Elon Musk's quest for an irresistible price could spell trouble for Tesla and its stock

Published Sun, May 21 20238:44 AM EDT

Tesla is attempting a huge pivot in its strategy at a time when demand for electric vehicles is threatened by a slowing economy and competition is greater than it's ever been. "We basically adjust our pricing to match demand," Musk said in a Tuesday interview with CNBC . "All car companies make a significant adjustment to price. ... It's just that Tesla is so immediate, obvious and transparent [that] it's not a question of MSRP [manufacturer's suggested retail price], or mockups and discounts." Between January and April, Tesla cut prices at least six times for both its Model 3 and Model Y. Its goal has been to coax consumers to make the leap to its brand with the lower prices. The hope is that enough will do so that the volume sold will offset the lower profit it makes on each vehicle. Time will tell if this strategy will work for Tesla, the dominant EV player. What is clearer right now is that the strategy shift is weighing on Tesla's stock. Although its shares have gained more than 46% since the start of 2023, the stock traded lower after it reported earnings. Since then, it's down 2.3%. "While we anticipate the 1x costs will boost gross profit margin in Q2, we fear the medium-term trend may be to still lower GPM [gross profit margin] as the company noted its willingness to lower prices and accept lower GPM in order to broaden adoption of TSLA cars and sell FSD [full self-driving] and other services," Truist said in an April 21 note, where the firm downgraded Tesla stock to hold from buy. In part, Tesla's success will hinge on how much demand there is for EVs. S & P Global predicts a mix of battery electric vehicles, plug-in hybrid electric vehicles and fuel-cell electric vehicles will make up about 47% of the cars on the road in the U.S. by 2030. But in the near-term, it sees EV demand being pinched by the culmination of an energy crisis in Europe, adjustments in China's EV subsidies, high inflation as well as worries over a potential recession in the U.S. Analysts have warned that Tesla could be going too far with the price cuts, and many lowered both their ratings and price targets as a result . These analysts expect the shares will remain under pressure until investors have more clarity on how the situation will play out. "As we wrote in our 1Q23 Tesla earnings takeaway note, we are expecting additional price cuts throughout the year, and sizable additional price cuts beyond our forecast is a risk," said Goldman Sachs analyst Mark Delaney in a research note published on May 14. Still, the market is growing. The International Energy Association projects 14 million electric vehicles will be sold globally in 2023. Roughly 13% of them would be Teslas, if the company hits its 1.8 million vehicle production goal and sells all it produces. Finding an 'irresistible' price Tesla's price cuts are an effort to take advantage of that growing market. The company is focused on widespread vehicle adoption and needs to find an adequate selling price for its best sellers — the Model 3 and the Model Y . "Most companies, let's say a traditional manufacturer, would seek to maximize profits, which is neither maximizing ASPs [average selling price] nor is it maximizing units," said Will Stein, a senior analyst at Truist. "[The balance] is understanding the tradeoff between the two, and understanding that at some point, as you continue to lower prices, you might not stimulate much more demand." Tesla's gross margin before accounting for EV tax credits was 22.6% for the quarter ended Dec. 31, 2022. In March 2023, gross margin fell to 19%, a quarter-over-quarter decline nearly 16%. Consensus estimates from analysts polled by FactSet expect gross margin to continue to decline, with a forecast of 16.7% for the quarter ending in June. "The bull/bear debate at the core is: When do the price cuts end for Tesla and what will margins look like on the other side of this cycle as we progress through 2023 in a choppy macro?" Dan Ives, senior equity research analyst at Wedbush wrote in a Thursday note. The price cuts didn't deter investors at first. From January to April of this year, Tesla stock added 68%, a staggering climb that helped the company recover from the 65% overall loss in 2022. In April, however, once investors digested the company's quarterly results and comments on further margin tightening, Tesla stock dipped nearly 15%. "The data suggests that demand isn't being sustained to the level that Tesla would like at current prices," said Philippe Houchois, managing director of automotive research at Jefferies. For now, Tesla may be willing to cut prices until it finds a selling point that's truly "irresistible" to customers, he added. There's another issue, according to Cox Automotive executive analyst Michelle Krebbs, "... How do you actually measure demand?" She explained that Tesla sales data is harder to come by because customers buy directly from the company as opposed to a dealership. Tesla doesn't openly disclose the number of vehicles it sells. Instead, it refers to deliveries — a figure that doesn't specify the region the cars are