Tesla (TSLA) has had an incredible run, up 131% since the March 18th low, shaking off any COVID-19 concerns despite the factory being closed for 7 weeks. Much of the bearish crowd for Tesla (and the rest of the market for that matter) has capitulated and moved on. But the policies that come from COVID-19 may impact Tesla more than many think, especially after the Model Y backlog is exhausted.

California and the Lockdown Impact

Tesla has been incredibly strong in its home market of California. In Q1, 23.6% of Tesla’s deliveries (23,250 of 88,400) happened in state per the CNCDA. This shouldn’t be surprising, as Tesla enjoys numerous advantages in California:

  • Ideal climate (minimal range loss, rarely salt on the roads during winter.)
  • Tech-savvy population supportive of the local employer and mission
  • HOV Lane usage
  • $2000 state rebate on Model 3 and Model Y
  • Extreme traffic congestion (Autopilot/FSD useful)
  • High gas prices

But COVID-19 and the resulting work-at-home policies may significantly hurt Tesla in 2020 and beyond. Many large Silicon Valley employers like Google (GOOG) (NASDAQ:GOOGL) have announced that non-essential staff will work at home until the end of this year. Facebook (FB), Twitter (TWTR), Square (SQ), and many others are looking at making work-at-home a more permanent arrangement.

I think this trend will continue. I believe we are at a unique point in time, where most people have a rich set of tools to collaborate remotely using products like Microsoft (MSFT) Teams and Slack (WORK) with video conferencing available on most phones and computers. Even 5 years ago, these tools were far less ubiquitous, and now COVID-19 is forcing the entire world to take a crash course in using them while removing the stigma of needing to be in an office. Employers may start looking at smaller offices as a major cost-saving. Interestingly, these “work from anywhere” predictions were common during the dot-com era and never really materialized. Perhaps the predictions were a few decades early.

If the work-at-home trend continues, it could reduce demand for all autos, but particularly for Tesla in California, since it would negate many of the benefits of owning a Tesla while leaving many of the drawbacks like expensive insurance and requiring charging stops on longer trips.

Price Cuts after a 7-week production halt?

On March 26, Tesla cut domestic prices on Model S and X by $5000 and Model 3 by $2000. Pricing on the new Model Y was unchanged.

This was surprising to me, since I expected investors would give Tesla (and all automakers) a pass on horrible Q2 results. With both factories and showrooms closed for the industry, I thought Tesla would “kitchen sink” this quarter, writing off anything the company could to clear the decks for an aggressive sales push in Q3.

So why cut prices? The obvious bearish explanation is that sales are poor and Tesla needs money. But Tesla has had no problem raising cash by selling shares, and I don’t see what would stop it from doing so again, especially with the stock above $800 and the broader market being strong. The company could have used the factory being closed and logistic challenges to explain away any delivery miss.

Instead, my interpretation of the price cut is bullish, at least short term. I believe Tesla may be pulling out all the stops to deliver a profitable Q2 to gain inclusion in the S&P 500 index. Inclusion in the S&P 500 requires positive earnings for the most recent quarter in addition to an aggregate profit over the previous four quarters. If domestic demand and pricing for the newly launched Model Y are strong and we see a rebound for the made-in-China Model 3, perhaps Tesla just needs some incremental sales on Model X, S, and 3 to achieve a small quarterly profit.

Another ace up Tesla’s sleeve to drive a small profit this quarter could be reduced warranty expense. I believe Tesla exaggerates gross margins and tries to avoid lemon lawsuits by classifying repairs as goodwill rather than warranty. By having a smaller warranty carved out, it improves current earnings and “kicks the expense down the road” where it is recognized later when the “goodwill” repair happens. With lockdowns in place for much of the quarter and fewer miles being driven, I think it is likely that Tesla didn’t have as many cars to fix.

Model Y delivery estimates down to 4-8 weeks

As reported by CleanTechnica, the estimates for Model Y delivery are already down to 4-8 weeks from the previous 8-12 weeks. Author Zachary Shahan says “there’s no denying that the delivery estimate in 4–8 weeks makes it seem as if Model Y demand isn’t as ginormous as expected.”

Tesla bulls expect Model Y to sell in far greater quantities than the Model 3 did. I just don’t see it, as I don’t see the vehicles being that different. The last quarter Tesla broke out Model S and Model X individually showed a fairly even split between them, even though the Model X was much newer and the Model S faced substitution from the Model 3. So I remain highly skeptical that the market for the Model Y is larger, let alone much larger, than that of the Model 3.

In Q2, I’m thinking Tesla will sell every Model Y it produces. Beyond that, the outlook is far less certain.

Expectations for Q2 and beyond

For Q2, I believe Tesla could squeeze out a surprise profit against the current forecast loss of $1.43 and the stock could rally. From there on I’m more bearish.

In addition to the above trends, I believe we will see credible competition show up for the Model 3, especially in Europe, from the Polestar 2, Volkswagen (OTCPK:VWAGY) ID.3, and others.

Some Tesla bulls have snickered at competition over the years, but consider what has happened to Tesla in Norway, which I consider a leading indicator for EV trends. Very few people would have expected the E-Tron to outsell all the Tesla brands combined by this large of a margin in a market that has been very strong for Tesla historically.

The next few weeks will be interesting and I will be watching to see if Tesla makes an all-out production and delivery push. I’d caution bears to watch out for better Q2 delivery and earnings than are expected. Likewise, if Tesla rallies significantly after Q2 results, bulls should consider taking profits with the stock already priced to perfection. A solid Q2 and economies reopening would raise expectations in Q3, which Tesla may have trouble meeting.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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2020-06-01