Tesla’s dirty little secret: the net profit doesn’t come from car sales

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Eleven states require carmakers to sell a certain percentage of zero-emission vehicles by 2025. If they can’t, the automakers will have to buy regulatory credits from another automaker that meets those requirements, such as Tesla, which only sells electric cars.
It’s a lucrative venture for Tesla, bringing in $ 3.3 billion in the past five years, nearly half of that in 2020 alone. The $ 1.6 billion in legal credits it received last year far outweighed Tesla’s net profit of $ 721 million – meaning Tesla would otherwise have posted a net loss in 2020.
“These guys are losing money selling cars. They are making money selling credits. And the credits are disappearing,” said Gordon Johnson of GLJ Research, one of the biggest bears in the world. Tesla (TSLA) shares.

Tesla executives admit that the company cannot count on that source of cash to continue.

“This is always an area that is extremely difficult for us to predict,” said Zachary Kirkhorn, Tesla’s Chief Financial Officer. “In the long run, regulatory credit sales will not be an integral part of the business, and we don’t plan the business around it. It may remain strong for a handful of additional quarters. It is also possible that it is not. . “

Tesla also reports other measures of profitability, as do many other companies. And because of those measures, the profits are so great that they do not depend on the sale of credits to be in the black.

The company reported adjusted net income for 2020, excluding items such as $ 1.7 billion stock-based compensation of $ 2.5 billion. Automotive gross profit, which compares total revenues from his auto business with expenses directly related to building the cars, was $ 5.4 billion, even excluding sales revenues from regulatory credits. And free cash flow of $ 2.8 billion was up 158% from a year earlier, a dramatic turnaround from 2018 when Tesla ran out of cash and threatened to run out of cash.

Its supporters say those measures show that Tesla is finally making money after years of losses with most of those measures. That profitability is one of the reasons the stock performed so well for over a year.

But the debate among the company’s skeptics and devotees as to whether Tesla is truly profitable has turned into a “ holy war, ” according to Gene Munster, managing partner of Loup Ventures and a leading technical analyst.

“They argue about two different things. They will never come to a solution,” he said. Munster believes that critics are paying too much attention to how the credits still outpace net income. He argues that the gross profit margin in the automotive sector, excluding the sale of regulatory credits, is the best barometer of the company’s financial success.

“It’s a leading indicator,” he said for that measure of Tesla’s earnings. “There is no chance GM and VW will make money from their electric vehicles on that basis.”

The future of Tesla

Tesla’s high stock performance – up 743% in 2020 – makes it one of the most valuable US companies in the world. Still, the 500,000 cars it sold in 2020 were a sliver of more than 70 million vehicles estimated to have been sold worldwide.

Tesla shares are now worth about as much as those of the combined 12 largest automakers who sell more than 90% of cars worldwide.

What Tesla has that other automakers don’t have is rapid growth – last week it predicted 50% annual sales growth over the next few years, and expects to do even better than that in 2021 as other automakers struggle to return to pre-pandemic sales levels.

Tesla disappoints Wall Street despite strong profits

The entire industry is moving towards a fully electric future, both to meet stricter environmental regulations worldwide and to meet the growing demand for electric vehicles, in part because they require less labor and parts and cost less to build than traditional gasoline cars.

“One thing most people can agree on is that electric vehicles are the future,” Munster said. “I think that’s a safe assumption.”

Although Tesla is the leading electric car manufacturer, it is facing increasing competition as virtually every automaker is rolling out or planning to roll out its own EVs. Volkswagen has surpassed Tesla in terms of EV sales in most of Europe. GM said last week that it hopes to switch completely to zero-emission cars by 2035.

“Competition makes Tesla’s cars irrelevant,” said Johnson of GLJ ‘Resarch. “We don’t see this as a sustainable business model.”

Other analysts argue that Tesla’s stock price is justified given how it can benefit from the shift to electric vehicles.

“They won’t keep an 80-90% share of the EV market, but they can continue to grow even with a much lower market share,” said Daniel Ives, a technology analyst at Wedbush Securities. “We’re looking north of 3 million to 4 million vehicles a year by 2025-26, with 40% of that growth coming from China. We think they are now on the path that even without [the EV] credits they will still be profitable. ”

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