After years without turning a profit, Tesla is now poised to be a powerhouse

It hasn’t received a lot of attention with all the Twitter wars and comments from CEO Elon Musk about Covid-19, but Tesla has become incredibly profitable.

It is a remarkable achievement for a company that reported its first annual operating profit only in January, and has never posted an annual profit using the strict accounting measures used to judge net income and losses.

Tesla followed that successful 2019 result by surprising Wall Street with a first-quarter profit, despite the Covid-19 pandemic cutting into its sales and forcing plant closings in California and Shanghai. (They have since reopened.)

The key to that profitability has to do with product itself — electric vehicles are far less complex to make than those with internal combustion engines — and a labor force that Musk has aggressively tried to prevent from unionizing.

In its January note to investors the electric automaker predicted “further cost efficiencies should allow Tesla to ultimately reach an industry-leading operating margin.” Unlike the past, when Tesla would fall short of Musk’s bold promises, it was the industry profit leader, at least in the first quarter.

Tesla’s gross profit margin was 20%, compared with 17% at Toyota and Volkswagen, and less than 10% at General Motors, Ford and Fiat Chrysler. The company has maintained a profit margin of 18.8% or better for the last three quarters.

Perhaps most importantly, there now are reasons to believe Tesla’s profit guidance.

“EVs are not just profitable,” wrote Morgan Stanley auto analyst Adam Jonas in a recent note. “When they’re made at scale with the right cost structure they can be extremely profitable.”

Making electric automobiles rather than cars with the more complex internal combustion engines, with nonunion labor to boot, is a pretty good competitive edge. And electric cars have far fewer moving parts than cars with traditional internal combustion engines.

Auto industry experts say building an electric car requires nearly one-third fewer worker hours than building a traditional gas-powered car.

It’s a major part of the reason that traditional automakers are spending billions to develop their own electric vehicles. And it’s why the United Auto Workers union is so concerned about the future of their members’ jobs as automakers plan to shift to electric vehicles at GM, Ford and Fiat Chrysler.

And it might be the reason that despite Tesla’s still modest output of vehicles — only 367,500 cars sold last year, less than 5% of GM’s total — its stock is the industry’s second most valuable behind only Toyota. Tesla’s market value is more than that of Volkswagen, GM, Ford and Fiat Chrysler — combined.

Shares have risen 87% so far this year, despite the effects of the Covid-19 pandemic on production and sales, and despite falling from record highs for the stock in early February before the overall markets turned bearish.

“Proving that EVs are more profitable than [internal combustion engines] helps surmount a major impediment to investment in the tech and broader adoption… as well as recognition by investors that moving to EVs doesn’t have to come at the sacrifice of profitability,” Jonas said in his note.

Why it lost money in the past

Tesla’s past inability to turn a profit stemmed from its focus on building niche luxury vehicles, such as the Model S and Model X, in relatively limited numbers. It spent big money trying to get its first vehicle aimed at a more mass market, the Model 3, into production in the numbers it had promised.

It has finally done so. And its Model Y, which just started production, was profitable in its first quarter of production this year, a first for the company. Tesla is forecasting the Model Y will have a higher profit margin than the Model 3.

As car buyers shift their purchases to SUVs from sedans, the Model Y is expected become by far the company’s best-selling car. If its sales forecasts prove accurate, it would be the best-selling SUV of any kind in the United States — gas or electric — passing established models like the Toyota Rav 4.

Challenges in the near term

Tesla will have a challenge in reporting a second-quarter profit. Halfway through the quarter, the company is only now restarting production at its main plant in Fremont, California, as well as its Nevada battery factory which were shut by Covid-19 health concerns.

And it’s not clear how much safety measures being put in place – such as limits on the worker interactions, barriers between workers and limits on the number of people in different areas of the plant at one time – will affect productivity at the plants.

Then there’s the question of sales demand.

Record job losses and millions working from home have eliminated the need for work commutes, a major factor behind car sales. And the huge drop in gasoline prices doesn’t provide an economic argument for buying an electric car.

Even so, Tesla said it ended the first quarter with the biggest-ever backlog in orders for its cars. It also had nearly 20,000 completed cars on hand at the end of the first quarter that it was unable to deliver amid the shutdown. Those sales could show up in the second quarter with virtually no additional cost to Tesla.

Tesla has ambitious growth plans, including a plant already under construction in Germany, and it is expected to announce a new US plant by the end of July.

Musk doesn’t plan to stop there. Within five years, he said, there will be “several” more plants beyond the two it operates today, potentially expanding Tesla’s profit margins even further.

Investors are starting to realize that, too.