Tesla (NAS: TSLA) is set to release its third-quarter earnings report on Wednesday, Oct. 18, after the close of trading. Here’s Morningstar’s take on what to look for in Tesla’s earnings and stock.

Key Morningstar metrics for Tesla

  • Fair Value Estimate: $215.00
  • Morningstar Rating: 3 stars
  • Morningstar Uncertainty Rating: Narrow
  • Morningstar Economic Moat Rating: Very High

What to watch for In Tesla’s Q3 earnings

We’ll be looking at three main areas:

Automotive profit margins: These are an important gauge of how Tesla’s strategy to cut prices to spur demand is affecting profits. Our base case is that the firm will likely see lower margins in the second half of the year versus the first. Seeing the impact of the price cuts will help us determine the extent to which we would need to modify our profit forecast for the automotive segment.

Energy generation and storage profits: Tesla’s automotive segment is still its largest source of revenue and profits, but this segment is growing. EG&S turned profitable last year, and it has generated strong growth in 2023 thanks to a massive spike in energy storage (large batteries) sales. We forecast that this segment will become an important secondary profit source as the market for stationary energy storage continues to grow.

New products and services: We will be looking for management commentary on new products and services, namely Cybertruck and full self-driving software. The Cybertruck has been long awaited and would mark the fifth vehicle Tesla could sell to the auto market, giving the company a new vehicle with which to grow volumes. The full self-driving software is one of the largest ancillary profit sources for Tesla, adding a potential new revenue and profit source from every vehicle sold once the full version of the software can be rolled out. We will look for updates from management to see if our outlook for progress is on track.

TSLA share price

Fair Value estimate for Tesla

With its 3-star rating, we believe Tesla’s stock is slightly overvalued compared with our long-term fair value estimate.

Our fair value estimate is $215 per share. We use a weighted average cost of capital of just under 9%. Our equity valuation adds back nonrecourse and non-dilutive convertible debt.

In the near term, we forecast Tesla will grow its annual total vehicle delivery volume to around 1.8 million in 2023, or roughly 37% versus 2022. However, due to price cuts far exceeding cost savings, we forecast automotive gross margin contraction to 19% in 2023 from the 29% achieved in 2022.

In the longer term, we assume Tesla will deliver around 5 million vehicles per year in 2030. This includes fleet sales, an expanding opportunity for the company. Our forecast is well below management’s aspirational goal of selling 20 million vehicles by the end of this decade. However, it is nearly 4 times the 1.31 million vehicles delivered in 2022. Our forecast assumes Tesla increases its Model Y deliveries, then successfully launches its light truck, sports car, semi-truck, and eventually its affordable sedan and SUV platforms.

We think Tesla will be successful in continuing to reduce its manufacturing costs on a per-vehicle basis. Combined with a shift to producing a greater proportion of higher-priced Model Y vehicles, we forecast segment gross margins will expand to roughly 31% from the 29% achieved in 2022, generating automotive profit growth in excess of revenue growth.

Price to fair value Tesla

Economic Moat Rating

We award Tesla a narrow moat, stemming from its intangible assets and cost advantage. The company’s strong brand cachet as a luxury automaker commands premium pricing, while its electric vehicle manufacturing expertise allows it to make its vehicles more cheaply than its competitors.

Tesla’s brand cachet is not likely to be impaired anytime soon as other automakers move into the EV space. We expect the company to keep innovating to stay ahead of startup and established competitors. By focusing on the luxury auto market first, Tesla was able to create tremendous publicity that reached beyond its customers. This generated strong consumer demand for its subsequent lower-price vehicles like the Model 3 and Model Y. As other new vehicles are launched, such as the Cybertruck or the platform that will produce the affordable sedan and SUV (known as the $25,000 vehicle), we expect the company’s strong brand will continue to generate consumer demand.

We think Tesla has a cost advantage in EV production thanks to its manufacturing scale. The firm’s total vehicle volume has grown from just over 100,000 in 2017 to over 1.3 million deliveries in 2022. During the same period, the company’s average cost of goods sold per vehicle has fallen over 50%, from $84,000 to under $39,000, and gross profit margins have expanded from 20% to 26%, excluding the sale of regulatory credits.

Even as legacy automakers begin to produce more EVs, we expect Tesla will continue to have lower costs, as it has outlined a plan to further reduce battery cell costs by 56% over the next several years. With Tesla’s cost per vehicle set to fall, incumbent automakers may take years to catch up, if they ever do, as they won’t want to build many new factories from scratch, as Tesla is doing.

We think Tesla’s moat will persist in the future and allow it to generate excess returns on capital. We see the potential for Tesla to outearn its cost of capital over at least the next 20 years, which is the measurement we use for a wide moat rating. However, the second 10-year period carries significant uncertainty for both Tesla and the broader automotive industry, given the rapid advancement of autonomous vehicle technologies, which could transform how consumers use vehicles. As such, we view a narrow moat rating, which assumes a 10-year excess return duration, as more appropriate.

Risk and Uncertainty

We assign Tesla a Very High Morningstar Uncertainty Rating, as we see a wide range of potential outcomes for the company.

The automotive market is highly cyclical and subject to sharp demand declines based on economic conditions. As the EV market leader, Tesla is vulnerable to growing competition from traditional automakers and new entrants. As new lower-priced EVs begin selling, Tesla may be forced to continue to cut prices, reducing its industry-leading profits. With more EV choices, consumers may view Tesla less favorably. The firm is investing heavily in capacity expansions that carry the risk of delays and cost overruns. The company is also investing in research and development in an attempt to maintain its technological advantage, with no guarantee these investments will bear fruit. Tesla’s CEO owns a little over 20% of the company’s stock and uses it as collateral for personal loans, which raises the risk of a large sale to repay debt.

Tesla faces environmental, social, and governance risks. As an automaker, it is subject to potential product defects that could result in recalls, including its autonomous driving software. We see a moderate impact should this occur. Another risk involves employee retention. If Tesla is unable to keep key employees, such as CEO Elon Musk, its favorable brand image could decline. Should the company not be able to retain production line employees, it could see delays. We see a low probability but moderate materiality for both risks.

TSLA bulls say

  • Tesla has the potential to disrupt the automotive and power generation industries with its technology for EVs, autonomous vehicles, batteries, and solar generation systems.
  • Tesla will see higher profit margins as it reduces unit production costs over the next several years.
  • Through the combination of Tesla’s industry-leading technology and its unique supercharger network, the company’s EVs offer the best function of any on the market, which should help Tesla maintain its market-leader status as EV adoption increases.

TSLA bears say

  • Traditional automakers and new entrants are investing heavily in EV development, which will result in Tesla seeing a deceleration in sales growth and being forced to cut prices due to increased competition, eroding profit margins.
  • Tesla’s reliance on batteries made in China for its lower-price Model 3 vehicles will hurt sales, as these autos will not qualify for U.S. subsidies.
  • Solar panel and battery prices could decline faster than Tesla can reduce costs, resulting in little to no profits for the energy generation and storage business.