Tesla: The Future Leader In Autonomy And AI

Summary:

• The Tesla, Inc. Q2 2023 report was mixed, as revenues and gross margins were in line, but EBIT and free cash flows missed.
• Tesla’s pricing strategy was also validated in the results as there was a smaller decline in gross margin per car relative to the decline in ASP.
• Without a raise in volume guidance for 2023, I see it as a positive as the company will likely remain price-disciplined in the near term.
• CEO Elon Musk reiterated the long-term autonomy opportunity and the strong competitive advantages Tesla has today.
• While there is a huge long-term opportunity for Tesla, the near-term risk reward is fair and my 1-year price target implies 5% upside potential.

The Tesla, Inc. (NASDAQ:TSLA) share price has corrected following the Q2 2023 earnings report.

In my opinion, while the 2Q23 report was mixed, the weakness in share price came from an expectation of a major positive surprise, as implied from the almost 150% share price rally YTD.

Review of the 2Q23 quarter

The second quarter results were mixed in my view. The second quarter revenues were ahead of consensus by 1%. Gross margin came in at 18.2%, was in line with consensus which was expecting 18.2% gross margin. The 2Q23 gross margin of 18.2% was 682 basis points lower than the prior year, when gross margin was at 25% in 2Q22. In terms of the breakdown, auto gross margin was at 18.1%, slightly below expectations of 18.7%, while energy and services margins were both better than expected.

With auto gross margins coming in at 18.1%, this implies that COGS improved by $500 per car sequentially. This reduction came as a result of both a change in the mix of deliveries in 2Q23, as well as fundamental lower COGS per unit as a result of improvement in Austin and Berlin cost.

In fact, I think that the results validated the pricing strategy, as there was only a smaller reduction of Tesla’s auto gross margin ex-credits of $400 per car quarter on quarter relative to the decline in ASP by $900 per car on a quarter-on-quarter basis.

The GAAP EBIT came in at $2.4 billion or 9.6% GAAP EBIT margin, which was 6% below consensus expectations of $2.56 billion as a result of higher operating expenses. The slight miss in GAAP EBIT was due to $0.3 billion higher operating expenses sequentially as a result of Cybertruck, AI and other large projects, which drove down operating profit margins by 180 basis points sequentially to 9.6%.

Also, free cash flows were 56% below consensus, coming in at $1 billion as a result of outflows in working capital.

On the guidance front, there was not much of an update. While the 2Q23 delivery numbers were a beat, Tesla continues to expect that the vehicle deliveries for 2023 will still be 1.8 million. This can be explained by the 3Q23 production numbers being down as a result of shutting down in the summer for factory upgrades, which will result in a slight decrease in production numbers of 3Q23. Nothing new on the product side of things, but the first deliveries for the Cybertruck were reconfirmed for 2023 while high volume production is expected for 2024.

While management did not rule out more price cuts, I think that without a raise in the 2023 volume guidance, this does imply that Tesla will likely remain price-disciplined in the near term to protect margins.

Autonomy and FSD licensing

CEO Elon Musk reiterated his convictions in the long-term opportunity that autonomy will bring in the 2Q23 earnings call. This includes its robotaxi product, which is expected to have a unique design and be manufactured in a revolutionary way.

Autonomy needs to be built and trained, and Tesla has all the necessary ingredients to be successful in autonomy. It has one of the largest amount of training data, strong computing resources through Dojo and Nvidia (NVDA), and the necessary talent.

One of the key advantages Tesla has is that it has millions of vehicles that provide it with a massive amount of data to train its neural net, and as the number of vehicles grows, the more training data Tesla has and the more superior the outcome of Tesla’s autonomy capabilities. To date, Tesla has more than 300 million miles driven using its full self-driving (“FSD”) beta, although I think this number will grow exponentially with Tesla putting more vehicles on the roads. There is no doubt that with the large number of vehicles it has on the roads, there are not many other companies that are building autonomy that can compete meaningfully with Tesla’s scale.

