After Tesla reported a surprising third-quarter profit on Wednesday, its first in 13 quarters, analysts dug into the results and founds that Tesla had sold a lot of zero-emission vehicle (ZEV) credits in Q3, amounting to $139 million.
Tesla bear Colin Langan, lead auto analyst at UBS, has a “sell” rating and a $160 target price on Tesla stock, which is now trading above $200.
In a tough-minded research note published Wednesday, he brushed off the Q3 surprise, chalking it up to the ZEV credits, and did not offer optimistic thoughts about the fourth quarter.
“We see TSLA’s guidance for positive GAAP net income in Q4 as very challenging.” he wrote. “Excluding ZEV credits, Q3’s $0.71 profit would have been a $0.18 loss. With no ZEV, higher opex, and [approximately] flat [quarter-over-quarter] deliveries, achieving the target Q4 profit will be tough, in our view.”
For what it’s worth, when Tesla CEO Elon Musk was asked about ZEV credits on a conference call after earnings, he took the opportunity to lay into the California Air Resources Board (CARB), the agency that oversees the ZEV regime for the biggest state that requires automaker to meet ZEV requirements.
He had already upbraided CARB on Tesla’s second-quarter earnings call, but in light of Langan’s analysis, his disdain for the way the program is administered took on new meaning this time around.
Calling the “CARB ZEV credit mandate is incredibly weak” and insisting that it “needs to be fixed,” Musk went on to say that ZEV credits are actually a crummy business for Tesla.
“There were some quarters where we simply cannot even find a buyer for credit,” he said. “And then when we can find a buyer, it’s typically fifty cents on the dollar for the ZEV credit.”
Bad business or not, and responsible for Tesla’s Q3 profit or not, there’s an important point here that’s being lost.
For starters, Tesla’s gross-margin per vehicle is increasing, and as production increases, that should logically lead to more consistent profits.
But on the “ZEV Factor” — Tesla, unlike all other significant carmakers, doesn’t build any cars that generate tailpipe emissions. That’s why it accrues ZEV credits that it can sell. And it can sell those credits whenever it wants — or, as Musk said, take a frustrating hit on its ZEV sales when it can’t get what it considers to be full value.
This maths is speculative, but if Tesla did unload a lot of ZEV credits in Q3 for fifty cents on the dollar, it could have picked up $280 million rather than $139 — and notched an even higher profit.
Also, why would we consider Tesla’s ZEV sales are somehow an adjacent business, unrelated to its core operations, where presumably investors are looking for signs of future profitability? If you make zero-emission electric cars, you’re going to rack up ZEV credits in ZEV states and to a degree can considers them a product that you’re “created,” in a sense. They’re actually an important part of the business plan.
Langan doesn’t think Tesla will sell any ZEV credits in Q4 and will go back to losing money. But so what? Tesla isn’t necessarily aiming for profitable quarter after profitable quarter — the master plan is to spend whatever the balance sheet will support to launch the Model 3 mass-market car on time in 2017.
Sure, a no one wants 14 profitless quarters in a row, and Musk did make clear to his team that a profitable quarter would be helpful to the cause. If they sold every ZEV credit they could find, well, that’s a valid and legitimate decision. It isn’t against the rules to sell ZEV credits — Tesla would be foolish not to.
Meanwhile, the company is on track to deliver more vehicles in 2016 than ever before. Tesla could be moving into a new phase, and getting hung up on how it turned a profit in one quarter is a distraction.
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