Tesla delivered an awesome earnings surprise. How come no one saw it coming?
When a company beats Wall Street analysts’ earnings expectations, its stock price tends to rise.
When Tesla announced third-quarter results last week, it didn’t merely beat analyst expectations — it trounced them. Cable TV tickers flashed the news worldwide. The company’s stock price didn’t simply rise; it soared.
“They pulled this off very well,” said Anton Wahlman, an investor who goes short and long in Tesla depending on the price of its volatile stock.
Now Wahlman, other Tesla investors, Wall Street analysts and anyone obsessed with Chief Executive Elon Musk’s high-wire style all eagerly await the imminent release of the company’s official 10-Q report for the quarter.
They’ll be seeking details that go beyond the company’s preliminary announcement, looking for further clues on how Tesla managed its strong profit and cash-flow performance — and to assess whether the results can be sustained into the fourth quarter and beyond.
So why was the report such a surprise? Nobody but Tesla’s top executives anticipated the blowout scale of third-quarter profit numbers. Stock analysts on average expected a loss of 95 cents per share, according to FactSet; their forecasts ranged from a $2.90-per-share loss to a 55-cent-per-share gain. Instead, Tesla turned in a $1.75-per-share profit.
“It’s such an erratic situation there, I can understand why earnings estimates are all over the map,” said David Schneider, who runs Schneider Wealth Strategies in New York City.
In notes to investors afterward, analysts avoided talking about their big miss. And the debate over whether Tesla stock is overvalued or undervalued continued. The better-than-expected results, said Bank of America’s John Murphy, are due to “transitory factors” that likely can’t be sustained. Ben Kallo of Baird, however, said “the flip to profitability in [the] third quarter could be the start of a narrative shift” and push the stock higher.
That stark difference of opinion demonstrates how a consensus average can mislead to the point of uselessness if the range is wide enough.
When the media say a company “beat expectations,” they’re almost always talking about the consensus of a dozen or more analysts. But if the range goes from a loss of $2.90 a share to a gain of 55 cents a share, it’s obvious someone is misinformed or making erroneous assumptions.
There are a number of reasons why Tesla is so tough to figure out.
It doesn’t help that Musk is given to wild forecasts that later prove exaggerated or fall completely flat. Two years ago he told analysts that Model 3 manufacturing would mark “a quantum change in productivity, like really, really crazy.” He said the Fremont, Calif., factory would look like a spaceship in a video game. But Tesla’s attempt to install a revolutionary new automation system to build the Model 3 flopped, and this summer, Tesla built a pop-up assembly line in the parking lot under a tent.
Tesla is also unusual in the way it reports some of its key financial metrics. When calculating gross margins — the sales price of a car minus the direct costs of manufacturing — traditional carmakers include research, development and engineering costs. Tesla does not, which tends to make its margins look better.
The company is opaque about the deposits customers plunk down on future car deliveries. In the third quarter, Tesla stated it had on hand $900 million in deposits, but that includes everything from $1,000 put down on a basic Model 3 to $25,000 for a not-yet-in-production semitruck, to $250,000 for a planned new exotic electric roadster sports car. If the company broke those deposits into segments, future demand would be easier to assess.
Like most companies, Tesla offers scant information on its relationship with suppliers. But news reports earlier this year said Tesla was asking some of its suppliers for discounts and cash rebates to help boost cash. That would lower expenses and, if sizable enough, affect results.
Panasonic is Tesla’s key supplier. It manufactures battery cells at the Tesla battery factory in Sparks, Nev., which Tesla buys and installs in its cars. Discounts and rebates from Panasonic could have a material impact on Tesla’s profits. On Wednesday, the Japanese company released third-quarter financial results and said that its arrangement with Tesla “has yet to contribute to profit” and blamed lower earnings in part on “ramp-up expenses at [our] automotive factory in North America.”
These and other issues have led to an almost random range of analyst forecasts, and not just in earnings. In the week before Tesla released its results, according to FactSet, analysts forecast the following ranges:
- Research and development spending. Range of estimates: $299 million to $614 million. Actual: $351 million.
- Free cash flow. Range of estimates: Negative $56.3 million to positive $346 million. Actual: $881 million.
- Operating income. Range of estimates: Negative $102 million to positive $314 million. Actual: $416 million.
With the uncertainty so high, some analysts who follow Tesla, such as Morningstar’s David Whiston, don’t even bother making quarterly estimates.
The fact that Tesla had an earnings surprise is not unusual in itself. General Motors on Wednesday reported $1.75 in earnings per share, above consensus expectations of $1.29, reflecting better-than-expected truck and SUV sales and price hikes that stuck. But the range of analyst estimates was much tighter for GM.
Analysts’ stock price targets also vary for GM, from $33 a share to $53. But Tesla’s target price range runs from $100 a share to $500 a share, reflecting the extent to which Tesla is a “story stock,” where many investors are motivated more by the possibility of long-term glory than short-term profits or losses. Behind the low end of that stock range is the assumption that Tesla will never do better than the current quarter’s results; on the high end, that the glory days have just begun.
The third quarter was a milestone for Tesla, no doubt. It tripled Model 3 deliveries to 55,840 cars, proving it’s capable of mass manufacturing the sedans. It raised free cash flow enough that paying $1.15 billion in debt over the next four months looks doable, provided the cash keeps coming in. The company said about 336,000 people still have deposits down on the Model 3.
But do more big surprises lie ahead? At Tesla, that’s guaranteed.