Red Flags in Tesla Earnings Report

As one of the hottest stocks of the last few years, Tesla (NASDAQ:TSLA) is subject to careful examination every time the company reports earnings. In Q3’s report, investors saw several early indicators that the company could be facing real challenges.

 

Here are some of the red flags from Tesla’s Q3 earnings that investors should be aware of.

 

One of the most significant warning signs in the Tesla earnings report was the drop in gross margins. For the quarter, Tesla reported a gross margin of 27.9 percent, down from 30.5 percent in 2021.

 

While Tesla is still operating near its highest historical margin level, this slowdown is cause for investor concern. If margins continue to drop, Tesla could see slower earnings growth and, as a result, lower future share prices.

 

Lower margins could also be a problem for Tesla if revenue growth begins to slow down. In Q3, Tesla’s revenue underperformed analyst expectations by more than half a billion dollars. The company reported $21.45 billion in quarterly revenue, compared to a consensus estimate of $21.96 billion.

 

This slower-than-expected revenue growth is particularly concerning, as Tesla’s price has an extremely high growth level baked in. Although it has fallen from the extreme highs of 2020 and 2021, Tesla’s P/E ratio is still 64.1. If the company’s revenue growth slows, investors may have a difficult time justifying such a high multiple.

 

Tesla watchers will be well aware that one of the company’s key initiatives was to increase its total deliveries by 50 percent this year.

 

In the most recent quarter’s reporting, however, the language shifted to reflect only a 50 percent growth in production. While not massively negative, this subtle change could indicate that Tesla is still struggling to meet its own lofty delivery goals.

It should be noted that Tesla has not changed its forecast for long-term delivery growth. The company still expects to achieve 50 percent growth in deliveries over multiple years, even if it misses that target in 2022. If it cannot achieve that goal, however, share prices could suffer as a result.

 

During the Q3 earnings call, CEO Elon Musk addressed the role of macroeconomic conditions in Tesla’s growth. Europe and China were cited specifically as markets entering potential recessions.

 

While Musk remains positive on Tesla’s long-term international growth, he did concede that temporary disruptions in foreign markets could present challenges for the company.

 

One of the most concerning metrics in the inventory report was an increase of inventory to $10.3 billion. This is nearly double the inventory Tesla held on hand during the same period in 2021.

 

While the amount is still relatively low for a company of Tesla’s size, the sharp spike in inventory value could become a problem if it becomes a more prominent trend in future quarters.

 

This problem will almost certainly persist, as Tesla will no longer be rushing deliveries for quarterly reporting purposes. While this will give investors a more accurate view of the company’s business, it will also translate to less cash on the quarterly balance sheet. If Tesla’s inventory becomes too large, this could eventually drive share prices down.

 

Beyond manufacturing, Tesla struggled to expand its service footprint in Q3. The company’s number of service centers increased by just 6 percent during the quarter.

 

If Tesla cannot increase its service availability, its vehicles may become less attractive to consumers seeking fast, convenient maintenance on their cars.

 

With competition in the EV space much more intense than when Tesla first went public, this service weakness could be a significant vulnerability.

 

Tesla’s future growth trajectory is one of the most hotly debated topics in the investment world. Some of the most bullish projections suggest that Tesla could more than pentuple by 2026, while bearish analysts have suggested that the stock could be overvalued by 50 percent or more. The latest earnings report, unfortunately, does little to clear up this muddled topic.

 

Despite several potential red flags, Tesla did beat its estimated earnings of $0.91 per share, reporting a healthy $1.05. If margins continue to fall and revenue growth fails to meet expected growth targets, however, Tesla could struggle to perform as well in the future. Given the likelihood of both a US and a global recession in the next year, Tesla could see a period of muted growth before regaining its footing.

 

Tesla is touting the possibility of an initial share buyback in the near future. According to Musk, the company could buy back $5-10 billion worth of its shares in the coming year. This move would very likely support higher share prices and bolster investor confidence. Buying back shares would also be an excellent use of some of Tesla’s cash reserve, provided it doesn’t interfere with the addition of manufacturing capacity.

 

Analysts project that Tesla shares will reach a median price of $305 in the next 12 months, giving it an upside of more than 50 percent. Even if this number proves to be too bullish, this would still give Tesla a great deal of room to generate returns for investors. This is especially true if a share buyback materializes.

 

While there are some red flags emerging that investors should keep an eye on, Tesla still appears to have opportunities for growth. Even if deliveries don’t achieve 50 percent year-over-year growth, they will still rise considerably. The same is true of revenues, which continue to advance at a healthy rate.

 

Tesla certainly carries risks, as demonstrated by its high valuation. Investors who are willing to take those risks, however, may be rewarded by outsized returns on their capital. With that said, it will be crucial to watch inventory and especially margin reporting in the coming quarters. If these metrics continue to deteriorate, Tesla could become a less attractive buy.

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