Tesla: You Haven’t Seen Anything Yet

Summary:

• Tesla is facing a new set of geopolitical challenges.
• The worsening of Sino-American relations could make Tesla another casualty of an ongoing trade war.
• As globalization collapses, we’ll likely see a rise in costs, a decrease in margins, and additional disruptions of Tesla’s supply chains in the foreseeable future.

In addition to having a distracted CEO, who is likely looking for ways to recoup his investment in Twitter (TWTR), Tesla (NASDAQ:TSLA) is also exposed to a number of significant geopolitical risks that could prevent it from achieving its long-term goals in the future.

Unlike a year ago, when it was possible to make fortunes by buying almost every major stock including Tesla and benefiting from the zero interest rate policy of the Federal Reserve, the current environment requires the company to think strategically about how to mitigate global risks in order to thrive and prevent its share price from collapsing. While the business is beginning to think seriously about how to secure its supply chains, Elon Musk’s lack of complete focus coupled with an ongoing economic confrontation between Beijing and Washington creates a possibility of a further decline of Tesla’s share price in the foreseeable future in a time when globalization collapses.

A New Geopolitical Reality

Over the recent years, Tesla has aggressively entered the Chinese EV market in which it managed to greatly increase its market share and at the same time build a production facility in Shanghai that gives its business a pricing advantage in the region. The latest report for Q3 indicates that out of $21.45 billion in revenues that Tesla generated during the period, $5.13 billion in revenues were generated in China, up 64.8% Y/Y, which accounted for roughly 24% of total revenues. At the same time, the latest data shows that in November its deliveries from the Shanghai Gigafactory surged to 100,291 units, up 90% Y/Y, in a single month, out of which 37,798 cars were exported primarily to Europe.

However, now there’s an indication that the growth of sales and deliveries in the region could slow down in the foreseeable future due to economic and political reasons, putting the company’s long-term goal of growing its deliveries by 50% Y/Y each year at risk.

There are already signs that the demand in China for new electric vehicles is slowing down, which indicates that we could see lower growth than previously expected this year. Earlier this month there were already reports that Tesla has stopped additional hiring in Shanghai and at the same time reduced worker schedules. On top of that, due to the implementation of a zero-Covid policy in China earlier this year, Tesla’s operations were nevertheless disrupted, which makes it nearly impossible for the company to achieve a goal of increasing its deliveries by 50% Y/Y in 2022. However, the growth nevertheless is going to be significant and could be improved next year to average out a ~50% growth rate over a longer horizon.

What’s more important at this stage is that while economic downsides could be mitigated over time, the same couldn’t be said about the rising political challenges that could put the company’s whole operation in China at risk of further disruptions. Earlier this year, I’ve already noted how the reelection of Xi Jinping for an unprecedented third term as a general secretary of the CCP is likely to lead to a worsening of Sino-American relations over time. A couple of weeks before that article was published, the White House released its annual National Security Strategy report in which it stated that China is the only country with the intention and capacity to reshape the global order.

Considering that the trade war that began in 2018 is still ongoing while the relations between the biggest economies are unlikely to improve anytime soon, any potential implementation of additional protectionist policies could easily make Tesla a casualty of this economic confrontation.

The good news though is that so far, Tesla managed to mitigate the major downsides of this confrontation despite negatively being affected by it back in 2018. Let’s not forget that in July 2018, Beijing has retaliated against Washington by raising tariffs on imports of American vehicles to 40%, which left Tesla no other option but to hike prices for its cars by ~20%. Later it was reported that the company’s sales plummeted by nearly 30% during that time due to such a hike, which prompted Tesla to start the process of decreasing the prices at the end of the year in order to successfully compete with its local rivals.

While at the end of 2018 a temporary deal was reached between Beijing and Washington that deescalated the confrontation, in August of 2019 it was announced that China is reinstating the additional tariffs that once again include the increased tariffs for U.S.-made vehicles. However, a couple of months later, Tesla started producing its vehicles in the new Gigafactory in Shanghai, which helped it to alienate the risks of reinstated tariffs and made it possible for it to aggressively grow its sales and continue to expand its market share in China to this day.

At the same time, a year ago, Tesla decided not to expand its Shanghai facility and make it a global export hub so that it doesn’t become a hostage of global protectionist policies, and instead opted to create manufacturing hubs in major geographical regions in order to decrease the potential disruption of its global operations.

While those moves so far helped Tesla to successfully navigate through the changing geopolitical landscape, there’s a risk that it won’t be able to successfully do the same thing in the foreseeable future.

An Upcoming Casualty Of An Ongoing Trade War?

