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

David Kudla, Marketwatch, May 2, 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 will continue, regardless of the company’s first-quarter earnings.

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 the 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 are none yet 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 production goals originally set were 5,000 Model 3s per week by the end of 2017 and 10,000 per week sometime in 2018. But last fall, Musk proclaimed that Tesla was experiencing “production hell”. Suppliers were blamed for missing 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 mid-year, but in April Tesla was still only building about 2,000 M3s per week.

Even if M3 production gets to 6,000 per week or more, can Tesla build them profitably? The company’s numbers for M3 margins are ambiguous at best.  And those certainly did not include all the rework and other problems in building the M3, 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 M3s 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 is0 noteworthy in this regard.

By 2020 there will be dozens full electric vehicle models offered by other auto 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 set-ups for short opportunities. They tend to precede poor earnings reports or other harsh realities for Tesla about to be announced or uncovered by stock analysts and industry expert

Tesla 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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