going to or the specific model being sold. In the company's latest quarterly earnings report, Tesla said it delivered 422,875 cars. That's shy of 432,000 vehicles analysts expected, according to FactSet. Despite the shortfall, Musk reiterated his target of 1.8 million total deliveries this year. "We have real time information on demand, so we know how many people placed an order for a Tesla yesterday," Musk told CNBC on Tuesday. "Literally every day, we get an automated email to the executive staff that says how many people placed an order, in which countries, [and] for which cars." Musk didn't expand on where demand sits today. If Tesla cuts and raises prices to adequately match demand, then the continued price cuts are perhaps the clearest — and loudest — signal that demand isn't where the company wants it to be. "You don't want to overreact to these things, because sometimes you get little dips for reasons that are hard to explain," he said of fluctuations he sees. Tesla vs. Ford There are broader implications as well. "Tesla's price cuts signal that legacy automakers will ultimately need to lower their EV prices to levels that are not much higher than comparable internal combustion engines," said Seth Goldstein, equity strategist at Morningstar. "While the high-end luxury autos will still have higher prices, the entry-level luxury and high-end affordable segments will need to have prices that are more comparable to internal combustion engines in order to attract consumers." Rivals are already responding to Tesla's strategy. Take Ford . It has slashed the price of its Mustang Mach-E EV on multiple occasions. The most recent cut on May 2 reduced its sticker by about $1,000 to $4,000, putting its price in a range of $42,995 to $59,995. Tesla hiked the price of both its Model 3 and Model Y on the same day by roughly $250. With this change, the Model 3 now sells for $40,240 and the Model Y is priced around $47,240 in the U.S. Ford's price cuts aren't helping its situation. It is working off an 8% margin in its EV segment. Ford shares down slightly since the start of the year, largely due to the burden its EV investments. The automaker is pouring billions into EV development and production, while losing money on every EV it produces. "We have written extensively on the drag EVs have on margins for legacy [original equipment manufacturers] and the impact of EV price deflation. We believe that Ford (and other legacy OEMs) will continue to evaluate their EV plans & that F's mgmt. see the value in the capital not spent," Morgan Stanley equity analyst Adam Jonas said in a May 2 note on Ford. Still, legacy automakers have no other choice. Goldman Sachs expects EVs will make up 12% of overall sales this year, then climb to 17% in 2025 and 50% in 2035. Krebbs said the pricing situation may not have a broad impact. "I don't see this as an all-out price war. I see it as price-war skirmishes against prime competitors, since Tesla doesn't compete in every segment," Krebbs said. She added that the price cuts are an effort for Tesla to retain market dominance and stave off competition from big competitors like Ford. "Ford's Mustang Mach-E is in Tesla's bullseye," she said. Chief Executive Jim Farley has cautioned that Ford will only go so far in cutting prices to keep pace with Tesla. He maintained that demand remained strong when he spoke to investors on the company's latest quarterly earnings call. "...We feel great about the demand [for the Mustang Mach-E] or else we wouldn't be doubling production this year," he said. A more crowded market Tesla has been losing market share as a flood of new EVs have come to market, according to S & P Global . In 2021, a broad range of carmakers — which includes Volvo, Cadillac, Mercedes and BMW — had no EV brands registered in the U.S. A year later, 10,390 EVs were registered from a wide range of manufacturers, it said. Tom Libby, S & P Global manager of industry analysis, told Citigroup on Wednesday that the number of EV models will grow from 74 in the U.S. to 113 by 2024, and to 151 by 2025. The surge in new models are bringing new consumers into the EV segment. Longer term, Tesla's price fluctuations could do more harm than good if they end up turning consumers off. "Over the next few months, [if] Tesla keeps lowering prices [and] lowering prices, the buyer becomes a little annoyed that they paid a price, now it costs less," Stein said. "I don't know yet if that's a big problem, but I think it's a more common issue with this pricing strategy." Krebbs concurred, and added that EV "pricing is as confusing as price for airline tickets, constantly changing," which could "tick off buyers who bought a Tesla at one price and it is cut shortly after." TSLA YTD mountain Shares of the electric vehicle maker are higher year to date despite a push for lower margins and higher vehicle production The constant change in prices is likely to continue to be a headwind for Tesla stock, which is something Musk hasn't been hiding from investors, according to Houchois. "The most loud reaction I've heard is, 'I wonder if he [Musk] is just setting expectations low,' because this doesn't sound great," Stein said. "I hope he's setting a low bar."