Tesla earnings are ‘being outdone by production disruption in China’: Analyst

Nishit Madlani, S&P Global Ratings analyst and automotive sector lead, joins Yahoo Finance Live to discuss Tesla earnings, production issues due to COVID lockdowns in Shanghai, and the electric vehicle maker’s plans to increase capacity at its gigafactories.

Video Transcript

DAVE BRIGGS: Welcome back, everybody. Shares of Tesla down 5% on the trading day, but the important number is after-hours trading. They have risen on news of first quarter earnings, a record quarterly profit.

Let’s break down the numbers with Nishit Madlani, Senior Director at S&P Global Ratings. Good to see you, sir. So tell us how they achieved record quarterly profits despite the supply chain issues and the Shanghai shutdown.

NISHIT MADLANI: Yeah, so our sense is that, you know, they’ve had a fairly solid demand story leading up to Q1. So it wasn’t very surprising. And the story really is that they’re being outdone by production disruption in China because without that, we would have seen even stronger numbers.

And that’s not something that’s unique to Tesla, to be honest. These are macro challenges for the entire industry. And them producing over 300,000 units in Q1, despite a three-week shutdown in China, what that tells me is they’re well on track for achieving over 50% annual growth on an average in sales, and [INAUDIBLE] efficiently from a cost perspective.

RACHELLE AKUFFO: And as we saw Elon Musk tweeting that he is going to be on that investor call that’s coming up at 5:30 PM Eastern time, where we do expect to get more details on things like production timeline, demand trends, and the energy storage business. How important is what he contributes to that call going to be?

NISHIT MADLANI: I think it’s going to be very important. The front and center as far as most analysts are concerned is going to be what’s really happening in terms of China production. You know, with Berlin and Austin coming online this year, it’s really going to be important in terms of how that ramp up towards their production targets occur.

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Longer term, I think hearing from him in terms of what are the key challenges, what’s the strategy as far as the non-auto business is concerned, it is important. But I would say that the critical focus for most analysts on the call is probably going to be more around short-term supply chain and, of course, what’s happening on the profit side.

BRAD SMITH: Certainly. On the profit side, let’s talk about the free cash flow they were able to generate. I mean, the year-over-year growth was just astounding. It hit ludicrous mode quite frankly. So with that in mind, does it put to rest some of the criticism that was commonly leaned into by bears for Tesla that Tesla wouldn’t be able to generate enough free cash flow to sustain their operations and continue to invest at the rate that they were pitching to investors?

NISHIT MADLANI: Now that’s certainly true. They’ve certainly outperformed. And the story there is, look, they’ve done a good job raising prices. I mean, every automaker today is facing the challenge of rising commodity costs.

And here’s a company that’s facing a very large wait time for its products. I mean, if you order one in the US today, you’re not going to get one for the next six to nine months on the Model Y. So the pricing has helped.

But I think the critical aspect there on the profits is manufacturing efficiency. And that’s something they’ve promised, you know, over the past decade or so as they’ve ramped up production. But now we’re really seeing that come to fruition.

DAVE BRIGGS: So they delivered 310,000 cars. That’s up from 308,000. That’s despite, as you point out, an estimated 90,000 loss because of Shanghai. Might we see the effect of those shutdowns in the next quarter?

NISHIT MADLANI: Yes, I think to the extent we see those delays extending, yes, we probably are going to see some impact. Now how long that extends? That really up for grabs.

And that’s why the earnings call, which starts in about 30 minutes, is going to be really critical to understand that outlook because right now, you speak to any automaker, the visibility on production is really a little low. And that’s what’s going to drive near-term volatility as far as results are concerned. But I think, longer term, we’re seeing a good pattern as far as their trajectory is concerned.

RACHELLE AKUFFO: And as we look at the Chinese market, we are seeing a slowdown in demand. You obviously have a lot of domestic car makers there who could also rival. And you’re also seeing a slowdown in some registrations in the EU as well. Looking forward then, how challenging could this landscape be as we do see competition increase even though, obviously, Tesla is leaps and bounds ahead of others?

NISHIT MADLANI: Yes, so from a credit perspective, I mean, the evolution of their story really hinges on how quickly they ramp up production to better match supply with demand but also on what you mentioned, which is what’s happening as far as market share is concerned, because many of their China-based competitors have begun to export cars to compete with them even in Europe. And we’re seeing some market share wins from some of those competitors in that market.

So, yes, maintaining current market share, maintaining the desired quality because we’re going to see not just the Chinese automakers but a lot of Germans coming into the space. So I think the consistency of quality and making sure that they don’t hit any manufacturing inefficiencies, I think, is going to be critical for the business story.

BRAD SMITH: When we think about that competition, it’s going to have to ramp up to the amount of production that they also output. For comparison, I mean, we’re looking at Tesla. And even the 100,000 of vehicles that they’re able to create, produce, deliver, sure, that’s great.

But you’re also going up against other companies that are producing 4, maybe 5 million production units as well and then have an entire delivery system and are changing the way that they’re going to mark it at the end of the day as well. And so when that does ramp up, what does that signal to you about how long Tesla has to really retain this first-mover advantage prior to some of the big players getting into it? We only got about 30 seconds.

NISHIT MADLANI: Yeah, what I will say is that the pie overall for EV makers is increasing. I mean, our forecast is that, globally, by 2025, EVs are probably going to touch around 20% of overall sales. And that number today is very low. So just given that the pie is increasing, yes, we’re going to see some market share erosion for Tesla, but it’s because the pie is increasing. It’s just going to lead to a lot more revenue and profits.

RACHELLE AKUFFO: Want to thank our guests. They will have to leave it there. Nishit Madlani, the Senior Director at S&P Global Ratings.