In 2018, Tesla CEO Elon Musk signed an agreement with the Shanghai regional government to set up the first Gigafactory in China. Here we discuss why Tesla decided to enter China, the competitive advantage it has over other local players and how Tesla’s entry in China will impact the domestic electric vehicle (EV) market.
Why China?
China is among the largest automobile markets in the world with annual vehicle sales of around 25 million. Long-term growth potential and supportive government policies for EVs make China an attractive market for Tesla.
China is the largest EV market in the world, accounting for 1.1 million EV sales, out of the 2.2 million sold globally in 2019.
EVs have strong government support in China. It aims to increase the penetration of EVs to 25% by 2025. Since 2012, the government has supported EV adoption through billions of dollars in subsidies. These subsidies have since been progressively reduced. From 2019 onwards, automakers are required to sell a specific number of EVs annually to earn tradable EV credits.
Competitive advantages
Like Apple in smartphones, Tesla enjoys a strong brand image in the minds of Chinese car buyers. Tesla cars are perceived to be of better quality, better designed, offering a high range and relatively long-lasting when compared to other EV
Tesla is technologically advanced compared to local EV Examples of Tesla’s advanced technology include:
Autopilot: Tesla’s autonomous platform is considered among the most advanced in the world.
OTA updates: The company uses over-the-air (OTA) software updates for maintenance and adding/loading new features.
Battery: Focus on improving battery technology, range and efficiency. The new LFP battery lasts a million miles.
Infotainment and connected services: Software update V10 provides advanced infotainment features like video and music streaming, and karaoke. It also includes a Smart Summon, or smart parking, feature.
There are more than a million Tesla cars on the road globally. The company has the advantage of collecting feedback and data from these cars and improve its current software like Autopilot and Smart Summon. Not many automakers have sold so many EVs till now or have enough focus on autonomous cars/technology updates.
Shanghai factory
The key advantage of owning a factory in China is the cost savings associated with local sourcing and production. Utilizing parts manufactured by Chinese suppliers, rather than importing them from the US and paying additional tariffs, brings down the production cost. Around 30% of parts used in the China facility are sourced locally and Tesla plans to increase it to 100% in 2020.
Recently, Tesla reduced the price of Model 3 to avail government subsidies and remain competitive. Lowered costs due to localization and falling battery prices could encourage Tesla for further price reductions.
Impact on Chinese EV market
Domestic Chinese companies will continue to dominate the New Energy Vehicle (NEV) category as a vast majority of cars sold in the country cost less than $45,000, a price segment where Tesla does not compete. The share of expensive EVs (>$45,000) is limited in China.
Start-ups like Nio and Byton, which focus on high-end EVs, will be most impacted by Tesla. These start-ups are already struggling to make sales and profits. Tesla is expected to give them competition with its global experience and expertise in EVs, batteries and technology.
The price of Tesla Model 3 is expected to decline due to falling battery prices and localization. Automakers (especially premium EVs) would need to upgrade in terms of battery, build and technology to stay competitive.
Increasing pressure to upgrade product quality will benefit the overall Chinese market. Despite many local Chinese brands in the conventional car market, international brands like General Motors and Volkswagen (with JVs) account for the majority of sales in the country. Chinese government restricted the entry of (standalone) foreign players, which impacted the overall evolution of domestic automakers. Companies like Tesla will change this and promote competition, forcing domestic EV companies to innovate.
Conclusion
Tesla sales will see significant growth in China due to the above-mentioned advantages. However, the current growth rate in sales comes from a low base and increasing competition is expected to slow it in the long term. New models like Model Y (possibly Cybertruck) will benefit sales in the mid-term.
Tesla surpassed analyst expectations showing a significant increase in car deliveries when compared to Q1 2019. However, despite increasing deliveries, Tesla still remains unprofitable.
The company revenues surged by close to 59% annually to reach US$ 6.3 billion, however, it registered larger than expected loss of US$408 million. Counterpoint expects profitability to improve, driven by falling battery prices and reducing manufacturing costs.
Gross margin declined by 125bp to 18.9% compared to Q1 2019, due to a higher mix of lower-cost Model 3’s that meant a reduction in average selling price (ASP) of vehicles and lower (EV production-related) regulatory credit revenues. The company believes increasing uptake in extra-cost autonomy features by car owners will increase gross margins.
