Will Tesla Cutting Back on Capex Slow Down Growth?

Tesla Gigafactory 1
Tesla Gigafactory 1

Wall Street analysts and the media, who have long complained about Tesla’s lack of profitability and over-the-top spending, have now come up with another Tesla problem: Spending cuts will slow down the launch of new models, hurting revenue prospects.

Well, we cannot ask a company to prove that it can be profitable, and then when they try to control costs, turnaround and say – you are shortchanging your future potential. But I guess that’s how the story is going to evolve over the next few months as Tesla drives hard to secure its bottom line.

Myth: Tesla cutting back on Capex will slow down growth

Tesla initially projected 2018 Capital Expenditures to be slightly more than the $3.4 billion the company spent in 2017. By the end of the first quarter of 2018, Tesla lowered its expectation to slightly below $3 billion, and three months later they further reduced their expectation to slightly below $2.5 billion.

Tesla may have overestimated its expenses related to ramping up production because, at the end of the fourth quarter of 2017, Tesla was at far less than 1000 Model 3s being produced per week. But they went from building 753 model 3s a week by the end of December 2017 to more than 2000 cars in a week by the end of March 2018. They then went on to reach 5,000+ Model 3 units produced per week by the end of June.

Tesla learned a heck of a lot during those three months and was able to cut back on expenses.

As we spent a lot of time debugging a wide range of manufacturing issues that the potential for our existing lines to be able to produce far more cars is much greater than expected.

By simplifying production lines, by speeding them up in some cases, everything is being done manual instead of automatic, and in other cases, having be done automatic instead of manual, we’ve been able to achieve dramatic improvements to the output of existing lines, which means that our CapEx growing from 5,000 to 10,000 is a tiny fraction of the CapEx needed to grow from 0 to 5,000 Model 3s. – Elon Musk, Q2 2018 Earnings Call

Tesla is cutting back on capital expenditures because of the mistakes they have done in the past and implementing those learnings to improve production. This was the reason the management pegged the Gigafactory 3 in Shanghai to cost the company around $2 billion.

“The experience curve is an idea developed by the Boston Consulting Group (BCG) in the mid-1960s. Working with a leading manufacturer of semiconductors, the consultants noticed that the company’s unit cost of manufacturing fell by about 25% for each doubling of the volume that it produced. This relationship they called the experience curve: the more experience a firm has in producing a particular product, the lower are its costs.”

The problem with the ‘reducing Capex will hurt growth’ statement is that it does not carry a time frame to go along with it.

Will Tesla keep reducing its capital expenditures forever? Absolutely not. Tesla is planning to build Gigafactories all over the world. Things have already started to roll in China, and there are reports that German states are fighting each other to get Tesla to choose them.

Tesla’s Capex slowdown will obviously be a short-term one. And it makes sense to slow things down because Tesla now has time on its side. Tesla is hoping that it will be able to build around 600k units in its facilities in the United States.

If Tesla gets close to 10k units per week by the end of this year according to their plan,  annual production run rate will near 520k. There isn’t much room to go higher from there, just an addition of 1500 cars/week will max out capacity.

The obvious next step is Gigafactory 3 and then Gigafactory 4. Tesla will certainly need at least another year or maybe even two to see its cars roll out from the Shanghai plant. So what happens between now and then? Capex will have to drop as Tesla gets closer to maxing out capacity in the United States, but it should slowly start rising again as investments pour into Gigafactory 3 and beyond.

If most of Giga3 funding is going to come from the local Shanghai government, then Tesla may even start building Giga4 and still expect to spend less than what it spent in 2017.

None of this is going to affect Tesla’s long-term growth plans, because that’s the stage the company is in: very close to maximizing its utilization of current facilities and start planning new ones. Tesla needs to make use of the time lag between those two events to improve profitability and start using internally generated cash flow to fund future growth.