Tesla is biggest battle on smallest battlefield

Tesla Inc.’s earnings can be viewed as the market’s most intense conflict fought on its smallest battlefield.
The third quarter just gone is a prime example. The much-loved and much-shorted stock jumped 28% between last week’s earnings release and October 29 filing of the quarterly 10-Q statement. The $13 billion that added to the market cap was effectively balanced on this figure: $377 million. That’s the difference between the consensus forecast for a loss and Tesla’s reported net profit of $143 million.
The vital element there is, of course, less the number and more the fact it came up in black rather than red ink. And that dynamic is a function of the fact that the numbers towards the bottom of the P&L statement tend to be small, magnifying the perceived importance of relatively small swings — and the factors driving them. Tesla’s sales of emissions credits, for example, have long been a swing factor as they drop largely unhindered to the bottom line. The latest quarter was no exception, with $134 million of them equating to 76% of Tesla’s pre-tax income.
Thankfully, Tesla discloses all its revenue from those credits in its earnings release, rather than saving some for the 10-Q. One other swing factor that does come from the filing, though, is the warranty provision. When this shrinks, it bolsters gross margins and vice-versa.
In a report, Roth Capital analyst Craig Irwin, who rates the stock a “sell,” calculated the warranty accrual per vehicle had dropped versus the second quarter. Calculating the accrual per vehicle isn’t exact because warranty provisions include those on Tesla’s energy business, for products such as solar panels. That said, more than 85% of Tesla’s revenue is derived from the automotive business, and Tesla reports that its accrued balance relates primarily to this due to the “magnitude” of that division, so it is reasonable to ascribe the changes in that way. On that basis, it fell by $187, quarter on quarter. If the provision had been kept constant, then it would have added about $18 million to cost of goods sold.
Tesla also enjoyed a swing in the liability on existing warranties worth another $37 million, effectively reversing a negative swing recorded in the first quarter, when the company suffered a big loss. Altogether, the $55 million benefit from warranties equate to 1 percentage point on Tesla’s automotive gross profit margin — again, assuming it relates mostly to vehicles — and about 30% of its pre-tax profit. Indeed, over the past few years, such favourable changes in warranty provisions have tended to coincide with Tesla reporting a GAAP net profit.
Warranty provisions can swing around for all sorts of reasons, given they reflect estimates of future costs and are influenced by historical claims activity.
So like the emissions credits, they can have a meaningful and unpredictable impact on Tesla’s results. When the stakes are so high, and yet the underlying numbers are so small, the
wildcards really matter.
—Bloomberg

Liam Denning is a Bloomberg Opinion columnist covering energy, mining and commodities. He previously was editor of the Wall Street Journal’s Heard on the Street column and wrote for the Financial Times’ Lex column. He was also an investment banker