Tesla Motors Inc is in trouble. Consumer Reports, the magazine that arguably created the massive rise in demand for the Tesla Motors Model S back in 2013, says that the car is no longer recommended. The reason has nothing to do with the feel of the Model S, or its performance, but with how long the parts last and how often they break. That’s a problem that Tesla Motors has been paying for for a long time.
Tesla Motors puts a pretty extensive warranty on the cars it sells. That means it has picked up the tab for almost every single little problem with the cars since release. That’s how the firm managed to get a remarkable 97 percent satisfaction rating in the Consumer Reports survey, but it’s not the cheapest way to run a business.
Tesla Motors pays for problems
Over at Forbes on Wednesday Chuck Jones took a look at how much Tesla Motors has been paying for warranties thus far. He notes that the base rate the firm has been paying has stayed broadly similar since 2013. Tesla Motors has said it’s putting away 3.1-3.2 percent of total sales in order to pay for warranty costs since a Consumer Reports piece pushed demand for the car skyward.
The firm has also, on more than one occasion, socked away extra cash in order to pay for major problems that had gotten through its Fremont plant. In September 2014 the firm took $14MM out of its sales, about 1.6 percent of the total, in order to pay for issues with its Powertrain.
In March 2015 the firm took $10.7MM, around 1 percent of total sales, in order to pay for issues related to its high-performance battery and drive units.
The issue around the problems that Consumer Reports highlighted about the Model S isn’t that it’s going to cost a lot to fix, it’s that it may reduce demand, and it might reduce Tesla Motors’ ability to get the cash it needs to keep going forward. That cash doesn’t come from car sales, and its source has been known to be fickle.
Shareholders pick up the Tesla Motors tab
Tesla Motors has to pay for the problems with the Model S, and it will likely have to pay even more for issues with the Model X, but the firm has bigger problems. It doesn’t make money, and it has no easy place to get that cash. For years shareholders have bought into new issues of stock, and dealt with the implicit devaluation when Tesla Motors takes on more and more debt.
It’s those that have backed Tesla Motors with their own savings that have been paying to fix the issues with the Model S so far. That’s not the worst system in the world, but relies on a belief that Tesla Motors stock will keep going up. That belief may be wavering after mistake after misstep in recent weeks.
Pacific Crest analyst Brad Erickson reckons that Tesla is now running the risk of losing its “cult stock” status. If Wall Street stops having faith in the story that Elon Musk is telling, the firm’s main source of cash may run dry. That would make it much more difficult to complete the roll out of the Model X and the build out of the Model 3 and Gigafactory.
Tesla Motors worries about demand
Tesla Motors, in the wake of the Consumer Reports change of mind, will be worried about the effect on its sales in the year ahead. Now, as always due to the cash-raising system discussed above, is a sensitive time for the firm. Tesla has already pulled in its sales targets for the full year 2015. The firm now reckons it will sell between 50,000 and 55,000 cars for the full year.
The roll out of the Model X is slow, and that, by itself, could cut into the firm’s ability to hit that target. The Consumer Reports reveal, if it does affect demand, could cause a raft of cancelled orders and break up the firm’s production run for the weeks and months ahead.
Even if it doesn’t hurt Tesla Motors before the end of the year, it might have an effect in 2017 and beyond. The firm traded off of its reputation as a high-quality car firm and, though it’s not the only car maker with issues, it may hurt off of the back of the news.
Erickson of Pacific Crest says that “Assumptions of perpetually strong demand have always been heavily baked into the name, which leaves potential for significant further downside.” He reckons now just isn’t the right time to hold stock in Tesla Motors, and many who ignored that advice in recent weeks may be agreeing now.
Tesla Motors shares were selling for more than $260 each at the start of October. At time of writing shares were selling for $211.59.
Shareholders worries about manufacturing mistakes
Shareholders aren’t just worried that Tesla Motors might see lower demand in the next year, there’s also questions about the firm’s ability to make a quality car. Model S owners seem to be very happy with their experience despite the many issues with the car, but the next raft of buyers may not forgive as easily.
The Model X has not been sent to its first Signature buyer just yet. There’s not telling when the first “normal” Model X will leave the Tesla Motors plant in Fremont, California.
Elon Musk has been very open about how hard the car has been to build, and the trouble the firm has had with suppliers. In the light of the report on problems with the Model S, there are questions about whether the Model X will face similar problems. The EV SUV may face bigger issues given the greater complexity of some of its parts.
Tesla Motors is still in a start up phase. The Model X is only the firm’s third car, and Wall Street, as can be seen from its funding, is willing to forgive a lot given the long term hope for a market-bending Tesla Motors.
There may be some kind of breaking point, however, and, as Mr. Erickson pointed out, if Tesla Motors loses its cult stock status it may start to look very different. Tesla will release its earnings for the three months through September in the first week of next month. We’ll be looking for CEO Elon Musk, and as yet un-replaced CFO Deepak Ahuja to explain warranty charges, and give some insight into the risks that right face the firm going forward.