A Week In Tesla: SEC Alarms, Low-Cost Model 3 And Dealership Closures

Earlier this week, Tesla Inc TSLA fell briefly when the Securities and Exchange Commission sought to hold CEO Elon Musk in contempt for violating their fall settlement.

But shares sunk steeply Friday after Musk guided for an unprofitable first-quarter — a near-term loss Loup Ventures called “immaterial” compared to the progress driving it.

The news offset enthusiasm over the earlier-than-anticipated rollout of a $35,000, stripped-down Model 3. The costly product is supported by ongoing restructuring, including the closure of dealerships and a heightened investment in services.

“It's excruciatingly difficult to make this car for $35,000 and still be financially sustainable,” Musk said.

Musk declined to provide guidance for the low-cost vehicle’s profit margins. He did say he expects Tesla to be profitable again in the second quarter.

"The bears have more material to work with than bulls here," Morgan Stanley analysts wrote in a note.

Here’s what analysts have to say about the week’s events.

Part 1: The Noise Of SEC Fallout

As part of his settlement with the SEC over his controversial “going private” tweet, Musk had agreed to oversight for his online postings to prevent the leakage of information material to shareholders.

The SEC alleges Musk violated the mandate last week when he inaccurately tweeted that Tesla will make around 500,000 cars in 2019. He later clarified that the figure reflected an annualized production rate, not deliveries.

“At this point we are more concerned around this issue being another distraction for Musk & Co. as the company navigates one of its most challenging periods in its history and certainly did not need this news,” Wedbush analysts wrote, forecasting overhang from another entanglement with the SEC.

Part 2: The Jolt Of The Model 3

Loup Ventures managing partner Gene Munster hailed Tesla’s low-cost Model 3 as a turning point in domestic autos.

“This is perhaps the most significant event for the U.S. EV market since the announcement of the Model 3 in 2016,” Munster wrote. “The mass adoption of EVs that has become a foregone conclusion would not occur without lower-cost vehicles, and the Model 3 base model sets a new precedent in the industry for quality and price.”

He noted that the base Model 3 is the first EV to be priced below gas-powered rivals.

Between the price and high quality relative to Nissan’s Leaf, Chevy’s Bolt or BMW’s i3, JMP Securities anticipates solid penetration in the U.S. mass market.

“That is important, because it is clear that demand for the Model 3 in the U.S. has softened substantially since the beginning of the year,” JMP analysts Joseph Osha and Hilary Cauley wrote. “In fairness to Tesla, the company has cut its pricing to the degree necessary to counteract the reduction in the federal EV tax credit, but we believe that surge of late 2018 demand as buyers rushed to catch the full credit has created a hole in Q1 demand that Tesla is still working to figure out.”

Bank of America Merrill Lynch suspects the vehicle’s early release signals saturation in Tesla’s higher- and mid-price market. While it anticipates a near-term, material increase in sales volume, it expects to weigh on earnings for some time.

“In our view, the result of what appears to be an earlier push of lower range/price Model 3s will likely be an increase in volume in the near term, rather than an increase in profits, as the cost structure for mass market electric vehicles (specifically those priced around $35k) is not yet breakeven,” Bank of America analysts wrote. “And while TSLA noted that these new models will be lower in cost, it appears this may be more a function of reduced battery size and range, rather than any other major cost efficiencies.”

Morgan Stanley read the news with similar skepticism, noting Tesla may be losing its "halo of exclusivity."

Part 3: A Sales Revolution

By JMP’s estimates, release of the lower-end Model 3 and investment in scaling services may help catalyze U.S. growth. At the same time, shifting sales online could stunt it.

“We wonder how switching to an entirely online sales model is going to work for selling cars,” Osha and Cauley. “We don’t doubt that Tesla’s existing fans are willing to buy online, but we wonder about prospective buyers in other parts of the U.S. where EV penetration is lower and customers still need some convincing.”

They suspect Tesla will forfeit certain clients with this new sales system. Loup Ventures received the update more optimistically, especially given the new 7-day or 1,000-mile refund and return option.

“By removing the sales organization along with most test drive opportunities, the cost of the average vehicle can be reduced by about 6 percent,” Munster wrote. “While this marks a radical change in how cars are purchased, we believe the value proposition of Model 3 is strong enough that the positives of shifting to online-only will outweigh lost sales from consumers that require a traditional buying experience.”

Part 4: A Pain In Profitability

Model 3 progress was quickly overshadowed by projections of unprofitability. Musk attributes the expected quarterly loss to restructuring costs and shipment difficulties with Europe and China sales.

“While this is a setback, we expect these issues to be corrected by the end of the June quarter,” Munster wrote.

The Ratings

• Bank of America Merrill Lynch maintained an Underperform rating and a $225 target;
• JMP Securities maintained a Market Outperform rating with a $406 target;
• Morgan Stanley maintained an Equal-Weight rating and a $283 target; and
• Wedbush maintained an Outperform rating with a $390 target.

Tesla's stock traded around $297.72 per share at time of publication, down 7 percent for the day.

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