Musk's Quest For An Irresistible Price Could Spell Trouble For Tesla's Stock

Tesla is currently undertaking a significant strategic pivot amidst a challenging economic environment and increased competition in the electric vehicle (EV) market. In a recent interview with CNBC, Tesla CEO Elon Musk emphasized the company's approach of adjusting pricing to align with demand. Tesla has already reduced prices multiple times for its Model 3 and Model Y vehicles between January and April, aiming to attract more consumers to its brand. The hope is that the higher volume of sales will compensate for the reduced profit margins on each vehicle. However, only time will determine the effectiveness of this strategy for Tesla, the leading player in the EV industry.

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The shift in strategy has had a negative impact on Tesla's stock performance. Despite a 46% increase since the beginning of 2023, the stock experienced a decline after the earnings report, currently down 2.3%. Analysts at Truist expressed concern about the potential long-term impact of lowering prices and accepting lower gross profit margins (GPM) to drive adoption of Tesla vehicles and services like full self-driving (FSD). As a result, Truist downgraded Tesla stock to hold from buy in an April 21 note.

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Tesla's success will largely depend on the overall demand for EVs. According to S&P Global, battery electric vehicles, plug-in hybrid electric vehicles, and fuel-cell electric vehicles are projected to constitute approximately 47% of the U.S. automobile market by 2030. However, near-term EV demand may be constrained by factors such as the energy crisis in Europe, adjustments in China's EV subsidies, high inflation, and concerns about a potential U.S. recession.

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Some analysts caution that Tesla's aggressive price cuts may be excessive, resulting in downgraded ratings and price targets. Investors are awaiting more clarity on how the situation will unfold before regaining confidence in the stock. Nonetheless, the global EV market continues to grow, with the International Energy Association predicting the sale of 14 million electric vehicles in 2023. If Tesla achieves its production goal of 1.8 million vehicles and sells them all, approximately 13% of the market share would belong to Tesla.

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Tesla's price reductions are part of its strategy to capitalize on this expanding market. The company is focused on widespread adoption of its vehicles and aims to find an optimal selling price for its popular models, the Model 3 and Model Y. Will Stein, a senior analyst at Truist, explains that traditional manufacturers often seek to maximize profits, but Tesla needs to strike a balance between average selling price (ASP) and unit sales to achieve its goals. However, as prices continue to decline, the potential to stimulate further demand may diminish.

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Tesla's gross margin (before accounting for EV tax credits) was 22.6% for the quarter ending December 31, 2022. However, it dropped to 19% in March 2023, representing a quarter-over-quarter decline of nearly 16%. Analysts surveyed by FactSet anticipate further decline in gross margin, with a projected figure of 16.7% for the quarter ending in June. The ongoing debate revolves around when Tesla will end its price cuts and what the margins will look like as the year progresses, considering the uncertain macroeconomic conditions.

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Initial price cuts did not deter investors, as Tesla stock experienced a remarkable 68% surge from January to April. This recovery helped the company bounce back from the significant losses incurred in 2022. However, after analyzing the quarterly results and Tesla's comments on further margin tightening, the stock declined by nearly 15% in April.

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Philippe Houchois, managing director of automotive research at Jefferies, suggests that the current data indicates that demand may not be sustained at the current price level. Tesla may be willing to continue cutting prices until it finds an irresistible selling point for customers. Additionally, measuring demand for Tesla vehicles is challenging due to the company's direct sales approach, which lacks detailed disclosure of the number of vehicles sold by region or model.

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In the latest quarterly earnings report, Tesla reported delivering 422,875 vehicles, falling short of the 432,000 vehicle estimate by analysts. However, Musk remains confident in achieving the target of 1.8 million deliveries for the year. While Musk claims to have real-time information on demand, the continued price cuts suggest that Tesla is not achieving the desired level of demand. Musk advises caution against overreacting to market fluctuations, as they can sometimes be challenging to explain.

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