After ‘production hell’, Elon Musk is headed for ‘warranty service hell’

David Kudla, Marketwatch, May 3, 2018

I have made a profit shorting Tesla stock several times over the past year — and am once again short the stock.

Like many others, I think Elon Musk is brilliant and a visionary. But I see several problems with this “story stock” that aren’t going away.

One problem is Elon Musk’s arrogance and dismissive attitude, as evidenced by the conference call with analysts following Tesla’s first quarter-earnings announcement on Wednesday.

Beyond that, with the competition that is coming in the market for electric vehicles, Tesla at best becomes a boutique car company, not a category killer. With its internal problems and its cash-burn rate, the worst-case scenario is that Tesla ends up bankrupt.

The bears calling for bankruptcy in the near term will be proven wrong. Musk can continue to find money in the capital markets to keep the company running for quite a while yet. Mounting lawsuits are problematic as well, but aren’t yet something that could critically cripple the company.

Musk certainly won’t find enough revenue in the Model 3 anytime soon that can sustain the company, no matter how bold his future production rate claims become.

Tesla’s ramp-up of the Model 3 has been nothing short of a disaster. The original production goals were 5,000 Model 3s per week by the end of 2017 and 10,000 per week sometime in 2018.

But Musk has admitted that Tesla is experiencing “production hell”. Suppliers have been blamed for missed delivery deadlines, battery module production was constrained, and vehicles intended to be built with sophisticated automation were instead being built largely by hand. Overkill on the use of robotics and automation at final assembly have become an Achilles’ heel. Musk is now calling for a production rate of 6,000 per week by midyear, but in April Tesla was still only building about 2,000 Model 3s per week.

Even if Model 3 production gets to 6,000 per week or more, can Tesla build them profitably? The company’s numbers for Model 3 margins are ambiguous at best. And those certainly didn’t include all the rework and other problems in building the Model 3, many of which are yet to be solved.

But even as Tesla tries to muddle through Elon Musk’s self-proclaimed production hell, he is entering what I have termed, “warranty service hell”. Quality problems arising from trying to push Model 3s out the door will only make matters worse. The Tesla loyalists might be forgiving of a quality issue or two, but more discriminating customers will not.

A major misbelief by Tesla loyalists and Tesla bulls is that Tesla owns the EV market and autonomous driving. Tesla owns nothing. It has no barriers to entry, no proprietary technology in batteries, EVs, or in autonomous-driving technology. Granted, it has been the first mover in some areas, but this has also tarnished the company and set up future lawsuits, as it moved too fast and put customers’ lives in danger. The Autopilot feature is noteworthy in this regard.

By 2020 there will be dozens full-electric vehicle models offered by other manufacturers. Will Tesla even be profitable by then? If so, how well will they compete in a market full of electric vehicles from multiple manufacturers? And, at what profit margin?

Despite all the issues, Musk has been able to prop up the stock price from time to time. It is in his best interests to do so, as his new pay package depends largely on the performance of Tesla shares over time. He has unveiled a Tesla semi-truck and a new roadster, and, of course, shot a Tesla vehicle into outer space. But these sideshows are meant to distract investors from Tesla’s immediate problems.

That said, pay attention to them, as these circus events have been great setups for short opportunities. They tend to precede poor earnings reports or other harsh realities for Tesla that are about to be announced or uncovered by stock analysts and industry experts.

Tesla’s stock rallied for years on the promise of a story stock. Now reality has set in and Tesla bears have the upper hand.

David Kudla is CEO and Chief Investment Strategist of Mainstay Capital Management, a fee-only independent, Registered Investment Advisor. Follow him on twitter @David_Kudla.

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