Tesla (NASDAQ: TSLA) reported an impressive gross margin of 25.5% in its Shareholder's Letter for Q1 2020. According to EV automaker, its gross margins remained strong despite the temporary suspension of the Fremont factory.
"Q1 ended up being a strong quarter despite many challenges in the final few weeks. This is the first time we have achieved positive GAAP net income in a seasonally weak first quarter," said Elon Musk in his opening remarks. Tesla stopped Fremont operations in late March to comply with California's lockdown guidelines. The ongoing shutdown concerned Tesla investors and supporters of the company.
However, Tesla survived--and thrived--the first quarter of this year relatively unscathed. "Even with all the challenges, we achieved a 20% automotive gross margin, excluding regulatory credits while ramping two major products," said Musk. TSLA listed Giga Shanghai's volume growth for the MIC Model 3 and the Model Y's profitability during Q1 as strong contributors to its impressive gross margin.
Zachary Kirkhorn talked more about Tesla's profitability during Q1 in his opening remarks as well. "It's hard to understate the significance of demonstrating profitability of this program in its first quarter of production. Our Shanghai Model 3 margins improved dramatically since Q4 of last year, nearing equivalents of Model 3's built in Fremont. This is despite not yet running at full capacity, while also managing through the production shutdown in early February."
Kirkhorn added that Tesla already announced the MIC Model 3 Long Range and Performance variant in China, which he said would positively impact ASPs in the country. Tesla's CFO shared that China's new NEV subsidy regulations did not negatively affect Giga Shanghai's demand. "In fact, we exited the quarter with our highest ever backlog yet again," he said.
During the Earnings Call, Kirkhorn also stated that as Giga Shanghai's production costs for the MIC Model 3 are already lower than the costs of Model 3s made in Fremont, and there was still room to make further cost reductions.
"So fixed cost absorption from higher production volumes, which are occurring in Q2 and will occur through the rest of the year were not fully localized on the supply chain yet. And so while a lot of the supply chain is localized, it's not complete, and there's additional opportunities there. And so we'll continue to bring the price down and expand margin," he said.
Tesla's early Model Y ramp also seemed to boost its gross margins in the first quarter. Both Elon Musk and Zachary Kirkhorn stated that the Model Y demonstrated profitability, despite being a newly launched product. The Model Y's profitability in the first quarter says a lot about Tesla's potential gross margins and revenue after lockdown orders are lifted and Fremont continues operations.
"Thus far, the Model Y ramp has been even faster than the Giga Shanghai ramp in Q1. In other words, we are ahead of the schedule that we were ahead of already. Most surprisingly, Model Y was profitable already in its first quarter of production, something we haven't achieved with any product in the past," said Elon Musk about Tesla's Model Y ramp.
Emmanuel Rosner from Deutsche Bank wondered how the Model Y could substantially contribute to Tesla's Q1 2020 gross margins despite its low volume for the quarter. Kirkhorn explained that the higher ASP of the Model Y and the fact that Tesla started deliveries with the Performance variant helped "create some of the margin." He also said that the Model Y's common parts and manufacturing processes with the Model 3 helped Tesla manage its cost of production.
Pierre Ferragu from New Street Research closed the Earnings Call with a question about gross margins as well. He theorized that Tesla's gross margin would have evolved sequentially in the first quarter had it not been for three factors: 1) tailwind from credits, 2) Model Y's ramp cut short, and 3) Fremont's shut down.
Kirkhorn agreed with Ferragu's assessment that if those three factors were removed, Tesla would have a sequential increase in gross margin. "I haven't specifically calculated that, but I think your intuition is right," he said. "And I think this also lends itself to the power of the gross profit contribution to [Tesla] once we get through these ramp inefficiencies, we get Fremont up and running again, we increase capacity so we can spread out fixed costs and continue to execute on cost reductions on our products, we feel very optimistic about that path going forward."
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