Tesla’s Technological Advantage Will Remain in Place as EV Adoption Grows

Strategist

Seth Goldstein

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Tesla is one of the largest battery electric vehicle automakers in the world. In less than a decade, the company went from a startup to a globally recognized luxury automaker with its Model S and Model X vehicles. The company also competes in the entry-level luxury midsize car and crossover SUV markets with its Model 3 and Model Y vehicles. Tesla also plans to sell new vehicles over the next several years, including a light truck, a semi truck, a sports car, and an affordable sedan and SUV.

Tesla aims to maintain its market leader status as EVs grow from a niche market to reaching mass consumer adoption. We forecast EVs will reach 40% of global auto sales by 2030. To meet growing demand, Tesla opened two new factories in 2022, which increased its production capacity. Tesla also invests around 4% of its sales in research and development, focusing on improving its market-leading technology and reducing its manufacturing costs. For EVs to see mass adoption, they need to reach cost and function parity with internal combustion engines. To reduce costs, Tesla focuses on automation and efficiency in its manufacturing process, such as reducing the total number of parts that need to be assembled in a vehicle. The company also began designing its own batteries. Tesla's goal is to reduce costs by over 50%.

To reach functional parity, EVs will need to have adequate range, reduced charging times, and availability of charging infrastructure. Tesla’s extended-range EVs are already at range parity with ICE vehicles. The company also continues to expand its supercharging network, which consists of fast chargers built along highways and in cities throughout the U.S., EU, and China. The range and supercharger network help eliminate road trip anxiety, or the functional barrier to mass market EV adoption.

Tesla is also attempting to take a larger share of its customers’ auto-related spending, which includes selling insurance and offering paid services such as autonomous driving software.

Tesla also sells solar panels and batteries used for energy storage to consumers and utilities. As the solar generation and battery storage market expands, Tesla is well positioned to grow accordingly.

Business Strategy & Outlook

We award Tesla a narrow moat rating. Tesla’s moat stems from two of our five moat sources: intangible assets and cost advantage. The company’s strong brand cachet as a luxury automaker commands premium pricing, while its EV manufacturing expertise allows the company to make its vehicles cheaper than its competitors.

Intangible Assets

Tesla’s brand cachet is not likely to be impaired anytime soon as other automakers move into the battery electric vehicle space because we expect the company to keep innovating to stay ahead of startup and established competitors. The Model S Plaid, the most upgraded version of Tesla’s luxury sedan, offers 390 miles of range, which is at the high end for electric vehicles. It does 0-60 mph in under 2 seconds and has 1,020 horsepower, putting the Model S Plaid in a rare class of performance among all autos, regardless of powertrain. By focusing on the luxury auto market first, Tesla was able to create tremendous media publicity for the company that reaches beyond its customers. This generated strong consumer demand for its subsequent vehicles at lower price points, such as the Model 3 and Model Y. As other new vehicles are launched, such as the Cybertruck or the platform that will produce the affordable sedan and SUV (known as the $25,000 vehicle), we expect the company’s strong brand will continue to generate consumer demand.

Tesla has a more high-tech vehicle with the ability to do drivetrain updates and other updates via Wi-Fi or a cellular connection, and customers do not have to visit a store for many service needs. Tesla will instead pick up the vehicle from home and often return it the same day, while providing a fully loaded loaner for no charge, or visit the customer's home or work and service the car there. This experience is much easier than many other automakers' service, which helps Tesla's brand equity. Further, this has been accomplished with little to no spending on advertising, which is rare for a consumer brand. This strong brand equity has carried over to Tesla’s energy generation and storage business, where the company can charge a premium for its fully integrated solar panel, inverter, and home battery storage systems sold to consumers.

Tesla’s proprietary technology contributes to its intangible asset-driven competitive advantage. This form of intangible assets applies to EVs due to their innovative, highly engineered nature and because patents for EV technologies hold somewhat less value due to the ability of competitors to create alternatively designed, but ultimately similar, products. Since launching the Model S in 2012, Tesla has been the industry leader in electric vehicles, producing the best EVs on the market. The company invests nearly 6% of sales in R&D to maintain its best-in-class range, which is well ahead of the competition on a miles per kilowatt-hour basis and continues to improve other vehicle specs such as power. Tesla is also investing heavily in its proprietary autonomous vehicle technology and building one of the world’s largest supercomputers to train self-driving artificial intelligence. With R&D spending in line with its peers, we think Tesla will be able to maintain its proprietary technological advantage.

Tesla will face increasing competition in the coming years. Automakers plan to electrify their fleets by adding EV versions of existing vehicles and creating new platforms. However, we see EVs becoming a greater proportion of auto sales, growing to 30% by 2030, up from 3% in 2020, which will expand the market as EVs rapidly take share from internal combustion engine vehicles. As new models are introduced, Tesla’s technological advantage and the strength of its brand will remain intact, which will allow the company to continue to charge a premium price for its EVs.

Cost Advantage

We think Tesla benefits from a cost advantage in electric vehicles production thanks to its manufacturing scale. Tesla’s total vehicle volume has grown from just over 100,000 in 2017 to over 1.3 million deliveries in 2022. During the same period, the company’s average cost of goods sold per vehicle has fallen over 50%, from $84,000 to under $39,000, and gross profit margins have expanded from 20% to 26% excluding the sale of regulatory credits. While some of this is due to manufacturing a greater proportion of midsize cars and SUVs versus luxury autos, the majority of the COGS decline has come from the company’s focus on reducing manufacturing costs due to scale. Legacy automakers are gradually transitioning to BEV production from internal combustion engines, but we expect they will be saddled with legacy ICE costs for a long time. Even as legacy automakers begin to produce more EVs, we expect Tesla will continue to have lower costs as it has outlined a plan to further reduce battery cell costs by 56% over the next several years. With Tesla’s cost per vehicle set to fall, incumbent automakers may take years to catch up to Tesla, if ever, as they won’t want to build many new factories from scratch like Tesla is doing.

We think Tesla’s combination of intangible assets and cost advantage will persist in the future and allow the firm to generate excess returns on capital. We see the potential for Tesla to outearn its cost of capital over at least the next 20 years, which is the measurement we use for a wide moat rating. However, the second 10-year period carries significant uncertainty for both Tesla and the broader automotive industry, given the rapid advancement of autonomous vehicle technologies that could transform how consumers use vehicles. As such, we view a narrow moat rating, which assumes a 10-year excess return duration, as more appropriate.

Narrow

Economic Moat

Tesla

SolarCity is a subsidiary of Tesla, Inc. that specializes in solar energy services. SolarCity markets, manufactures, and installs residential and commercial solar panels in the US. It has also provided other energy services. In 2016, the company merged with Tesla, Inc. and now offers energy storage services through Tesla, including a turnkey residential battery backup service that incorporates Tesla's Powerwall. The company, in partnership with Panasonic, operates the Tesla Gigafactory 2 in Buffalo, New York, where it manufactures solar module components.

SolarCity

Tesla, Inc. engages in the design, development, manufacture, and sale of fully electric vehicles and energy generation and storage systems. The company operates through the following segments: Automotive and Energy Generation and Storage. The Automotive segment includes the design, development, manufacture, sale, and lease of electric vehicles as well as sales of automotive regulatory credits. The Energy Generation and Storage segment includes the design, manufacture, installation, sale, and lease of stationary energy storage products and solar energy systems, and sale of solar energy systems incentives. The company was founded by Jeffrey B. Straubel, Elon Reeve Musk, Martin Eberhard, and Marc Tarpenning on July 1, 2003 and is headquartered in Austin, TX.

Earnings data Q4 2023

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