Tesla And The All-Important 25% Gross Margin Level

For Tesla Inc TSLA investors, 2017 is all about the rollout of the Model 3. The company is expected to begin delivering the new car this summer, but Tesla bears question both the timetable for production and the potential profitability of the cars.

One of the most common sources of market skepticism about the Model 3 is the company’s expectations that it will achieve gross margins of 25 percent on the car.

Bernstein's Analysis

In a new report, Bernstein analyst Toni Sacconaghi says Tesla investors should be very concerned about Model 3 margins. Sacconaghi spelled out three primary concerns he has with the 25 percent target:

1. Battery costs: Model 3 powertrain will cost at least $11,000 compared to the typical ICE powertrain cost in the $3,000–$5,000 range.
2. Expenses: Tesla expects to spend $2 billion in capex in the first half of the year and up to another $1 billion to reach full Model 3 production capacity. Sacconaghi estimates Tesla’s upcoming expense ramp will cut into the company’s gross margins by 3 percent in the second half of 2017.
3. Low-end rollout: CEO Elon Musk expects to begin the Model 3 launch with low-end rear-wheel drive models first. Sacconaghi says low-end automobiles typically have thinner margins than higher-end models and that the all-wheel drive versions of the Model 3 could have an addition 4–5 percent of gross margins than the rear-wheel versions.

“Our analysis suggests it is difficult to have conviction in Tesla’s ability to achieve 25 percent automotive gross margins in the near to medium term with Model 3,” Sacconaghi concluded.

Bernstein maintains a Market Perform rating on Tesla and a $250 price target for the stock.