In recent weeks, investors have been debating whether the vehicle price cuts Tesla (TSLA 11.00%) has announced in all its major markets were forced by a drop in demand or a strategic plan. Tesla is the only profitable pure electric-vehicle (EV) maker. It has room to reduce margins and still have a very profitable business.
When the company reported its fourth-quarter results on Wednesday, it gave investors a window into its thinking on the future EV market and its strategic path. While Tesla’s gross and operating margins declined, the company reported record net earnings in the quarterly period, showing that its plan is paying off. Investors responded by continuing the positive momentum the stock has shown so far in 2023.
Growth plans continue
Other big news from the company is a new $3.6 billion investment to expand its existing Nevada Gigafactory. The company’s original factory mainly is a battery-manufacturing facility that supplies Tesla’s California EV assembly plant with battery packs and sells its battery-storage products.
Now it will add two new factories in Nevada. One will produce its latest battery cell packs, and the other, the fully electric Semi heavy truck. Tesla shipped its first Semi truck in late 2022 to PepsiCo.
Tesla began construction of its first battery factory in Nevada in 2014. The expansion will add 3,000 new workers to produce the Semi truck at scale, as well as its newest 4680 battery cells. The battery plant will have the capacity to supply 1.5 million light-duty EVs annually.
The right strategy
Tesla has basically chosen volume over margin by slashing its product prices by as much as 20%. That seems to be a smart strategy in a recessionary environment, as demand could use a boost
But there’s another good reason for Tesla to focus on gaining additional customers: It will result in more units on the road that can be upgraded in the future with high-margin automation upgrades like full self-driving (FSD) software or other technologies.
While the company’s operating margin declined quarter over quarter, it’s still rising when viewed on a trailing-12-month (TTM) basis.
Tesla’s ability to lower margins yet still grow profits stands out among peers in the EV sector. The EV maker earned $3.7 billion in the fourth quarter, bringing net income for all of 2022 to over $12.5 billion. It also generated $7.6 billion in free cash flow, even in a year in which Tesla spent considerable amounts of money on growth investments.
That’s not good news for automakers like Ford and General Motors, which are in the early stages of ramping up EV lineups with hopes to capture market share. Those companies already have much lower operating margins than Tesla and presumably will lose money on their EV products in the near term.
Tesla is making sure to leverage its leading position by growing its customer base, while other EV makers struggle to gain traction. The pricing strategy does appear to be increasing demand for Tesla vehicles. On the company’s fourth-quarter conference call for investors, CEO Elon Musk said he believes demand will remain strong despite a slowing economic environment. Musk added, “We currently are seeing orders at almost twice the rate of production.”
That’s good news for investors who were concerned that the price cuts were a sign of desperation. Instead, it looks like a rather good strategy right now.