Elon Musk's Production Plan For New Tesla: Too Fast, Too Furious? – Investor's Business Daily

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By now you’d think Elon Musk would be used to close calls, having snatched a number of notable enterprises from the jaws of defeat and ushered them to stunning success.

Now, however, Musk could be facing his greatest challenge. Having staked a reputation as a rock star of the business world, the question is whether he can transport his Tesla (TSLA) car company from a boutique builder of head-turning luxury electric vehicles into a mainstream automaker capable of bringing the company’s upcoming Model 3 to the workaday masses.

XAutoplay: On | Off This latest pursuit for Musk is a big step, and Tesla’s most ambitious project. The company plans to make five times as many Model 3s than any other car it now builds and the to-do list — before building gets underway in a scant two months — is formidable.

First, Tesla’s assembly line is taking a gamble by forgoing the common use of prototypes, and instead is going headlong into production right from the start. Further, pricing and profit expectations rely on a massive battery-manufacturing plant the company is building. Meanwhile, Tesla has to expand dealerships, service centers and charging stations to accommodate this more moderately priced car. And it needs to pull all this off while competitors are breathing down its neck.

“There’s a lot that could go wrong here,” said Brad Erickson, equity research analyst at Pacific Crest Securities.

Tesla’s goal is to ramp up production to 500,000 Model 3 vehicles a year — a huge leap from its 100,000 run rate with the Model S sedan and Model X sport-utility vehicle. The Model 3 is a five-seat sedan with a starting price of $35,000, vs. $68,000 for the Model S and $82,400 for the Model X, both of which typically sell for about $100,000 when customer options are included.

Execution Risks

Tesla recently affirmed that its Model 3 production is on track to begin in July at its Fremont, Calif., assembly plant, but plenty of execution risks remain.

“The demand for Model 3 will be there and that’s why you’re seeing investors lean into the stock,” Erickson said. “But the thing that sticks out is Tesla has modified their initial approach to manufacturing the Model 3.”

Erickson is referring to an apparent shift in manufacturing plans by Tesla. A year ago, Musk said he was completely rethinking Tesla’s factory process and was convinced that dramatic improvements in manufacturing could be achieved by “factors of 10 or even 100 times.”

Musk had led analysts to think the dramatic improvement would start with the Model 3. Instead, Tesla now plans to do that with its Model Y, a crossover vehicle yet to be unveiled but expected to enter production by 2019.

“Historically, they’ve always said things will go wrong,” Erickson said. “They told us before the Model X and Model S that things will go wrong and they did.”

The Media Darling

But the manufacturing volumes for those cars started low. Customers were loyal and committed to the company and to Musk, who has emerged as a Wall Street media darling with a passionate following similar to that of Steve Jobs.

The devotion to Musk got its roots in 2008, when he rescued Tesla from the dustbin of car companies. That year, Musk was Tesla chairman, but much of his time was going into SpaceX, a rocket ship company he founded in 2002.

With the Great Recession in full swing, Tesla was near bankruptcy, as was Musk. And his spaceship company was about to crash after its first three launches failed. Topping it off, Musk was going through a heated divorce.

“I felt pretty damned bad,” Musk told IBD in a 2012 interview. “It looked like all my companies would die.”

They didn’t, of course. Musk became chief executive of Tesla in late 2008 and pulled it out of a nose-dive, while SpaceX now has billion-dollar contracts. Musk has shown he’s not one to bet against.

Different Gamble

This is a different kind of poker match, though. Tesla is preparing to sell a high-volume car, in which major manufacturing issues could have a much bigger impact on the Tesla brand, just as rivals such as BMW, Ford (F) and General Motors (GM) threaten its standing among electric-car makers.

Tesla’s current production goal is to be making 1 million cars a year by 2020. With Tesla shares up more than 50% this year, the stock is pricing-in auto sales of 2 million units in 10 years, estimates UBS analyst Colin Langan. This would be in line with BMW today and just shy of the 2.4 million from Daimler‘s (DDAIF) Mercedes unit, Langan wrote in a research report.

It also assumes that Tesla can reach operating margin targets in the midteens, which is well above the auto industry’s average margin of about 7%.  Moreover, all major manufacturers of luxury cars have electric vehicle launches planned in the 2018-20 time frame.

Langan is one of the most persistent Tesla bears. He has a sell rating on Tesla and price target of 160, 50% below where the stock currently trades.

