Tesla's earnings mark the car industry's 'Windows 95 moment'

Equities 7 minutes to read

Peter Garnry

Head of Equity Strategy

Summary:  Tesla's Q3 earnings saw the company report a surprise quarterly profit with earnings per share coming in at $2.90 versus a forecasted $0.15 loss.


Tesla delivered its Q3 earnings last night after delaying the release for one week. This was seen as a sign of strength, and that anticipation proved correct.

Here are the headline numbers:

• Q3 adjusted earnings per share at $2.90 versus a forecasted $0.15 loss
• Q3 free cash flow $881 million versus a forecasted $280m
• Guidance is for positive Q4 numbers on net income and free cash flow
• Q3 revenue growth is 129% year-on-year to $6.82 billion. Consensus expects revenue of $35.5bn in FY’20
• Deposits only marginally down despite a strong uptake in deliveries. This indicates strong underlying demand for Tesla cars.
• Model 3 deliveries in Europe to start early 2019
• Model 3 production in China to start in 2019 to local customers only and using locally sourced components
• Automotive gross margin 25.8% (25.5% excluding govt credits) up from 18.3% a year ago

The results basically confirm our October 2 comments (‘Are markets underestimating Tesla?’).

Here is my take away on Tesla:

With its Q3 numbers, Tesla just created nothing less than the car industry’s ‘Windows 95 moment’ – the industry is changed forever and the uptake will likely be massive. Tesla is showing that it is way ahead of the competition in electric vehicles, or EV; it is also now hurting even internal combustion engine (ICE) volume. 

Daimler’s latest profit warning, for example, was partly driven by sharp declines in its luxury segment in the US where Tesla is eating market share. In the wake of Tesla's strong quarterly numbers, we see the firm's default probability significantly lower as a result (see chart below); Tesla bonds could see heavy bidding over the coming quarters.

If Tesla’s run rate on free cash flow is now 4 * 881 = 3,524m (it’s too early to say with confidence), then its current free cash flow yield is 5.9%. Compare this to Toyota’s FCF yield of 6.9%; in this light, Tesla suddenly doesn’t look that expensive. Volkswagen and BMW are both running negative FCF and BMW has had negative free cash flow for the past six fiscal years. I think the German carmakers have re-enacted Nokia versus Apple – they were too arrogant and too slow.

Another interesting observation concerns Tesla’s less-discussed Energy division. Revenue there was $399.3m, up 26% y/y with gross margin at 17.2%. Distribution has always been the biggest issue for solar companies due to high customer acquisition costs. With a current base of 450,000 Tesla car owners, the company increasingly has a large and easy-to-tap customer base for energy production and storage sales. 

My take is that the energy division will be a big positive surprise for shareholders going forward. 

There do remain some notable risks ahead for Tesla:

• Elon Musk is still a key risk
• Tariffs are a negative on gross margin
• Higher interest rates could curb demand
• Consumer Reports has recently lowered its ratings of Tesla cars
• Competition is rolling out competing EVs over the coming years
• Management exodus is elevated
• Higher commodity prices on lithium and cobalt
Tesla default rate (white line, source: Bloomberg)
Tesla volume and sales v. competition in cars excluding the pickup segment, which is larger in the US (source: Saxo Bank, CleanTechnica, and EV Obsession)
Source: Bloomberg, Saxo Bank
Source: Tesla Q3 release
TSLA (daily, five-year, source: Saxo Bank)
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