Will regulatory credits continue to support Tesla’s earnings?

Rregulatory credits have been a controversial topic for Tesla investors in the past. (see our updates below) These almost profit-making credit sales have been a key driver of Tesla’s margins over the years and the company has relied heavily on these credits to post profits of ‘operating over several quarters in 2019 and 2020. While credit sales have been quite volatile, there have been quarters where credit sales alone have exceeded $ 500 million and have boosted Tesla’s gross margins up to ‘at 6%. That said, with the rise of Tesla’s vehicle deliveries and the start of economies of scale, Tesla now appears to be solidly profitable, even without selling on credit. To put it into perspective, for the first three quarters of 2021, we estimate that pre-tax profits would have amounted to over $ 2.5 billion, excluding tax credits. This compares to 2020 when Tesla reportedly recorded a pre-tax loss of over $ 400 million, excluding credits. See our analysis on What is the impact of regulatory credits on Tesla’s gross margins? for a detailed look at Tesla’s regulatory credit sales and their impact on Tesla’s margins and profitability.

So are regulatory credits likely to remain a driver of Tesla’s profitability in the future? Governments are stepping up regulatory efforts to decarbonize the auto industry, given the urgent need to tackle climate change. This could boost Tesla’s credit sales over the next few years, as the company remains a major EV player by volume. However, mainstream automakers are also doubling their own electric vehicle programs, meaning they could become less dependent on Tesla for credits. For example, Europe’s Stellantis, once Tesla’s biggest customer for emissions credits, intends to sell more of its own zero-emission vehicles, noting that it was likely to achieve its own single-handedly. CO2 emissions targets in Europe for 2021. Given this, it is likely that Tesla will have to rely more on cost improvements, higher deliveries from its new factories and software sales to increase its profit margins long-term.

[7/23/2020] Soaring Emissions Credit Sales Boost Tesla Q2 Pace

Tesla (NASDAQ: TSLA) released second-quarter 2020 results on Wednesday, posting net income of $ 104 million – well ahead of consensus estimates that predicted a small loss. So how did Tesla manage to exceed expectations with such a wide margin? The main reason for this was the surge in sales of regulatory credits.

The sale of regulatory credits grew to around $ 428 million in the second quarter, from around $ 354 million in the first quarter, and only $ 111 million in the second quarter of 2019. Since these credits are almost pure profit (Tesla is not hiring probably no direct expense to earn them), the company most likely reported a loss on a GAAP basis if it did not recognize this income. In addition, we believe that Tesla’s automotive gross margins reportedly lower by more than 600 basis points (6%) in Q2 2020, otherwise for these sales.

So why is Tesla’s emissions credit sales skyrocketing, when its auto deliveries have only increased 3% sequentially and are down about 5% year-on-year? First, the revenue recognition for these credits is quite spotty and Tesla could sell vehicles in one quarter and recognize the related credit revenue in subsequent quarters. Second, higher demand for credit could also push up prices. The European Union introduced stricter emission standards this year, requiring average carbon dioxide emissions per kilometer to drop to 95 grams, from an average of over 120 grams in 2018 for passenger cars. With this in mind, automakers need to buy credits from clean vehicle makers like Tesla to avoid heavy fines for violating these new emissions rules. Fiat Chrysler is a big customer of Tesla’s credits, agreeing to buy credits worth around $ 2 billion over 2020 and 2021.

Certainly, this cash cow will not last too long. In the medium to long term, major automakers will increase their sales of zero-emission vehicles, reducing the need to buy credits from Tesla. However, Tesla is expected to continue improving its margins and profits through higher software sales and battery upgrades (related to: A detailed look at the impact of Tesla’s battery costs on its gross margins). Tesla’s autonomous driving software upgrades, which currently cost around $ 8,000 per vehicle, are very lucrative and we estimate they have contributed around 400 basis points (4%) to Tesla’s automotive gross margins of 21 % in 2019. (See our analysis: What is the impact of Tesla’s software upgrades on its margins?)

[5/1/2020] How emissions credit sales helped Tesla’s first quarter 2020 results

Tesla (NASDAQ: TSLA) posted a stronger-than-expected first quarter 2020 earnings package, despite the coronavirus pandemic, with revenue growing about 32% year-over-year and adjusted earnings of $ 227 million, compared to a loss of about $ 494 million. one year ago. While the company has benefited from strong deliveries of the Model 3 and a production ramp at its Shanghai plant, much of the improvement in profitability has come from higher sales of emissions credits which has climbed to about $ 354 million from an average of about $ 150 million over the past four quarters. . Without the surge in regulatory credit sales, Tesla would likely have barely reached breakeven point. Below, we take a look at how regulatory credit sales have helped Tesla, and why we think the company’s near-term outlook looks pretty tough.

For more details on Tesla’s revenue outlook, see our dashboard analysis. Tesla Income: How Does TSLA Make Money?

What are regulatory credits and how do they help Tesla?

Several states and countries in the United States have zero-emission vehicle (ZEV) regulations that require clean vehicles to account for a certain mix of automaker sales each year. If automakers, which still largely sell internal combustion engine vehicles, fail to meet these standards, they can buy credits from Tesla who earn them because they only sell electric vehicles. While the income from these credits is quite volatile, they are very lucrative for Tesla as it likely doesn’t come at any direct cost to earn them. The increase in these regulatory credit sales is likely to be partly responsible for the sequential increase in automotive gross margins from 300 basis points to 25.5%. While it is possible that such credits will become more valuable in the medium term, as new emissions regulations come into play in Europe and US states seek to enforce stricter standards, the current slump in auto sales global markets could hurt Tesla’s ZEV credit revenue in the near term.

The outlook remains difficult for Tesla in the short term

Tesla is likely to face significant revenue pressure in the near term, and the company has suspended its guidance for 2020, due to uncertainty surrounding the coronavirus pandemic and the broader economic recovery. There is little reason for people to buy expensive cars right now and Tesla’s production at its Fremont plant, which is around three-quarters of its annual capacity, remains on hold and it’s unclear when it could resume. .

However, despite strong headwinds in the near term, the company’s shares have continued to rally, nearly doubling since the start of the year. The company is trading at a P / S multiple of around 6x, compared to GM which is trading at around 0.3x, based on trailing revenue. This means that the stock presents a significant valuation risk, causing it to react more strongly to negative news compared to its peers.

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Return November 2021
MTD [1]
2021
YTD [1]
2017-21
Total [2]
TSLA return ten% 58% 2511%
Return of the S&P 500 3% 25% 110%
Trefis MS Portfolio Return -2% 49% 304%

[1] Monthly cumulative and annual cumulative at 11/25/2021
[2] Total cumulative returns since 2017

Trefis
Wallets beating the Trefis market
Price estimates

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.


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