“We remain cautious on the launch timing and see Model 3 profitability as challenged given the lower price point and high battery cost,” Langan wrote in a recent note to clients. “Tesla expects the Model 3 plant to be leading in efficiency, but investors will need to wait for the Model Y plant in around 2019 before it implements major changes to auto production and automation.”

“We remain cautious on cash burn long term given the challenging Model 3 profitability,” Langan wrote.

Where’s The Earnings?

Tesla has labored under financial pressure since it was founded in 2003, and has yet to turn an annual profit. Earlier this year, Musk said the company was financially “close to the edge” — low on cash as it expected to spend $2 billion to $2.5 billion on the Model 3 launch.

Tesla got some breathing room by raising $1.2 billion in fresh capital in March when it sold a 5% stake to Chinese internet company Tencent Holdings (TCEHY). Tesla’s balance sheet now lists $4 billion in cash and equivalents.

First-quarter revenue for Tesla came to $2.7 billion, up 135% from a year earlier. Yet the carmaker reported an adjusted loss of $1.33 a share, exceeding the 81-cent-per-share loss that Wall Street expected. The stock fell 5% in reaction.

The shares quickly recovered, though. Over the past 12 months, Tesla stock is up 57%. The stock has a higher market valuation than Ford and is close to that of General Motors.

“In many ways, Tesla seems to play by its own rules,” wrote Piper Jaffray analyst Alex Potter in a research note last month. “The company burns through cash at a rate that better-established companies would likely be crucified for — especially considering Tesla’s rickety balance sheet and penchant for raising equity.”

No Prototype

Model 3 production risks run high. Tesla plans to bypass the usual manufacturing-prototype stage and go straight to full car production. Most automakers also test their production-line process for a new model by building vehicles with relatively inexpensive prototype tools. Tesla is skipping that step as well.

By omitting steps, Tesla hopes to save time and money. The risk is that manufacturing problems could be costly to fix, slow production and damage its reputation.

As Tesla moves to ramp up production another huge project is playing out, in partnership with Panasonic. Together they are building the massive battery-production plant in Nevada that’s crucial to reaching Model 3 pricing goals.

At the corporate level, Tesla also is working to integrate SolarCity into its business operations.

In the earnings conference call that followed Tesla’s first-quarter results, Musk was asked if any critical outstanding items could slow the Model 3 launch or deliveries.

“There’s plenty of things with uncertainty, but I don’t know anything that would prevent us from starting production in July, and exceeding 5,000 units a week by the end of the year,” said Musk. “It’s been pretty close to the bull’s-eye.”

More Automation

Working in Tesla’s favor is that Model 3 production will be vastly more automated and the car will be simpler to build than a Model S or X, according to Tesla.

“We’ve gone to great pains with the Model 3 to design it for manufacturing, and to not have all sorts of bells and whistles and special features, like that deployed with Model X,” and to have a much better supply chain, Musk said. “But there could be something that we missed that we just don’t know about right now.”

Tesla also needs more retail outlets and charging stations. Tesla says it plans to add nearly 100 retail, delivery and service locations globally, representing a 30% increase in facilities.

It says it will double the number of Supercharger stations to more than 10,000 this year, along with 15,000 connectors that replicate home-charging systems and will be provided to hotels, resorts and restaurants.

One big question is whether Tesla will have enough manufacturing capacity to make 500,000 Model 3 cars a year in addition to the 100,000 Model S and X vehicles that Tesla also expects to make.

In December, Tesla won approval from the city of Fremont to nearly double the square footage of its plant to 9.9 million square feet, from 5.3 million.

‘Fraught With Greater Risk’

JPMorgan analyst Ryan Brinkman in a recent report said Tesla’s high-volume expansion with the Model 3, along with a lower price point, “seems fraught with greater risk relative to demand, execution and competition.”

He added, “We continue to be cautious relative to the potential for a slower than guided start to Model 3 assembly, and now believe that the potential for Model 3 pre-order cancellations may increasingly become a point of investor concern.”

Brinkman has an underweight rating on Tesla and price target of 190.

RBC Capital Markets analyst Joseph Spak said Tesla made bullish comments about Model 3 production during the May 3 earnings conference call. Officials had the opportunity to hedge bets on Model 3 production at that time, but didn’t.

“We are still skeptical about hitting their timeline, but do expect progress to be made,” Spak wrote. “For Model 3 we are not overly worried about demand, more about supply.”

Spak has a sector perform rating on Tesla and price target of 314, but with an upside scenario of 350, which assumes higher-than-expected vehicle deliveries, faster revenue growth and higher gross margins.

Tesla shares are hovering above a buy point and ended Friday trading down 0.7% to 310.83.

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