Tesla - Q1 2022 Results Confirm Hard Moats
Supply chain challenges cannot hold them down
I own a Model Y. But even better, I own Tesla shares.
Tesla is one of the most popular stocks amongst younger investors, and the amount of Twitter chatter around it is pretty much unprecedented. Beyond the hype, Tesla is a steely machine that no one seems to be able to catch up with.
For Q1 2022, results defied all odds: supply chain challenges – which have been the excuse for many companies reporting less-than-stellar results – did not stop Tesla from hitting record gross margin of 30.0% (highest ever) and operating margin of 19.2% (also highest ever). The results are in stark contrast to other automakers; some of them have had to even stop production due to bottlenecks from their supply chains.
So, what is it about Tesla that allows it to reach its highest deliveries in Q1 2022, and bust out such phenomenal margins, despite widely reported chip shortages and logistical challenges?
A key differentiating factor here is vertical integration and pure engineering ingenuity. Unlike other automakers – or consumer brands for that matter – Tesla is amongst the most vertically integrated, from software to hardware. It is the secret sauce to owning its own destiny, even as some of its suppliers may struggle. See below quote from Q4 2021 earnings call earlier this year:
“We spent a lot of engineering and management resources solving supply chain issues: rewriting code, changing our chips, reducing the number of chips we need, with chip drama central. And that was not the only supply chain issue. So, there is just hundreds of things. And as a result, we were able to grow almost 90% while at least almost every other manufacturer contracted last year”
As a result, Tesla continues to expect 2022 to grow in production volume by at least 50% (with a reasonable shot at 60%) over last year.
Manufacturing is hard – as Elon Musk lamented in the past – and it is underestimated as a “hard” competitive moat. But Tesla’s advantage in manufacturing becomes increasingly clear – to me at least – as it has been able to navigate manufacturing challenges so successfully, due to its unique setup, years of experience since ramping up Model 3 at Fremont, and a culture of engineering excellence. And this advantage is almost insurmountable: it is arguably harder than building a brand, writing codes or grabbing media attention. More importantly, it is additive – the more Giga factories Tesla builds, the better it gets. Already, Tesla expects Austin and Berlin to ramp up faster than it did at Giga Shanghai.
Hard moat is hard earned, and Tesla has certainly earned it after years of toiling under limited capital raises, especially compared to EV companies these days that have access to so much more. Constraints breed resourcefulness, and Tesla is the most battle tested out of all the EV companies out there.
Combined with a brand that is equaled by few and coveted by millions, Tesla has strong pricing power which allows it to offset inflationary pressures. Inelastic demand is the ultimate demonstration of branding, comparable to the best of luxury names like Channel and Louis Vuitton.
On top of that, there is the software that weaves through every aspect of Tesla. FSD is the most obvious proof point, but its iterative principles drive the entire organization. Traditional automakers – or any traditional manufacturing organizations for that matter – do not run their businesses with the same adherence to a software-driven paradigm. Telsa can iterate quickly – think Agile – because it was built on the same principles as software development. Elon Musk was a software coder and a PayPal co-founder before he started Tesla, and he has brought that same level of agility to how Tesla approaches its business processes. Latest case in point is how Tesla is growing its burgeoning insurance business – see below extract from its Q1 2022 earnings call:
“This has become a real passion program for us…It is also a feedback loop for Tesla because we see, if there is a crash, large or small, like we sort of see exactly what that cost. And then we think about how we (can) change the design of the car or the software in order to minimize the probability of that accident…And how do we make the repair associated with that accident superfast? Like aspirationally, it would be like a same-day repair for a collision, which is night and day difference compared to sometimes having to wait for a month while insurance claims are settled and figured out because Tesla is also doing collision repair.…we can then identify areas of cost inefficiency, feed those back to our engineering teams, and also our software teams, to actually improve the product. This lowers the cost of insurance, improves reliability of the product. So it's a full circle.”
Much has been written about how Ford and GM will eventually catch up with Tesla. Or how Rivian and other next-generation EV makers will take over. I disagree – I believe Tesla has a long runway of impregnable competitive advantages that will allow it to gain market share for years and years.
And it will always remain multiple steps ahead, with relentless innovation as its modus operandi.
(Author is long $TSLA)
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