Tesla announces huge increase in profit margins as vehicle production increases

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All the controversy surrounding CEO Elon Musk aside, You’re here (TSLA 1.09%) just announced another fantastic quarter. Revenue and profitability in the second quarter of 2022 were down from the previous two quarters, but up sharply from the same period a year ago. As vehicle production gradually increases in factories around the world, profits increase. That doesn’t necessarily make the stock a buy, but Tesla continues to prove its car-building capabilities are the real deal.

A year-over-year jump in margins excluding regulatory credits

Tesla’s gross profit margin on vehicles was reported at 27.9% in the second quarter of 2022. If you keep score, that compares to the stellar gross margin of 32.9% in the first quarter of 2022 and – more importantly again – at 28.4% a year ago in Q2 2021. Queue up the music signaling Tesla’s impending doom.

Except there are a few caveats to consider with this vehicle gross margin figure. Several factors have combined to drive down Tesla’s margins on vehicles.

First, limited operations at Tesla’s Shanghai factory, where regulators are trying to keep tight control over resurgent COVID-19 infections. Inflation and a strong US dollar (which reduces revenue when a multinational company converts foreign currencies for financial reporting here in the US) also contributed to lower vehicle gross margin. Additionally, Tesla produced more vehicles than it shipped in the second quarter compared to the past three quarters where it shipped more vehicles than it produced. Tesla doesn’t realize revenue until a customer takes possession of the car, so the cadence of quarterly production versus deliveries also impacts margins.

But here is another factor to consider. Tesla’s regulatory credit revenue (electric vehicle incentives from governments given to Tesla and purchased from Tesla by other automakers) continues to decline. As automakers increase their own electric vehicle lines, it has always been inevitable that the sale of these credits will decline. In the second quarter of 2022, revenue from sales of regulatory credits was $344 million, compared to $679 million in the first quarter and $354 million a year ago. As a result, regulatory credits represented only 2.4% of automotive revenue this past quarter, compared to 4% in the first quarter and 3.5% of revenue in the second quarter of 2021.

So, excluding these credits, automotive gross margins in Q2 2022 actually increased to 26.2% from 25.8% last year (and 30% gross margin in Q1). Not quite the dire situation some financial outlets present.

Earnings will vary from quarter to quarter, but…

Beyond vehicle-specific margins, Tesla reported total operating profit of $2.46 billion last quarter. That is an operating margin of 14.6%. That’s a steep drop from the abnormally high 19.2% in the first quarter, but still a big jump from the meager margin of 11% a year ago.

Various measures of profit margin are going to be wildly variable from period to period for any manufacturing company, but especially for Tesla as it attempts to rapidly ramp up its global production of electric vehicles. But over time, focus on metrics like free cash flow (operating income minus capital expenditures) per share. So far it has been an absolute success.

Data by YCharts.

Again, I’m not saying Tesla is a buy. It’s just not a stock for everyone, especially since Musk and company can be unpredictable on a good day. And the shares currently trade at 133 times over 12 months of free cash flow, a premium that gauges the company’s ability to continue growing its cash-generating potential for years to come. But in many ways Tesla, the automaker, is meeting or exceeding expectations as it ramps up operations. If you don’t like the company, that’s fine, but I wouldn’t bet against it.

Nicholas Rossolillo holds positions at Tesla. Its clients may hold positions in the stocks mentioned. The Motley Fool holds positions and recommends Tesla. The Motley Fool has a disclosure policy.

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