inventories will be higher.

Tesla used logistics as an excuse for missing Q3 delivery targets and ending with a higher inventory. That is probably true, but it was more likely precipitated by a lack of new orders, especially in China, rather than a voluntary change in delivery policies.

Signs of slowing China demand

During September, there were other indications that Tesla’s order backlog in China has evaporated.

• Incentives of an 8,000-yuan ($1,800) credit towards car insurance were offered for orders placed in September and delivered before the end of the quarter.
• Quoted delivery times were reduced to only one to four weeks (equivalent to the time needed to process, manufacture, and deliver a new order to anywhere in China).
• The Shanghai plant is expected to operate at only 93% capacity in Q4.
• Sales in the final week of September were well below the previous week (10k vs 23k), a strong indication that Tesla had simply run out of buyers before the end of the quarter.
• Production for export started on the 21st rather than the 26th of the month, with three ships leaving for Europe during the first week of October.
• Sales in the first week of October (2,218 cars) show no signs of an “in-transit” spillover from September.

In Q3, Tesla sold 117,794 cars in China, including 77,613 retail sales in September. However, they entered Q3 with a healthy backlog after the Shanghai factory had been closed for part of Q2. It appears that the backlog disappeared in Q3, new orders could have been as low as 60 to 70,000 for the quarter.

A major drop in China sales is a huge problem for Tesla, it comes at a time when the Shanghai factory has been expanded and Tesla is ramping up a factory in Germany which will produce cars that would otherwise have been imported from Shanghai. To maintain market share, they may have to cut prices and take a margin hit at a time when production costs are increasing.

Real competition from BYD in China

In China, competition has been biting at Tesla’s heels for some time now, but the overall growth in the electric car market has been able to offset the loss in market share, leaving Tesla with healthy growth.

The three start-ups NIO (NIO), Xpeng (XPEV) and Lixiang (LI), along with several other new entrants have grown rapidly but from a small base. None of them are yet large enough to present a serious challenge to Tesla’s dominance, and Volkswagen (OTCPK:VWAPY) seems to be selling just enough cars to meet its regulatory obligations in China.

However, BYD (OTCPK:BYDDF) has become a formidable force in China’s EV sales. BYD is quickly converting all its production to New Energy Vehicles (BEVs and PHEVs). It already leads global sales of plug-in cars and sold 258,000 BEVs last quarter, most of them in China – that’s double Tesla’s China sales.

BYD claims to have a backlog of 700,000 vehicles and is planning to increase production to 280,000 per month by year-end and 4 million in 2023, split roughly 50/50 between BEVs and PHEVs. It has been selling the Tang, a family-size 7-seater SUV, in Norway this year and will be entering Benelux countries with three models in 2023. It has already signed an agreement to sell 100,000 cars to rental company Sixt between now and 2028.

BYD will almost certainly take over Tesla’s position as the global EV sales leader in 2023, and with a wider range of better-quality products at cheaper prices, it is likely that BYD’s growth will continue to negatively impact Tesla’s China sales.

Europe has its own problems

In Europe, after a dismal Q2 affected by Covid shutdowns at the Shanghai factory, Tesla should have entered Q3 with a sales backlog and high expectations for record sales. But Tesla sales for Q3 came in at only 52,420, a 14% increase over Q3 of 2021 but 9% below Q1 of this year. Germany was the only major market to record a sales increase for Q3 versus Q1, no doubt driven by enthusiasm for the local product as the German factory started up this year. Sales in the other major markets (UK, France, and Norway) were all down versus Q1.

Europe has its own problems, an energy crisis has led to significant increases in electricity prices and a threat of blackouts this winter. Energy-intensive industries are reducing production or moving production overseas and a deep recession seems inevitable. Despite generous subsidies, EVs will be a tough sell this winter. It’s a bad time to be ramping up a new factory to produce a car with a three-year-old design whose sales are currently only 20% of the proposed factory’s capacity. Building new factories does not guarantee sales growth.

No justification for the high valuation

Tesla shares are off about 20% since the publication of the Q3 delivery numbers, but they are still grossly overvalued compared to other companies in the automotive business. Tesla’s market cap of $700 billion exceeds the market cap of the ten biggest automakers combined. For a company that sells less than 2% of the vehicles, that market cap needs to be justified by a seriously high growth rate.

Non-existent products like the robotaxi and the Tesla robot are only a distraction, they add no value.

Tesla CEO, Elon Musk, has often talked about a 50% per year growth rate, a figure that is picked up by both retail bulls and professional analysts and used to make future projections to justify their overblown target prices. That 50% growth rate requires sales of 500,000 cars in Q4 for a total of 1.4 million this year, a figure which now seems well out of reach.

The Tesla growth story is starting to falter, if you are a long-term investor sitting on profits, it is probably time to cash in your gains. If you are thinking of “buying the dip” be careful, you could be “catching the falling knife”.