Just as the books are beginning to close on Tesla’s challenging second quarter, CEO Elon Musk has launched something akin to a neutron bomb.
The two new gigafactories in Germany and Texas are “giant money-making furnaces,” he confided in the third episode of a marathon interview with members of the YouTube channels Tesla Owners Silicon Valley and The Kilowatts.
“There should be a giant roaring sound, that’s the sound of money on fire,” he said, adding “Berlin and Austin are losing billions of dollars right now.”
Coming from a company that has spoiled shareholders with gross margins of more than 30% in the automotive sector for three consecutive quarters – one of the absolute best in the industry – those words are sure to alarm investors.
Add to Musk’s words the weeks-long production loss in Shanghai due to COVID lockdowns, which prompted analysts to lower its second-quarter forecast to 250,000 vehicle production, and it seems Tesla’s level of high profitability is rising. simply not sustainable.
Then throw in a hefty charge for Tesla’s Bitcoin depreciation that could easily exceed $400 million, and you can see why bears are licking their lips. Even a bull like Morgan Stanley’s Adam Jonas lowered its price target.
Not as dramatic as they sound
Before Tesla bears get too excited, though, it’s worth noting that the problems in Berlin and Austin don’t have to be as dramatic as they sound — despite Musk’s colorful description (the Tesla CEO is known for demanding in terms of factory performance).
Adding a new plant will always hit margins because of a mismatch between the speed at which early revenues trickle in and hefty upfront investments that are written off as fixed costs over time.
The rule of thumb in the industry is that a manufacturing plant tends to operate at decent profitability when it uses approximately 80% of its installed production capacity in two shifts. Only when that number drops to 60% does a plant usually lose money.
However, when a factory just starts production, there is invariably a laundry list of teething problems that need to be worked out.
The supply chain must function flawlessly; machines should be calibrated to the micrometer to ensure that the exterior body panels fit together seamlessly with no gaps; and workstations must meet time targets in order not to hold up the assembly line – just to name a few obstacles.
If these problems aren’t addressed from the start, the mistakes will pile up and end up costing the manufacturer much more to fix later – when thousands, rather than hundreds, of cars are built per day.
So while the occupancy rates of Berlin and Austin are both miniscule, Musk has previously said it would take about 12 months to scale them up where they operate most efficiently.
Competitor Volkswagen is even trying to mimic the expected productivity of Giga Berlin, which aims to produce a Model Y crossover every 10 hours. That’s twice as fast as most factories thanks to new manufacturing techniques such as full castings for the front and back.
In addition, Tesla excels partly due to a very low production complexity. Virtually all of the volume comes from the Model 3 and Model Y, which offer minimal choice in trim options such as paint color, wheels, and interior.
slow for now
At the moment, however, Berlin only recently reached the 1,000-vehicle-per-week mark earlier this month, representing about 10% of its half-million installed capacity, even after nearly three months in operation.
“There’s a lot of cost and very little output,” Musk said.
The key is still what Musk went on to say: “This is all getting resolved very quickly, but it requires a lot of attention.”
His team expects to continue expanding Shanghai, Berlin and Austin to achieve 50% (or higher) sales volume this year. With 2022 EPS expected to approach $12, the stock is trading at a forward multiple of about 60x – lofty for most companies, but justified by bulls as few companies are around that can match that kind of growth.
Bears might even recall that the Q2 numbers will almost certainly mark the year-long lowest for the company. It’s not until these teething problems in Berlin and Austin continue well into the fourth quarter that investors should probably start to worry.
Indeed, shareholders seem to be taking Musk’s warning to heart. The stock is expected to open 1% higher on Thursday.
This story was originally on Fortune.com