Here’s why Tesla is so profitable

During the last years, You’re here (TSLA 1.14% ) recorded massive growth in profits. As recently as 2019, the electric vehicle pioneer was unprofitable by generally accepted accounting principles (GAAP) and barely broke even on an adjusted basis. However, Tesla‘s operating margin improved to 6.3% in 2020 and 12.1% in 2021, reaching nearly 15% in the second half of last year.

There’s a simple reason why Tesla has suddenly risen to the top of the auto industry in terms of profitability: the company sells a large number of vehicles built on a single platform at high prices. Yet this fact is not widely recognized as the source of Tesla’s improved fortunes. Let’s see what this means for Tesla in the future.

Increased production and income

Tesla delivered more than 936,000 vehicles in 2021, 155% more than the 367,656 vehicles delivered two years earlier. The Model 3 sedan and the Model Y crossover, which are built on the same platform, accounted for 97% of Tesla’s production last year. Model S and Model X deliveries fell to 24,980 (from a peak of over 100,000 a few years ago), due to a long production shutdown.

While some analysts expected the shift in the Model S and Model X mix to hurt profitability, that didn’t happen. A big reason is that Tesla’s average selling price (ASP) has held up quite well.

Excluding vehicles delivered under lease contracts, Tesla’s ASP exceeded $50,000 in 2021, down about $6,000 from 2019, when the combination of expensive Model S and Model X was much higher. As a result, auto sales (excluding leases) reached $44.1 billion, compared to $26.4 billion in 2020 and $19.4 billion in 2019.

A recipe for fat margins

Selling nearly a million vehicles in a year at an ASP of over $50,000 is obviously good for margins. This is especially true because the Model 3 and Model Y are built on the same platform and share many components. This dramatically reduces complexity (and cost).

Image source: Tesla.

This is not specific to Tesla. Legacy automakers General Engines (GM 2.33% ) and Ford Motor Company have high-volume companies selling full-size trucks and SUVs (built on common platforms) at equally high prices. For example, GM regularly sells over a million full-size trucks and SUVs each year in the United States.

While neither company provides exact details, the GM and Ford full-size truck/SUV franchises appear to consistently generate operating margins in the 20-30% range, which is the bulk profits of the two automakers.

Indeed, in the third quarter of 2020, when General Motors was operating its full-size truck and SUV plants at maximum capacity to replenish inventory without fully restoring production of some less popular models, GM posted an operating margin of 15 % in North America. The main reason his margins are generally lower is that the rest of his business is much less profitable.

What does this mean for Tesla?

Tesla’s strong momentum will likely continue into 2022. The company has expected to grow sales at a compound annual growth rate of around 50% for the foreseeable future. Unless supply constraints worsen significantly, it should have no trouble achieving that growth rate this year. Tesla cites long wait times for many models, suggesting demand continues to outstrip supply.

Like most businesses, Tesla is facing rising costs. But he had no trouble raising prices to compensate. The cheapest Model 3 sold on its website now has a base price of $44,990. The Model Y starts at nearly $60,000 and peaks in price at around $80,000 (including the “full self-driving” package). Additionally, only the most expensive models are available for short-term deliveries, with the cheaper versions having estimated delivery dates in the fourth quarter. This should support further margin expansion in 2022.

A blue Tesla Model Y.

Image source: Tesla.

In the longer term, the outlook is bleaker. For now, supply constraints are preventing the auto industry from meeting demand, which is sending prices skyrocketing. The average transaction price for auto sales in the United States recently topped $45,000. In that context, it wouldn’t be surprising if Tesla could push its ASP back toward $60,000 this year while boosting combined Model 3 and Model Y shipments well past one million.

As supply constraints ease, auto prices will decline. Other brands will seek to break Tesla’s stranglehold on the EV market by offering reasonably capable alternatives at much lower prices. (For example, GM is touting a Chevy Equinox EV starting at around $30,000 that will arrive in the fall of 2023.)

To continue rapidly increasing unit sales, Tesla will need to expand its vehicle lineup, including the addition of a cheaper entry-level vehicle. But offering a wider choice of models will increase costs and complexity, while Tesla’s ASP will decline due to competitive forces.

Tesla is still poised for strong profit growth as it expands in the years to come. However, even after its recent pullback, Tesla shares are trading at 77 times forward earnings. It will be difficult to stick to that valuation, given the margin headwinds it will inevitably face as it expands its product line over time.

This article represents the opinion of the author, who may disagree with the “official” recommendation position of a high-end advice service Motley Fool. We are heterogeneous! Challenging an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and wealthier.

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