Tim Mullaney: Tesla’s road gets easier from here

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Tesla seems to have mastered one of its main challenges, and is well on its way to conquering the other.

Two words you never thought you’d see in the same sentence: “Tesla” and “easier.”

But it’s true.

That’s the verdict — my verdict, anyway — after Tesla TSLA, +17.15%  reported after Wednesday’s close that it made $150 million in third-quarter profit when analysts expected a loss, even though sales dipped 1% from last year to $6.3 billion. Shares rose 20% in late trading after dropping slightly during the day.

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That’s a sign that, at Tesla, the hard part is mostly over.

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The electric-car maker came into this year with two huge challenges — one is basically done now, and the other appears to be on the way.

Tesla has capital

The first one seemed impossible to many pundits who were very, very sure they were right, but Tesla has substantially locked up the $10 billion that analysts had estimated as the high end of the amount of capital it would need to build out its suite of factories.

The company has already spent $1.5 billion to $2 billion of that, CFRA analyst Garrett Nelson estimated, and it raised $2.7 billion selling stock and bonds in May. It closed the third quarter with a record $5.3 billion of cash on the balance sheet.

With estimates of next year’s free-cash flow running as high as the $1.7 billion projected by Joe Osha of JMP Securities — before the earnings report — Tesla is basically home free on the cash front.

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Unless, of course, something goes massively wrong in the company’s operations over the next year — either demand growth cratering, which would likely require a recession, or gross profit margins somehow reversing their 400-basis-point third-quarter increase as Tesla nurtures its Model 3 line, opens a factory in China, and prepares to launch its Model Y crossover in 2020.

Surprise on profit margins

The second part of Tesla’s challenge has been to address the narrowing of its profit margins since it introduced the Model 3 sedan in 2017. The most stunning part of yesterday’s announcement was that its gross margin on cars — the amount left over after production costs, but before marketing and corporate-overhead expenses — zoomed to 22.8% of sales from 18.9% in the second quarter. The day before the report, Osha had predicted 18.5%.

The target Wall Street has been hoping for was that Tesla would be able to get that number to 25% — over a couple of years. Now it looks like a nearly done deal: If Tesla were not company with a long history of overpromising and under-delivering, it would be all but taken for granted.

That leads us to the other point: The tasks ahead of Tesla are much easier than the Model 3 launch that just about broke Musk’s reputation.

The other big surprise in the report by a company that has so publicly struggled to meet production targets on the Model 3, its first truly mass-market vehicle after the high-priced Model S sedan and Model X crossover that can easily run into six figures with options, is that its next two big projects are — wait for it — ahead of schedule.

Model Y crossover

Tesla said its Model Y crossover — whose prices begin at $39,000, with a 300-mile range between battery charges — will be ready next summer, moving up from next fall. And its big Shanghai factory, which will boost its production capacity to 590,000 vehicles, well more than the 360,000 or so it’s expected to sell this year, is basically done and awaiting final approval from Chinese regulators. It also cost a third of what Tesla spent, per car, to set up its Model 3 production.

“It’s just my opinion, but I think it will outsell the 3, S and X combined,” Musk said on Tesla’s post-earnings conference call.

The Model Y launch should not be the headache that Model 3 was, and its market is significantly bigger. The crossover shares about 75% of its parts base with the Model 3, meaning that, simplified, Tesla already knows how to make them. (By the time it begins to make trucks, which may be harder, it won’t be a company depending on a single model).

It’s expanding its California plant to make Ys, but Musk also said yesterday that the Shanghai plant, touted as mostly making Model 3s to sell in China, will at some point also produce Ys. A site for a plant in Europe will be picked by the end of the year, he added.

And Musk’s boast about the Y is not outlandish. At Ford F, -7.06%   , the Escape crossover sells more units than the mid-priced Fusion sedan and Ford’s entire luxury Lincoln brand. Toyota’s TM, +0.46%  RAV4, with nearly 325,000 U.S. unit sales through September this year, is bigger than the top-selling Camry and all Lexus cars put together.

Short version: People like small SUVs, so if the Model Y is as good as its hype, Tesla will sell a lot of them, especially in the U.S. It would help if the federal government weren’t phasing out the $7,500 tax credit for electric vehicles, but at prices still not much above the U.S. average for new vehicles, the Model Y will likely find its market nonetheless.

From there, it’s on to pickup trucks and even commercial freight tractors. But that’s for another day.

Yes, there will be some niggling about this report. Some have already pointed to the light revenue, a problem the Model Y should resolve with considerable prejudice.

CFRA analyst Nelson points out that much more electric-car competition is coming in the next few years, led by General Motors GM, -1.91%  and Volkswagen VW, +0.94%  . The company is also still run by the very mercurial Musk, who I’ve long argued needs more adult supervision from Tesla’s compliant board, and was lucky not to be fired after he tweeted a bogus claim that Tesla would go private for $420 a share.

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Investor relations

For one quarter, at least, Musk mastered Investor Relations 101 — Underpromise and Overdeliver, and not the opposite. Whether that will last is anyone’s guess.

But what small investors need to know, for now, is that Tesla had two jobs coming into this year: finance its expansion plans, and improve its operations to boost profits.

For now the verdict is that they have licked one problem and have the other, finally, under what appears to be firm control.

Osha told me Tuesday that if Tesla hit his 2020 cash-flow forecast — which is based on a sales gain of about 20%, and margins that are about what Tesla did in the quarter just completed — “the stock will go way up.”

He was right — just early.

Tim Mullaney is a columnist who covers the economy and corporate news.

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