Tesla's Shock & Awe: Negative Inventory

The pall of an industry downturn has settled over the automotive industry just as Tesla Motors appears to be hitting its stride – in spite of mounting losses. Tesla CEO Elon Musk reported satisfactory earnings and the potential need to raise more cash to support operations, but the company’s stock jumped on the news as the launch of the Model 3 made for a jubilant tone on the quarterly call with financial analysts.

Tesla Second Quarter 2017 Update - https://tinyurl.com/ybqgkkke

Musk may not have used the expression “negative inventory” in his earnings report, but he might well have. Tesla enters the launch of the Model 3 with a backlog of orders that will last through at least 2018. On the Q2 earnings call, Musk did describe a new metric of “finished goods inventory” which, for car companies with dealer networks is generally in the range of 70-90 days. For Tesla, that looks like 30 days, he said. But, really, it’s negative inventory, because Tesla has orders it can’t fill while competing car makers have cars they can’t sell.

The news couldn’t be much worse for the makers of internal combustion engine vehicles. J.D. Power and LMC Automotive report that:

“Last year, industry incentive spending fell by 14% after the July 4 holiday. In contrast, this year spending has remained at holiday levels throughout the month. Average incentive spending per unit to date in July is $3,876 per unit, a record for the month, surpassing the previous high for the month of $3,597, set in July 2016.

“The elevated inventory levels are reflected in slower turn rates for vehicles sitting on dealer lots. Despite record discounts, the average new vehicle sold in July spent 72 days in inventory, the highest level since 2009. Furthermore, the utilization of extended loan terms continues to grow. Loans of 84 months and longer are accounting for more than 6% of retail sales for the first time ever.”

“Retail Sales Pace to Fall 600,000 Units in July – Largest Decline in 2017 – J.D. Power - https://tinyurl.com/ycweq38w

It’s worth noting, as Musk did in Tesla’s earnings call, that Tesla engages in no promotional activity. That’s billions of dollars that remain in the bank. Tesla depends on an adoring press which promotes Tesla against its own interest, since the electric car maker doesn’t advertise...much.

I mention all of this in the context of the latest expert report asserting that electric vehicles are more expensive to own and operate, and have a greater deleterious impact on the environment and overall human toxicity than internal combustion engine vehicles. Arthur D. Little has published its latest report – “Battery Electric Vehicles vs. Internal Combustion Engine Vehicles: A U.S.-based Comprehensive Assessment” - which encompasses the competing and contradictory findings of the Union of Concerned Scientists and the Nation Bureau of Economic Research.

“Battery Electric Vehicles vs. Internal Combustion Engine Vehicles” – Arthur D. Little - https://tinyurl.com/y742v5gu

According to the ADL report, the UCS report (“Cleaner Cars from Cradle to Grave: How Electric Cars Beat Gasoline Cars on Global Warming Emissions”) concludes “that battery electric vehicles generate only half the greenhouse gas emissions of ICEVs” and “that BEVs are cleaner than ICEVs no matter where in the U.S. they are driven.” The ADL report summary of the NBER report (“Environmental Benefits from Driving Electric Vehicles?”) asserts that the authors “determined that the welfare maximizing national subsidy on BEVs would be -$742. In other words, owing to the greater environmental impact caused by BEVs compared to ICEVs, the NBER study implies that the current federal subsidy for BEVs should be replaced with a tax.”

All three studies focus on the regional impact of ICEVs and BEVs. While BEVs shift emissions and supply chain impacts to more centralized or distant locations of raw material extraction or manufacturing, the power generation impact redistributes those costs. This somewhat undermines the argument that EVs are increasingly preferred by cities to mitigate immediate and hyper-local emissions problems associated with ICEVs and diesel vehicles - which are increasingly subject to bans in a growing number of European cities.

The argument that BEVs represent a net negative is a strong one, but it will be steadily undermined by advances in battery technology and the shift of power generation to renewable sources. ICEVs will benefit from no such shifts and rely on ongoing improvements in fuel efficiency.

In the U.S., the push remains in place to improve ICEV fuel efficiency, but the Trump administration has hinted at weakening the corporate average fuel efficiency requirements which were raised by President Obama, and possibly decoupling or overriding California’s more stringent standards. At the Management Briefing Seminar in Traverse City this week representatives of the California Air Resources Board noted a lack of outreach from the federal government to resolve or at least clarify federal intentions. The head of GlobalAutomakers called for continued improvements in ICEV fuel efficiency efforts.

Meanwhile, higher gas taxes appear to be on the way according to indications from the Trump administration and the decisions of individual states struggling to address a funding crisis for overdue infrastructure repairs and upgrades. Weakened CAFé standards and higher gas taxes will only fuel Tesla’s ongoing rise and undermine ICEVs.

The biggest concern facing Tesla prior to the launch of the more affordable Model 3 wasn’t regulations or fuel prices. The biggest concern was that demand would shrivel for the existing Model S and Model X. To the contrary, Musk told earnings call listeners, given the order backlog for Model 3’s, interest in the preceding models has grown.

Lest EV fans get too excited, though, Magna CEO Don Walker, speaking at MBS in Traverse City this week, did his best to tamp down any irrational exuberance overtaking the automotive industry regarding EVs. According to the Automotive News, Walker predicted EVs “will account for just 3 to 6 percent of the global new-vehicle market by 2025.”

Walker also sought to cool anticipation of an autonomous driving future arriving in 2021. Walker noted that self-driving cars would not begin arriving in the market until about 2025, according to Automotive News.

Tesla is also working on autonomous driving tech with arguably a substantial head start on the competition given the company’s focus on the use of cameras to collect driving data and, more recently, imagery. More and more Tesla is operating beyond the bounds of conventional wisdom and technology adoption timelines prevailing in the automotive industry. That manner of thinking and doing business has translated into negative inventory at a time when the rest of the automotive industry is idling factories as unsold vehicles back up on dealer lots.

EVs may still be a niche market and autonomous vehicles a twinkle in the eye of many, but Tesla isn’t curbing its enthusiasm. EVs, self-driving cars and Tesla profits may all arrive sooner than the experts think. For now, investors and customers are lining up.

Roger C. Lanctot is Director, Automotive Connected Mobility in the Global Automotive Practice at Strategy Analytics. More details about Strategy Analytics can be found here: https://www.strategyanalytics.com/access-services/automotive#.VuGdXfkrKUk