June 28, 2022

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Tesla’s gross margin and profit are growing along with the prices, and it had to explain itself

Tesla's gross margin and profit are growing along with the prices, and it had to explain itself

Tesla’s gross margin and profit soared to record levels as it raises prices, which the automaker has blamed on rising costs. The company felt the need to explain itself.

Over the past few years, one of the biggest events in the auto industry and many other industries has been the price hike.

Tesla has been no exception with nearly a dozen price increases for its cars over the past two years. On several occasions, the automaker has justified price hikes with increased costs due to inflation, increased raw material costs, and rapidly rising logistics expenses.

However, there were concerns that Tesla was increasing prices because it could – with a strong backlog of orders as interest in electric cars grow – that Tesla’s automotive gross margin had been steadily supported over the same time period.

That wasn’t clearer than this last quarter when Tesla reported a record auto gross profit of 32.9%:

Tesla’s gross profit margin has risen from 26.5%, which was already one of the highest gross margins in the auto industry, to nearly 33% over the past year.

In its list of factors affecting earnings, Tesla actually lists both an increase in average selling price (ASP) and a decrease in cost per vehicle (COGS) as contributing factors:

  • (+) Vehicle deliveries growth
  • (+) ASP . increased
  • (+) Reduced Cost (COGS) per vehicle despite inflationary pressures
  • (+) Lower share-based compensation expense
  • (+) Increase sales of regulatory credit
  • (-) Rising costs of raw materials, goods and logistics, accelerating costs
  • (-) Increase in operating expenses

This quarter, regulatory credits had a larger-than-usual impact with gains of $679 million, but Tesla also made more profit than ever without the credits. With all of these factors in play, Tesla had to explain the reason behind the price hike, which may sound greedy.

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During the conference call that followed the release of Tesla’s financial results for the first quarter of 2022CEO Elon Musk felt the need to explain the situation. He said Tesla is raising prices based on projected higher costs in the future as new cars are sold at new prices, and higher prices are delivered three to 12 months from now:

In fact, on the price increase front, I have to mention that it may seem like we’re probably being irrational about increasing our car prices given that we had a record profit this quarter. But the queue for our cars is very long and some vehicles are requested by people, and the queue extends to next year. So now in-demand vehicle prices really anticipate the supplier and logistics cost growth that we understand and believe is going to happen over the next six to twelve months. That’s why we have a price hike today because the car ordered today will arrive, in some cases, a year from now.

Chief Financial Officer Zachary Kirkorn added that Tesla may cut prices “slightly” if expected cost increases do not materialize in the future.

Take Electric

What Musk said is undeniable, but you can make the argument that Tesla hasn’t been great at scaling and/or timing those increased costs since it reports gross margins are positively affected by price increases and cost-per-vehicle reduction.

Also, Kirkorn’s comment about the possibility of adjusting prices down wasn’t particularly encouraging:

If this cost growth does not materialize, we may in fact reduce prices slightly.

I’m talking about the words “maybe” and “a little bit” here. They point out that Tesla will likely maintain those higher prices even if there are no cost increases, which I think gives weight to the argument that the main reason for the price hikes is that Tesla has demand for it.

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In my opinion, as long as Tesla finds people buying Tesla cars at these high prices, it will remain high. While this is again in line with Musk’s previously stated goal of reducing the cost of electric vehicles, it can still align with Tesla’s broader mission to accelerate the transition to sustainable energy.

As long as Tesla is using those profits for significant capital spending in increasing production capacity, I think that makes sense.

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