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Last week Tesla reported their 2nd quarter earnings and shared that the Model S/X order rate for July was about 15% higher than the average order rate from April-June. They also projected for Model S/X sales to be higher in the 2nd half of the year than the 1st half of the year. While all of this is encouraging, perhaps the most exciting but overlooked part of the earnings release was Tesla guiding for 25% gross margin for the Model 3 next year.

First, 25% gross margin on the Model 3 is much higher than most people were expecting. Also, it’s shows a lot of confidence that Tesla is projecting to reach that 25% gross margin target for the Model 3 next year. Tesla must be seeing the fruits of their work to prioritize cost reduction and ease of manufacturing for the Model 3.

Most importantly though, if Tesla hits their 25% gross margin target for the Model 3 next year, then I’m confident that they will show large profits, which will likely surprise most people.

Here’s some rough numbers we’ll use to see to see when Tesla will likely become profitable. Let’s assume Tesla delivers 75,000 Model 3s in Q2 2018 (average roughly 6k/week) and 100,000 Model 3s in Q3 2018 (roughly 8k/week).

Q2 2018 Projections:

  • 75,000 Model 3 at $45,000 each = $3.375B revenue
  • 25,000 Model S/X at $95,000 each = $2.375B revenue
  • Total revenue = $5.75B
  • Gross profit (25% gross margin of revenue) = $1.44B
  • Operating expenses = $1.1B (this is a guess based off of Q2 2017 operating expenses being roughly $900M and Tesla guiding for flat operating expenses for 2nd half of 2017. Let’s assume operating expenses go up modestly in Q1/Q2 of next year)
  • Other expenses = $150M (including interest expense, etc)
  • Net profit = $200M

Q3 2018 Projections:

  • 100,000 Model 3 at $45,000 each = $4.5B revenue
  • 25,000 Model S/X at $95,000 each = $2.375B revenue
  • Total revenue = $6.875B
  • Gross profit (25% gross margin of revenue) = $1.72B
  • Operating expenses = $1.2B (let’s assume an increase of $100M from previous quarter)
  • Other expenses = $150M (including interest expense, etc)
  • Net profit = $370M

Now, of course these numbers are just an educated guess, but you can use them to plug in your own numbers. It’s also possible (likely?) that it takes longer than expected to ramp up Model 3 production and this delays these projections by a quarter or so.

However, what’s notable about these projections is that from my numbers I think Tesla could be profitable starting next year, as early as Q2 and with a substantial profit of $200M (that’s a $800M annual run rate). And since Tesla’s operating expenses will likely be growing much slower than their revenue, this operating leverage will allow them to make larger profits in quarters to come.

This is why I think Tesla is choosing to raise money via bonds and not equity. It’s because Tesla is seeing that next year they will become profitable and can start repaying such loans (or at least easily handle the interest payments with profit), and they don’t see any reason to dilute shareholders at the moment.

Now forecasting the exact quarter when Tesla becomes profitable is extremely difficult and that’s not the point here. Whether Tesla becomes profitable in the beginning, middle or late next year is besides the point. The point is that if Tesla actually achieves their target of 25% gross margin on the Model 3, they likely will become profitable and this will mark a huge transition and transformation of the company… to a company that makes profit and a lot of it.

DaveT, Editor (subscribers: 3058)

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