Published on October 28, 2019 |
by Paul Fosse
28. October 2019 by Paul Fosse
Two of the big news in Tesla's Q3 revenue announcement were that margins increased dramatically and the cost of building the new lines to produce Model Y in Fremont is half the cost of the existing Model 3 lines, and that the cost of Building the Model 3 line in China is 65% smaller than the same US Model 3 capacity lines. This means that the cost of the Model Y line may cost half of what an existing Model 3 line costs, or it may cost the same amount but have twice the capacity – or a combination of the two.
Are these two news related? Yes, but not really this quarter. Improving the gross margin appeared to be many small improvements at every stage of building the Model 3 (and to a lesser extent the other products Tesla makes). Tesla still uses the production lines it built before it learned how to build lines for much less money. The lower capital expenditure (CapEx) helps Tesla's balance sheet (because it has saved the company billions of dollars), but it does not change Tesla's earnings much this quarter. However, it will have a big impact in the future. Why is it?
Because until you start producing cars (sample production probably doesn't count) on one line, a penny does not flow to the expense of the income statement. Tesla can spend $ 2 billion or $ 20 billion on a new plant, but until the company starts using it, it will not affect its income statement. An exception is that it would have to pay interest on any loans if Tesla took out a loan. However, if Tesla paid cash, it would no longer earn interest on the cash, so it would reduce revenues a bit.
For example, if Tesla spent $ 2 billion on Gigafactory 3 and paid 5% on the loans, it would result in $ 100 million a year or $ 25 million as well. (Last quarter, Tesla reported paying $ 185 million in interest expenses, not just for Gigafactory 3, but for all the debt the company has collected). A year ago, the company paid $ 175 million, so you can see Tesla's interest expenses creeping up, even though the company collected a large amount of equity this spring. It's not a surprise, because even though Tesla has been profitable 3 of the last 5 quarters, it is still not profitable in the last 4 quarters, because the small profits in good quarters have not been large enough to offset the larger losses in loss-making quarters. If you want to follow, the link to the Tesla Revenue Letter is for Q3.
Depreciation from the income letter for the third quarter 2019.
Fixed assets and equipment from the third quarter Tesla income letter.  To know how property, plant and equipment converts to depreciation, I would need the life of each asset and accounting method used by Tesla. I can only assume linear depreciation for simplicity and I want to share existing depreciation with the assets to get an idea of life.
This shows that depreciation as a percentage of property, plant and equipment has been fairly constant, but is slightly lower than last year. It makes sense, since Tesla has the entire Gigafactory 3 as part of property, plant and equipment but it has not started to write it off yet. Tesla had no similar factories last year – built, but not yet turned on.
On the other hand, Tesla has taken in about $ 2 billion in depreciation over the past four quarters, reducing property, plant and equipment to the net line by a similar amount. I think the existing Model 3 production lines in Fremont and the support ramp up in Gigafactory 1 in Nevada cost Tesla about $ 4 billion in CapEx. We can use my figures above to estimate that it caused an increase of $ 200 million (5% of $ 4 billion) a quarter in depreciation when Tesla began building Model 3.
Depreciation from the 4th quarter 2017 income letter.
When I look at my thoughts with reality, it looks like quarterly depreciation has increased $ 255 million per quarter from Q4 2016 (when there was no Model 3 production) to the top in Q2 2019. Some of the extra depreciation was for equipment to produce other products (either Model S and X or Tesla Energy), but most of it was for the Model 3 ramp. It checks out.
So if Tesla charges about $ 200 million per quarter in depreciation related to Model 3 production and it yielded nearly 79,837 Model 3's in the quarter, we can only divide those two numbers and find that it adds $ 2,500 to the cost for each car. When the new lines in China were turned on and reduced to capacity, there should be 65% lower depreciation costs, or ~ $ 1,600 less per vehicle. This is in addition to the lower labor costs in China.
If we speculate that the Chinese production ramp is capable of saving $ 130 million (65% of $ 200 million) in quarterly depreciation costs and the Fremont Model Y production ramp is capable of saving $ 100 million ( 50% of $ 200 million (million), we could see $ 230 million in quarterly savings that would fall all the way to the bottom line (after a tax allowance). This is a nice addition that is already "baked in the cake." This is in addition to economies of scale (which are very large in a software-oriented company like Tesla), the constant innovation to reduce costs that Tesla is focused on each quarter (or every today), and the huge windfall in valuation Tesla will realize if it is able to get approval for a robot taxi without a security driver anywhere in the world before any other company.
This does not constitute investment advice. Please speak with an investment advisor who will evaluate your individual situation before making investment decisions.
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