Tesla’s Dojo supercomputer is designed to be optimized for video training, which is what is necessary to train self-driving vehicle systems. With the Dojo supercomputer, it is designed to significantly reduce the cost of neural net training and the company continues to invest heavily in its training capabilities. Tesla expects to spend more than $1 billion in the next year on the Dojo supercomputer, which includes the research and development efforts on its chip, and data center spend. The Dojo supercomputer utilizes the custom Dojo D1 chip architecture that was designed by Tesla for the company to train on video data.

On top of the Dojo supercomputer, Tesla has significant GPU footprint, with more than 10,000 GPUs across three high performance computing clusters as of 2021 and likely much more today. In fact, Elon Musk said that: “We’ll actually take Nvidia hardware as fast as Nvidia will deliver it to us.” As a result, Tesla has the combination of a large amount of spend with Nvidia and on its own Dojo supercomputer, and to compete against Tesla, other companies would likewise have to be spending billions on training compute.

Tesla mentioned in the second quarter 2023 call that the company is currently in “early discussions” with a major automaker about using the Tesla FSD.

As a result, Tesla is open to licensing FSD, which could mean competition for ADAS suppliers as a result of potential new competition from Tesla.

Of course, this is an early-stage discussion, and there is no need to read too much into this development. I am still positive about other ADAS suppliers, but this is one development to continue monitoring.

In my opinion, the sizeable catalyst for Tesla to bring upside to both margins and valuation is autonomy or FSD. While the main financial upside to autonomy will come only when full autonomy is achieved, this will be a multi-year process, with the Dojo supercomputer likely bringing a strong competitive advantage in terms of computing power and training advantage.

Valuation

The selloff in Tesla shares after the 2Q23 print was not so much a result of any particular disappointment from the earnings report but more so from expectations that were set too high coming into the 2Q23 print, which then needed major positive surprises in the earnings to justify.

As much as I am buy-rated on Tesla given the long-term opportunities, the near-term upside seems rather limited in my view after the strong share price performance of almost 150% YTD, which prices in the solid demand after the price cuts as well as perfect execution coming 2024.

My 1-year price target for Tesla is $282, which represents a 5% near-term upside opportunity. This is based on a 60x 2024 P/E multiple, which I think is justified for Tesla given the strong leadership position in EVs, AI and autonomy.

As a result, this near-term price target does suggest that near-term upside remains relatively limited, although I would emphasize that the long-term growth opportunity remains.

Conclusion

While Tesla share price was weak after the 2Q23 print, there was not much disappointment from the results in my view. The weakness were likely contributed from the share price pricing in too much after having rallied almost 150% YTD.

The results showed its pricing strategy worked, while guidance was not raised as a result of factory upgrades expected in 3Q23. GAAP EBIT margin came in weaker than expected as a result of spending on Cybertruck, AI and other projects.

As mentioned above, I think the likely catalyst for Tesla will come from autonomy. Progress in the licensing of FSD or continued progress in autonomy will bring near-term upside to Tesla. The advantage that Tesla has in the form of training data, computing resources and talent, will enable its continued success on the autonomy front.

In the near term, I would note that the factory upgrades in 3Q23, rising operating expenses as a result of Cybertruck, Dojo supercomputer and other projects, any improvements in the margins front will likely have to come from the autonomy front, which in my view, might be too optimistic to expect in the near-term.

While the near-term risk/reward looks balanced, I reiterate my view that Tesla is in the leadership position to bring electric and autonomous mobility to the world.

---

Analyst’s 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.

Seeking Alpha’s Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.

---

Outperforming the Market

Outperforming the Market is focused on helping you outperform the market while having downside protection during volatile markets by providing you with comprehensive deep dive analysis articles, as well as access to The Barbell Portfolio.

The Barbell Portfolio has outperformed the S&P 500 by 97% in the past year through owning high conviction growth, value and contrarian stocks.

Apart from focusing on bottom-up fundamental research, we also provide you with intrinsic value, 1-year and 3-year price targets in The Price Target report. 

Join us for the 2-week free trial to get access to The Barbell Portfolio today!