By the end of 2019, Model 3 production is planned to increase to around 8,000 per week from its Fremont factory. Global long-term weekly demand for Model 3 could top 15,000 cars, according to the company. The company also expects to start Model 3 production from its Shanghai (China) plant in 2019.
Exhibit 1: Tesla Delivery and Production, Q-o-Q Comparision
Counterpoint’s View
Tesla did not generate a profit despite Q2 2019 being a record delivery quarter. Tesla’s long-term strategy appears to be to use its vehicles for introducing technologies to the market and generate cash by monetizing connected services and driver data, as their cars gain autonomy features, through software updates. However, the future of autonomous vehicles and robo-taxis is still unclear, relying on complex regulations and customer acceptance, making long term margins look uncertain. Counterpoint expects Tesla will remain loss-making in 2019.
A jump in car deliveries was expected in Q2 2019, with several deliveries not materializing in Q1 2019. However, a growth of over 50% over Q1 2019 is significant and has surpassed our expectations.
Tesla, which has faced criticism for delays in the production of its Model 3 and missing delivery dates, has been maturing with each passing quarter. The company increased both its production and deliveries of cars in Q2 2019 when compared to Q1 2019.
While challenges remain, with a positive Q2 2019, Counterpoint expects Tesla can achieve its annual delivery target of 360,000-400,000 cars in 2019. Increasing deliveries reinforces how strong the Tesla brand is, not only in the US but also in Europe and China. Counterpoint expects Tesla to remain among the top three EV players in the near future.
The first quarter of 2019 was expected to be a tough one for Tesla. The cut in the US tax credit for Tesla cars from January 1, 2019, model upgrades, bottlenecks due to overseas deliveries affected the company’s performance.
The following are the key highlights from Tesla’s performance in Q1 2019:
The company reported a net loss of US$702 million and its cash and cash equivalents reduced by US$1.5 billion from Q4 2018, ending at US$2.2 billion.
Gross margins fell to 20.3% in Q1 2019 from 24.7% in Q4 2018, for the automotive segment.
Production and deliveries declined by 11% and 31% respectively, crossing 77,000 and 63,000 in Q1 2019
During Q1 2019, the company upgraded the Model S and X drivetrain and suspension, increasing their range. Moreover, these models will now be able to charge quickly supporting 200kW from V3 superchargers
The company plans to launch an in-house insurance product in May 2019, which would be ‘much more compelling’ for Tesla’s owners compared to third-party insurance.
Counterpoint’s View
According to Tesla, there were logistics and production bottlenecks while tackling the huge demand from overseas. This led to reduced deliveries. However, considering the decline in production and deliveries, one can infer stabilizing demand for Tesla cars with increases in electric vehicle offerings from other OEMs like GM and BMW.
The US$1.5 billion decline in cash and cash equivalent was mostly due to paying down debt, worth US$920 million, coupled with an increased number of vehicles in transit to customers at the end of Q1 2019.
Tesla’s in-house insurance product will lower insurance premiums on its cars, reducing the overall ownership costs. It will also open an additional revenue stream for the company, and develop another service in Tesla’s increasingly verticalized and service-oriented ecosystem.
The company will continue to benefit from its experience and will be re-using its developed platforms on the new models. For instance, the capital spends per unit capacity for the Model 3 factory in Shanghai is less than half that of the Fremont factory. Upgrades to the Model S and X reused the motors and associated technology from the Model 3 to increase vehicle range.
Expectations for Q2 2019
Due to logistics bottlenecks, the company delivered half of all Q1 deliveries during the last 10 days of the period. Car deliveries will improve in Q2, to an extent, with improving production and logistics learning curves, and in Q2 many unfulfilled Q1 orders will be realized. However, Tesla’s estimates of delivering 90,000-100,000 Model 3 in Q2 seems optimistic.
The sales also suffered due to the US tax credit cuts for Tesla cars to US$3,750 from US$7,500. The demand is expected to recover with car buyers eventually accepting the revised prices.
Gross margins are expected to fall during Q2 with an increasing share of lower-margin Model 3 in the sales mix. However, the upgraded Tesla Model S and Model X will help offset the downward pressure to an extent, during Q2.
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