Investors are starting to wonder just how bad things might get for Tesla (TSLA:NASDAQ) as it relentlessly chases volume at the cost of profits.

At the start of the month (2 Oct) Tesla unveiled another round of price cuts in the US, the seventh time this year that the world’s biggest electric car maker has lowered prices on some models. The aggressive pricing strategy was meant to boost sales in a slowing electric vehicle market and, crucially, put more miles between its industry leading profit margins and those of its legacy car maker and Chinese challenger rivals.

Tesla deliveries miss in third quarter and pose the risk of lower margins

You could argue that the plan had been working. Vehicle deliveries hit rough records of 423 million in the first quarter 2023 (to end March) and jumped in Q2 to 466 million. But price cuts’ ability to stimulate demand is now running out of juice.

Tesla’s gross and operating margins

	FY 2019	FY 2020	FY 2021	FY 2022	Q1 2023	Q2 2023	Q3 2023
Gross margin	16.6%	21%	25.3%	25.6%	19.3%	18.2%	17.9%
Operating margin	-0.3%	6.2%	12.1%	16.8%	11.4%	9.6%	7.6%

Source: Tesla, Statista

Investors had already learned that deliveries had been softer in Q3 at 435,059 vehicles, after its gigafactories in Austin and Shanghai shutdown temporarily for upgrade work. That was shy of consensus analyst estimates of 461,640 vehicles which were supposedly already recalibrated to reflect the manufacturing stoppages.

REAL COST OF PRICE CUTS

Investors can now see the savage impact this is having on Tesla’s profitability in the wake of Q3 results (18 Oct). Gross margins declined for the fourth quarter in a row at 17.9%, falling from 25.1% in Q3 2022. Gross margins peaked in Q1 2022 at 29.1%, which implies a 1,120-basis point drop in 18-months.

This is now no better, and worse than some, mass market vehicle makers, although the comparative figures include non-electric vehicles.

Tesla’s gross margins no better, or worse, than mass market rivals

Toyota	19.6%
Volkswagen	19.6%
Tesla	17.9%
Ford	16.7%
General Motors	12%

Source: Tesla, Google

But the shares of those rivals trade on single-digit or low double-digit price to earnings multiples versus Tesla’s 60-odd.

Operating profit margins, which include inflation-sensitive things like staff salaries, have more than halved in a year after steadily declining, down from 17.2% in Q3 2022 to 7.6% in the same quarter this year. This means that despite largely higher vehicle volumes, quarterly net income has plunged 37% since Q3 2022 to $2.32 billion, or 44% to $1.85 billion on a GAAP basis (generally accepted accounting principles).

TESLA’S BIG QUESTION

Tesla’s free cash flow in Q3 2023 fell 74% to $848 million and throw in Elon Musk’s uncharacteristically downbeat narrative on the Cybertruck, which could take 18-months before it becomes cashflow positive, and you can see why Tesla’s stock has barely budged since early June, racking up all of its year-to-date 125% gains in the first half of 2023.

Whether Musk can stop the erosion in Tesla profitability at a time when competition in the electric vehicle industry is becoming even more intense is perhaps the biggest question for the months ahead. That share price falls of more than 5% are being priced in by pre-market data (to $229.23) shows how concerned investors are becoming.

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