Tesla (NASDAQ:TSLA) has just presented its next high-volume production vehicle, Model Y. The Model Y is an affordable, electric, SUV meant to complement Tesla’s affordable sedan, the Model 3. The Model 3 went through a “production hell” when production first began, so Tesla has worked hard to avoid a repeat with the Model Y. To achieve a smooth transition into production, Tesla will be using assembly lines built with the lessons learned from the disastrous Model 3 production. The Model Y will also have significantly more demand than the Model 3, due primarily to the sheer size of the SUV market. Although there is a lot of competition in the SUV market, the Model Y will be able to outsell its competitors, especially in the electric segment. While another author critiqued this move as desperation, though Elon Musk, Tesla CEO, announced date of the reveal via Twitter (NYSE:TWTR) almost a year ago. Tesla will become more cash-flow positive into the foreseeable future as a result of the Model Y’s production.
Source: Mashable Production The Model Y’s production still has some mysteries surrounding it; however, the information currently available to the public covers many important characteristics of the vehicle. There is no doubt that Tesla faced a production hell when it first began assembling the Model 3 for the masses. The ramp was excruciatingly slow and left many customers waiting for years to receive the cars they had ordered. Tesla had full confidence upon the announcement of the Model 3 that it could successfully rapidly ramp its production, so what justifies Model Y as a “manufacturing revolution?” The Model Y is very similar to the Model 3, sharing 75% of the components with the Model 3. The Model Y will also be built on the same platform as the Model 3 which, as I have discussed before, is the most advanced of all electric vehicles (EVs). At the reveal, Tesla confirmed that the Model Y will not be built with the falcon wing doors of the Model X in order to cut costs and further streamline production. However, the Model Y will have 95% less wiring than the Model 3 according to the company’s 2017 Q1 earnings call. The Model 3’s 1,500 meters of wiring was a cause of many headaches in early production and the reduction to 100 meters greatly simplifies the production and reduces the cost of materials. This simplification will allow for faster production as well as reduced cost per vehicle produced. The reduced wiring is possible with a Tesla-made flex circuit, a component patented in 2013 that changes how automakers traditionally wire their vehicles.
Tesla said in its fourth-quarter earnings report that it is confident in its ability to half “the capital spend per unit of capacity for this factory [Gigafactory 3]” when referring to the Model 3. Although referring to the Model 3, this applies to the Model Y as well because of the similarities it shares with the Model 3 and the general improvements that were learned in the Model 3 ramp. As the Model Y lines will be built from scratch, this lowered cost prediction applies to them, with any other future vehicles as well and not only those built in Gigafactory 3. More specifically, Musk said on the 2017 Q4 earnings call that he believes the company can ramp to producing one million Model Y units annually for less than the Model 3 cost to ramp to 500 thousand units. Although Musk has infamously been a bit too bullish on Tesla’s future production capabilities, this seems quite plausible and even if this exact scale is not reached, Model Y will still be able to take advantage of lessons learned with the Model 3. As a result of the new design modifications and lessons learned from the Model 3, the Model Y will likely have a larger margin than the Model 3, which aims to achieve 25%. Gigafactory 1, located in Nevada, USA, will be the home to the Model Y’s first assembly lines with production expected to begin in the end of 2020. Gigafactory 3, located in Shanghai, China, will also house Model Y production lines when it is able (Recent reports now confirm that Tesla has successfully secured the necessary loans for the facility’s first phase of construction). However, Musk hinted in a tweet that there was one piece of information given in the presentation that was missed, and the photo below seems to support the fact that it is a European Gigafactory. The Model Y will begin production in the fall of 2020, according to the presentation. Both will offer access to different markets and are crucial for the future of Tesla.
Source: Tesla Demand None of Tesla’s improved manufacturing capabilities will mean anything without proper demand. The SUV market is continuing to grow, posting a 2.6% growth in global market share and representing 36.4% of the entire automotive market. SUV YoY sales volume increased by 7%, the first single-digit growth period for SUVs in four years, but still the largest growth of any other vehicle class. The Model Y, which is a Midsize SUV according to the presentation, is tapping into the second largest segment in the SUV market; Midsize SUVs represented 25% of all SUV sales. China leads the global SUV market, with 10.35 million SUVs sold in the country during 2018, with 42% of their automotive market made of SUVs. America was the runner up, with 7.75 million SUVs sold in 2018, representing 45% of their total car market. The worldwide growing demand is a key aspect of the Model Y’s ultimate success that Tesla is looking to capitalize on. Elon Musk said in the 2018 fourth-quarter earnings call that he “would expect that the demand for the Model Y would be… maybe 50 percent higher than Model 3?” The expected heightened demand is due to the greater overall demand for SUVs and Tesla’s ability to compete in that market. There is no question that the demand for SUVs is great, but that means that there are many more players in the SUV market that Tesla must beat. There are a lot of new electric SUVs coming in 2019, more than a year before Tesla’s Model Y is expected to begin production. What sets Tesla apart from the vast majority of them is the price range. The Nissan (OTCMKTS:OTCPK:NSANY) Leaf 2019, Kia (KRX:000270) Niro EV, and Honda (NYSE:HMC) Kona EV are the only electric SUVs in the Model Y price range. The 2019 Nissan Leaf starts at $29,990 with a range of 150 miles. The Kia Niro EV has not yet received an official price, but the hybrid model starts at $28,000 and fully electric vehicles tend to cost a bit more, so it will likely cost around $30,000-33,000. The Niro also has a decent range of 239 miles, but will only be available in twelve US states. Finally, the Honda Kona EV, the car I see being the Model Y’s biggest competitor, starts at $36,450 with a range of 258 miles. This is the most similar to the Model Y which will start at $39,000 with a range of 230 miles, though Musk did say that they may be able to do better. Musk also said that the base variant will not enter production until 2021. The Model Y’s interior is also more luxurious than its competitors, very similar to the Model 3 and likely with a similar safety rating of the Model 3, as Musk mentioned in the presentation. Even though it may be slightly pricier than its competitors, with almost 60% of trade-ins for the Model 3 coming as non-premium vehicles, Tesla has proven that customers are willing to pay a bit more of a premium for their vehicles.
