Photo courtesy of Tesla, Inc.

Morningstar recently increased its Tesla (NASDAQ: TSLA) fair value estimate to reflect their brighter forecast for the company's long-term automotive profitability, thanks to increased vehicle deliveries, higher average vehicle prices, and lower unit production costs. Senior Equity Analyst and Chair of the Electric Vehicle Committee at Morningstar Seth Goldstein shared the details of this.

Goldstein wrote that the firm still believes Tesla has the potential to disrupt the automotive and power generation industries with its technology for electric vehicles, autonomous vehicles, batteries, and solar generation systems. He notes that in less than a decade, the Californian manufacturer has grown from a startup to a globally recognized luxury car manufacturer, and Tesla's roadmap is full of high-end products.

In order to maintain its status as the leader in the EV market, Tesla is carrying out a large-scale expansion of production facilities to increase the number of vehicles produced. About 6% of sales profits are invested in the research and development of innovative technologies. To keep costs down, Tesla is focusing on automation and efficiency in the manufacturing process. Goldstein emphasizes that the company is trying to take on a larger share of its customers' car-related costs, which include insurance sales and paid services such as autonomous driving features.

Tesla also sells solar panels and batteries for energy storage to households and utilities. The manufacturer is well-positioned to grow in the emerging solar power and battery market.

The firm concludes that Tesla's brand reputation is unlikely to deteriorate anytime soon when other automakers start mass-producing electric vehicles. The point is, the company will continue to innovate to stay ahead of startups and established competitors. Already, thanks to innovative technologies, Tesla cars are several years ahead of competitors.

Tesla's total vehicle volume has grown from just over 100,000 in 2017 to nearly 600,000 (on a trailing 12-month basis as of the first quarter of 2021). During the same period, the company’s average cost of goods sold per vehicle has fallen 55% from $84,000 to under $38,000 and gross profit margins have expanded from 23% to a little under 27%. Much of the downturn stems from the company's drive to lower production costs through scale.

Legacy carmakers are gradually shifting to the production of BEVs from internal combustion engines, but the analyst expects they will be saddled with legacy ICE costs for a long time. Even as legacy automakers start producing more EVs, the firm expects Tesla to continue operating at a lower cost. With the cost of car manufacturing going down, it may take existing carmakers years to catch up with Tesla, and ultimately may never be able to do so as they don't want to build many new factories from scratch as Tesla does.

Morningstar thinks Tesla's combination of intangible assets and cost advantage will persist and allow the company to generate excess returns on capital. "We see the potential for Tesla to outearn its cost of capital over at least the next 20 years, which is the measurement we use for a wide economic moat rating."

Analysts assess the balance of Tesla as sound. The company’s revenue is subject to high cyclicality, and the majority of its debt and financial lease obligations are due within the next three years. The firm maintains an emphasis on cutting costs as this should allow Tesla to keep its price advantage unchanged. The reduced production costs should enable Tesla to increase the profitability of its existing vehicles and to produce affordable sedans and SUVs at a profitable level in the future.

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