Tesla Bears Have the Upper Hand for Now, but That Could Change Quickly

As the sharp selloff following its Q3 report drives home, greed and fear have long played outsized roles in how Tesla Inc.’s (TSLA) shares move.

Bulls filled with visions of Tesla becoming an EV/solar/energy storage colossus will bid shares sharply higher following positive news, and bears convinced the company won’t make good on its big promises and will eventually see its sizable losses catch up to it pounce following bad news.

When good news leads shorts to cover and makes bulls feel as if their optimism has been validated, Tesla rockets higher. When bad news compels shorts to add to their positions and makes some bulls questions theirs, Tesla falls sharply. It’s a story that has been repeating itself for years…though the long-term trend has been very much on the side of the bulls.

Tesla’s Q3 shareholder letter and earnings call, and in particular the commentary Elon Musk and others provided about the company’s ambitious Model 3 production ramp, gives bears the upper hand for the time being. But with Tesla signaling consumer interest in the relatively cheap sedan is as strong as ever, the pendulum could eventually swing back if the company shows signs of putting its current production woes to rest.

Tesla reported Q3 revenue of $2.99 billion (up 30% annually) and adjusted EPS of negative $2.92. Revenue slightly beat a $2.92 billion consensus, while EPS — hurt by giant Model 3 and battery Gigafactory investments — missed a consensus of negative $2.35. Those investments, which included $1.1 billion worth of capital spending, also weighed on free cash flow (FCF); it came in at negative $1.42 billion.

But it isn’t the (largely expected) cash burn that’s bothering investors as much as the push-out of Tesla’s goal of reaching a Model 3 production rate of 5,000 cars per week from the end of Q4 to “late Q1.” It also didn’t help that Tesla didn’t quite reiterate a prior goal of reaching a weekly production rate of 10,000 by late 2018; the company now only says “it has always been our intention to implement that capacity addition after we have achieved a 5,000 per week run rate.”

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Also: Tesla, which had previously said it will achieve a positive gross margin on Q4 Model 3 sales, now only says it aims for a “breakeven” Model 3 GM by quarter’s end. The company still insists Model 3 margins “should improve rapidly in 2018 to our target of 25%.”

Tesla shares — already pressured in recent weeks by growing reports of Model 3 production challenges and parts order cuts, declined 6.8% to $299.26 on Thursday, and have hit their lowest levels since May. They’re still up 39% on the year.

Aside from the Model 3 target push-out, Tesla shares might be pressured by the introduction of a GOP tax bill that does away with a $7,500 electric-car tax credit. But the bill still has a ways to go before passing.

On the earnings call, Musk claimed — in comments that Apple Inc.  (AAPL) investors following reports of production issues for the iPhone X’s front-camera dot projector module can sympathize with — that battery module assembly is “the primary production constraint” for the Model 3. “There are four [production] zones to module manufacturing…zones three and four are in good shape, zones one and two are not,” Musk said.

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He added that a subcontractor responsible for “zone two” had done a poor job, and that Tesla didn’t realize the scope of the problem until recently.

“We had to rewrite all of the software from scratch, and redo many of the mechanical and electrical elements of zone two,” Musk proclaimed, but qualified his remarks by saying Tesla still has a lot of work left. ” [T]he software working with the electromechanical elements need to be fabricated and installed, and getting those atoms in place and rebuilt [takes], unfortunately, a lot longer, and has far more external constraints, than software.”

For now, vehicle identification number (VIN) data for the NHTSA indicates Tesla is producing about 500 Model 3 units per week.

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As Tesla deals with these issues, expected delivery times for Model 3 reservations, which already stretched to the late 2018/early 2019 timeframe for those lower on the reservation list, will be pushed further out. Tesla still officially says those putting down $1,000 for a Model 3 reservation — they can be cancelled and refunded whenever one wishes — will see a delivery in 12-to-18 months. But I’ve anecdotally, I’ve heard salespeople suggest delivery times for new reservations will be closer to 18 months due to production delays. And that certainly seems realistic if Tesla struggles to reach a 10,000-vehicle weekly production rate by the end of 2018.

If there’s a silver lining here, it’s that Tesla says Model 3 net reservations, which stood at 455,000 as of late July, continued to “grow significantly in Q3.” Strong reviews for the sedan, which carries a $35,000 starting price for its base model and a $44,000 starting price for an extended-range model, have contributed to swelling consumer enthusiasm. And some reservation-holders promised a relatively early delivery have been selling their reservations at large markups.

And the company is still seeing healthy demand for its costly Model S sedan and Model X crossover, as it tries to upsell wealthier consumers interested in the Model 3 on the cars. Though it plans to cut Model S/X production by 10% sequentially in Q4 as it tries to cut inventory and devote more resources to the Model 3, the company reiterated its full-year guidance (effectively raised in early October) for 100,000 Model S and X deliveries. It also reported seeing record combined net orders for the cars in North America, Europe and Asia in Q3.

The delayed Model 3 ramp does put some additional pressure on Tesla’s balance sheet, but it’s not panic time yet. Following a $1.8 billion debt offering carried out in August, Tesla ended Q3 with $3.5 billion in cash, $540 million in restricted cash and about $10 billion in debt. With Tesla expected by analysts to burn another $1 billion or so in cash in Q4 and $1.6 billion in 2018 before significantly reducing cash burn in 2019, the company might need to raise more capital next year. But with the company still sporting a $50 billion market cap, and with the last debt offering oversubscribed by $300 million, the company shouldn’t have too much trouble raising what it needs, provided it doesn’t see additional big Model 3 production issues.

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Tesla has certainly been no stranger to production delays and missed deadlines over its history, as its Model S and Model X launches make clear. Musk’s company usually makes good on its promises to roll out compelling new products and technologies in volume, but often takes a while longer to do so than it originally promises.

What’s a little different this time around is the sheer magnitude of the production ramp Tesla is trying to pull off. Clearly, the challenges involved — both in terms of internal manufacturing and supply-chain needs — in transforming from a company that produces about 100,000 cars per years to one that makes several hundred thousand per year are producing some major growing pains. Investor nervousness about how long those growing pains will last is pushing shares lower, and could very well continue to do so in the near-term until more encouraging Model 3 production news arrives.

Still, as the giant run-up Tesla saw in 2013 amid its Model S ramp shows, investor sentiment in the EV pioneer can swing from fear to greed in a hurry once such worries are put to rest.

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