Tesla’s gross margin on the Model 3 could be a game changer in the auto industry

If Tesla can achieve a similar positive gross margin on the Model 3 as it has with the Model S and Model X, it will be one of the most decisive catalysts in the automotive industry. Why? It will show that an automaker can truly produce a mass market long-range electric vehicle for a profit.

Whether or not they will manage to is still up for debate, but an analyst today came out with a note predicting that they will be able to achieve a ~25% gross margin – comparable with the Model S’ margin.

Evercore ISI analyst George Galliers started coverage of Tesla’s stock today and gave it an Outperform rating with $330 price target.

In his research note, Galliers compared Tesla’s growth with Porsche:

“To put Tesla’s growth in context, we note it took Porsche 10 years and four product lines to grow from [about 35,000 units to just under 100,000 with four different product lines, compared with Tesla’s three]. Even with only a small contribution from the more affordable Model 3, Tesla is on course to achieve similar growth in only 3 years.”

The comparison is interesting because, in the past, Tesla CEO Elon Musk referred to Porsche, which is known in the industry for maintaining segment leading gross margins, when discussing Tesla’s long-term ambitions for gross margins.

Musk believed that it’s important for the electric automaker to generate a lot of positive cash flow from its automotive operations in order to show the industry that EVs can be profitable. It plays into Tesla’s mission to accelerate the advent of electric transport.

This ambition hasn’t been perceived seriously by industry watchers, but Galliers goes against the grain. He notes that “Tesla’s unadjusted gross margin of 25 percent last year is impressive by any standard,” and that he sees the company being able to maintain it even after the launch of the Model 3.

He sees Tesla’s Model S’ margin grow to roughly 30% – something Tesla has been guiding, while the Model 3 is expected to soon account for the vast majority of Tesla’s production and have a lower gross margin, he doesn’t believe that it will bring the average down below 25%.

It would be a game changer for Tesla since at a planned production of 400,000 units per year and an average sale price of ~$45,000, it would represent $18 billion in revenue and roughly $4 billion in gross margin from a single vehicle program.

In the process, it would remove the popular talking point in the auto industry that reasonably priced all-electric vehicles can’t turn a profit.

As Galliers pointed out, Tesla’s gross margin on the Model S is already impressive, but that’s for a vehicle starting at almost $70,000. GM achieved a $37,500 starting price on the long-range all-electric Chevy Bolt EV, but that’s not without taking a loss on every car before ZEV credits, which is why they are limiting availability despite demand.

On the other hand, the Model 3 would check all the boxes: relatively affordable, long range, and mass-produced.

Now can they do it? Let us know what you think in the comment section below.