China, however, is a much different story than America. Their electric SUV market is already full of various brands and models, all well established in the country. There are too many large competitors to list, but almost all of them are $5,000 – $10,000+ cheaper than a base Model Y would be. However, all of them also fall short in range by about 75 – 100+ miles and are much less sleek and polished than the Model Y. Both the Model S and Model X sold well in China, giving Tesla 9% of the EV market in 2017, the highest of any foreign manufacturer by over 5%. However, both models were sold at an incredible markup from the US price in order to account for tariffs and were also not subject to any government subsidies. Prior to the recent lowering of Chinese tariffs on Tesla’s vehicles, a base Model S cost $122,525 and a base Model X cost $171,000. To provide context, in America those same vehicles would cost $76,000 and $82,000, respectively. The purpose of showing these figures is to demonstrate that the Chinese market is willing to pay more than just a slight premium for Tesla’s vehicles. Overall Company Impact The Model 3 was meant to establish Tesla a real vehicle manufacturer and not just a player in a niche market of luxury EVs. I would argue that it has accomplished this even before it has become a truly affordable car; the Model 3 led the US luxury car market in 2018. The Model Y will take Tesla one step further as a manufacturer. Since Tesla will eventually be producing one million Model Ys annually, more than the Model 3 is projected to reach (both projections are under the guidelines of current publically known manufacturing facilities), the Model Y will have a longer lasting impact on the company. Without the Model 3, the Model Y wouldn’t be possible, but the Model Y is soon going to become Tesla’s best-selling vehicle as a result of the larger demand created by the SUV market. As I discussed before, the SUV market is the largest in the world which will allow for the Model Y to overtake the Model 3 in popularity. However, likely the Model Y’s largest contribution to the future of Tesla, will be its margins. Earlier in the article, I discussed the ability for Tesla to improve the gross margins on its Model Y through multiple design and production improvements, but what will those margins be? The Model 3 is targeting a non-GAAP gross margin of 25% for sometime in 2019. I used the price of the Model Y, as well as production improvements (including battery technology and overall greater production efficiencies which are also discussed above) to determine that the Model Y will likely target a non-GAAP gross margin of 30%, similar to Model 3, making it Tesla’s most profitable vehicle by far, especially when coupled with its volume. As a result of its incredible profitability, I expect Tesla’s value to rise by around 20% after its first two quarters manufacturing the Model Y. This is because the Model Y will be able to prove its profitability through the earnings reports as well as display the high demand for the vehicle.
As Tesla’s best-selling vehicle, this margin will have a large impact on the company and help propel it to greater profits in the future. The Model 3 production line at Fremont, excluding the “tent” structure, cost “hundreds of millions.” Following Tesla’s guidance for the Model 3 production ramp and previous statements, the Model Y production lines will be significantly cheaper yet still yield greater profits and volume. As a result of the lower costs, higher margins, and higher production, the Model Y will become Tesla’s most important vehicle and boost it into an era of consistent profitability. The Model Y will be able to generate the amount of capital needed to fund its development and production within just three quarters a year. To find this number, I took the average Model 3 sales price of $59,300 and equated it to what that would represent with the Model Y’s pricing. I then used a rate of 6,000 vehicles produced weekly, I doubled the rate of 3,000 units per week as it will be produced in both Shanghai and Nevada (3,000 units based off of target goal for initial Model 3 production in Shanghai), at a non-GAAP margin of 15% to find how long it would take for Model Y production at these numbers to generate $1 billion. I found that in slightly under half a year, Model Y production would generate $1 billion – and these numbers are quite conservative. The production ramp could entail 5,000 Model Y’s per week by the end of two quarters (faster production ramp than Model 3) with a margin greater than 15% (though the margins will be smaller during initial production as with any product). In addition, $1 billion is more than what is required to cover the Model Y’s development and production expenses in both Nevada at Gigafactory 1 and Shanghai at Gigafactory 3. This means that the Model Y development will not add to Tesla’s currently massive debt load and therefore be quite beneficial to the future health of Tesla without risking its current well-being. If Tesla is unable to generate the demand that I expect is reasonable, or if its production of the vehicle is delayed, this thesis would fail. As there are more competitors in its field now, electric SUVs, Tesla may face a bit of pressure with the demand for its vehicle. However, as I discussed previously, the Model Y will be able to compete successfully with the other vehicles as a result of the brand recognition and overall higher standard of the vehicle. In addition, the production is very unlikely to be delayed as Tesla will likely pick a conservative outline for its Model Y production, like the base entering production in early 2021, in order to avoid disappointing on production figures the company had promised. With all of the design improvements too, Tesla is set up to deliver on its production estimates without a production hell. Therefore, the largest risks of the thesis are unlikely to happen.
Overall, the Model Y will provide Tesla with a long-term profit boost with relatively little capital required. In terms of the future of Tesla, the Model Y is a key component in keeping Tesla profitable and continuously increasing its total profits. With strong demand and manufacturing capabilities, the Model Y will become Tesla’s most important vehicle and outsell all of its other vehicles. Not only will it be able to pay for itself rather quickly, but it will also allow for the continued development of Tesla’s other aspirations such as solar and new factories. The Model Y will have a lasting impact on Tesla and promote it to a real automotive power.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.