Is Tesla launching a price war, a disaster or a big bet on future growth?

Elon Musk believes that pursuing rapid growth is still the right thing to do in the long run.

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Elon Musk attends “In America: An Anthology of Fashion” at The Metropolitan Museum of Art on May 2, 2022 in New York, New York, USA. Fashion’s 2022 Charity Ball (The 2022 Met Gala Celebrating). Credit: Photo by Dimitrios Kambouris/Getty Images for The Met Museum/Vogue

There are multiple interpretations of Tesla’s (TSLA) move to slash prices in the U.S. and Europe. Prior to this, Tesla had carried out two rounds of price cuts in China within 10 weeks.

In the eyes of the pessimists, it is clear that Tesla is facing difficulties in increasing orders. In the fourth quarter of 2022, Tesla produced 34,000 more vehicles than it delivered, which is not a catastrophic difference, but it represents a change in Tesla’s development trend. After all, Tesla CEO Elon Musk told investors in October 2022 that the company expects to sell every car it makes “for the foreseeable future we have.”

“Tesla’s recent price cuts are in response to demand issues,” Bernstein analyst Tony Sacconaghi wrote in a Jan. 17 note to clients. Equivalent to a sell rating. “While we (and many investors) expected Tesla to cut prices, it was more aggressive and came sooner than we expected.”

To the optimists, Musk is simply launching a price war in which Tesla has a good chance of winning, even if it is unlikely to remain intact.

There’s no question that a 20% price cut on the Model Y and roughly $20,000 off the high-performance versions of the Model S and X will put pressure on the company’s profitability. But Tesla’s revenue far exceeds that of other electric car companies. Except for Chinese manufacturer BYD, no other automaker’s electric car production can match Tesla’s.

Bank of America analyst John Murphy said on January 17: “Tesla’s profit margins are higher than other automakers, including General Motors (GM) and Ford (Ford). Tesla’s further price cuts provide a cushion.” Murphy has a hold rating on the automaker’s stock. “Most OEMs are currently loss-making electric vehicle businesses, and Tesla’s price cuts could make it harder for these companies to do so as they try to increase production of electric vehicles. If favorable electric vehicle pricing ceases to exist , OEMs will have to reassess their electric vehicle investments and whether those investments will deliver sufficient returns.”

Tesla was on the verge of bankruptcy during the Great Recession about 15 years ago. The company has since grown thanks in part to chronically low interest rates, easy access to financing and less competition.

All this has changed. Interest rate hikes by the Federal Reserve have raised borrowing costs, and Tesla is no longer the only player in the electric car industry. In China, BYD is growing fast, and in Europe Volkswagen is trying to protect its turf. Ford and General Motors also maintain their own markets in the United States.

In 2022, after Tesla failed to meet its car delivery growth target, Musk decided to continue to promote Tesla’s expansion. Lowering prices on Model 3 and Y vehicles to make more models eligible for new U.S. tax credits under the U.S. Inflation Reduction Act.

In December 2022, in a conversation on Twitter Spaces, Musk predicted that the United States would fall into a severe recession this year and warned that consumers would reduce their consumption of commodities. He pointed to high interest rates and low demand as a “double whammy” and claimed Tesla faced a choice.

Musk asked rhetorically: “Do you want to increase sales, even though you have to lower prices? Or do you want to grow at a slower or steady rate? My preference is to pursue rapid growth without putting the company at risk.”

In this scenario, Tesla’s CEO said profits would “become negative” during a recession, as long as the company is in a healthy cash position.

“I think it’s still the right thing to do in the long run,” Musk said.

Translated by: Liu Jinlong

Reviewer: Wang Hao

There are several ways to look at Tesla’s deep price cuts in the US and Europe, which came on the heels of two rounds of reductions in the span of 10 weeks in China.

For the glass-half-empty crowd, it’s clear that the carmaker was struggling to drum up orders. The company produced over 34,000 more vehicles than it delivered in the fourth quarter — not a catastrophic difference, but part of an un-Tesla-like trend. After all, Chief Executive Officer Elon Musk told investors in October 2022 that the company expected to sell every car it could make, “for as far in the future as we can see.”

“Tesla’s recent price cuts were in response to a demand problem,” Toni Sacconaghi, a Bernstein analyst with the equivalent of a sell rating on the stock, wrote to clients on January 17. “While we (and many investors) had expected price cuts , they were bigger and came earlier than we expected.”

For the glass-half-full contingent, Musk just started a pricing war that Tesla stands a strong chance of winning, even if emerging unscathed is out of the question.

There’s no debating that slashing 20% ​​off the cost of the Model Y and making performance versions of the Model S and X roughly $20,000 cheaper will pressure profitability. But Tesla is soundly out-earning other EV companies, and with the exception of China’s BYD, no automaker is anywhere close to producing as many electric cars.

“Tesla has higher margins than other OEMs including GM and Ford, and cushion to lower prices even further,” John Murphy, a Bank of America analyst with the equivalent of a hold rating on the EV maker’s stock, said on January 17. “Most OEMS are currently losing money on EVs, and these price cuts are likely to make business even more difficult, just as they are attempting to ramp production of EV offerings. OEMs will have to reevaluate investments and whether they generate sufficient returns should EV price favorable.”

Tesla almost went bankrupt during the great recession that was getting underway roughly 15 years ago. The company then grew in part thanks to a long period of low interest rates, easy access to capital and little competition.

That’s all changed. The Federal Reserve’s rate increases have raised borrowing costs, and Tesla is no longer the only game in town. BYD is surging in China, Volkswagen is fighting to protect its turf in Europe, and Ford and General Motors doing the same in the US.

Musk is determined to position Tesla for continued expansion after the company fell short of its target for growth in vehicle deliveries last year. Cutting the prices of the Model 3 and Y will make more of those models eligible for new US tax credits introduced by the Inflation Reduction Act.

During a Twitter Spaces conversation in December 2022, Musk predicted a serious recession this year and warned consumers will cut back on big-ticket purchases. He called higher interest rates and lower demand a “double-whammy,” and said Tesla faced a choice.

“Do you want to grow unit volume, in which case you have to adjust prices downward? Or do you want to grow at a lower rate, or steady?” Musk asked, rhetorically. “My bias would be to say let’s grow as fast as we can without putting the company at risk.”

In that scenario, Tesla’s CEO said profits would be “lower to negative” during the recession, on the condition that its cash position is sound.

“I think that’s still the right move, long-term,” Musk said.

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