The decision of the Biden administration to put stricter restrictions on the export of advanced chips to China a few months ago has reignited the ongoing trade war and almost guaranteed that China would retaliate in one way or another going forward. Nvidia (NVDA) has already stated that the new restrictions would cost it $400 million in lost sales this year alone, while Apple (AAPL) began to seriously take the risk of potential supply chain disruptions in the following years and started to relocate its production to other countries.

Just like those two companies, Tesla could easily become another casualty of the ongoing Sino-American confrontation. A year ago, Tesla was already confronted by Chinese regulators allegedly for political reasons. A few months later, China’s state-owned Xinhua Daily Telegraph published a hit piece against Tesla in which it blamed the company for not following the regulatory guidelines. Earlier this year, the company’s cars were even barred from entering one of China’s resort towns where the CCP leadership frequently meets due to spying fears even though the cars are made in Shanghai.

At the same time, there are talks about a potential nationalization of Tesla’s Gigafactory in Shanghai in a scenario where Beijing and Washington are engaged in a direct confrontation. However, even if that’s not going to be the case, the fact that 30% to 40% of vehicles that are made in Shanghai are later exported exposes the company to additional tariffs risks, while a potential end of a beneficial tax rate policy in China after 2023 has all the chances to significantly affect Tesla’s performance in the future.

On top of all of this, there’s also a risk that the White House decides to impose even stricter chip restrictions in the future, which could undermine Tesla’s self-driving capabilities in China. The latest round of restrictions has already prevented Tesla’s Chinese competitors such as NIO (NIO) from obtaining Nvidia’s A100 GPUs, which have powered its data infrastructure and helped it to automate its vehicles. Considering that Tesla designs its own chips and uses the services of Samsung (OTCPK:SSNLF) to manufacture them outside of China, any new chip restrictions that target the exports of advanced chips that are used to create self-driving vehicles could disrupt Tesla’s operations in Shanghai in an instant. The fact that new crackdowns on the AI chip sector continue to happen to this day, it would be unwise to rule out such a possibility in the foreseeable future.

In addition to that, the latest report about the forced labor in China’s Uyghur Region published by Sheffield Hallam University earlier this month indicates that Tesla among many other automakers has several supply chain exposures to the Uyghur Region, which could be a violation of the Uyghur Forced Labor Prevention Act that was passed last year. That’s why a couple of days ago the Senate Finance Committee opened an inquiry in order to find out whether Tesla and others are using the materials made by forced labor. If that’s the case, then Tesla could come under fire from the regulators and have its supply chains disrupted once again.

Has Elon Musk Become A Liability?

The good news in all of this is that Tesla is not entirely complacent when it comes to the geopolitical risks outlined above. The company has been actively looking for ways to secure its supply chains by expanding production outside of China or its neighbors. Earlier this month, new reports stated that the company is planning to open a new production facility in Mexico, expand its battery cell development lab near Fremont, and have TSMC (TSM) develop its chips in Arizona starting in 2024. The problem nevertheless is that the company would continue to be dependent on China in terms of production and sales, and in case of a further Sino-American confrontation, it’s unlikely that it’ll be able to fully secure all of its supply chains.

What’s worse is that as globalization unravels and a new geopolitical reality requires businesses to think strategically about how to mitigate global risks, it appears that Tesla is not fully committed to doing so due to the distractions of its CEO. After Elon Musk purchased Twitter, it appears that he has been focusing mostly on keeping his new company afloat by looking for new investors, selling his Tesla shares, and playing politics, which is likely to alienate a significant portion of Tesla’s customer base over the long run. At the same time, his idea to appease the aggressors by ceding Crimea to Russia and Taiwan to China could lead to additional regulatory scrutiny, which could lead to a further depreciation of Tesla’s shares.

The Bottom Line

Considering all of this and the fact that Tesla’s bullish story relies on having the global order remain intact, as it’s the only way the company would be able to achieve its long-term goal of increasing its production and deliveries at an average annual rate of ~50% over the upcoming years, the company is risking failing to achieve that goal. As globalization collapses, we’ll likely see a rise in costs, a decrease in margins, and additional disruptions to Tesla’s supply chains. All of this could lead to Tesla losing even more value until it starts to trade in line with other automakers due to the challenges that it’ll likely face in the future.

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Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Bohdan Kucheriavyi and/or BlackSquare Capital is/are not a financial/investment advisor, broker, or dealer. He’s/It’s/They’re solely sharing personal experience and opinion; therefore, all strategies, tips, suggestions, and recommendations shared are solely for informational purposes. There are risks associated with investing in securities. Investing in stocks, bonds, options, exchange-traded funds, mutual funds, and money market funds involves the risk of loss. Loss of principal is possible. Some high-risk investments may use leverage, which will accentuate gains & losses. Foreign investing involves special risks, including greater volatility and political, economic, and currency risks and differences in accounting methods. A security’s or a firm’s past investment performance is not a guarantee or predictor of future investment performance.

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