Imagine a day when the city streets are no longer filled with the roar of internal combustion engines but are instead filled with the gentle hum of electric motors. As you step out of your home, the first thing you see is a row of neatly parked electric vehicles, patiently waiting for commands. There are no longer traffic signals flashing 24 hours a day; instead, countless sensors and cameras monitor the real-time positions of vehicles and pedestrians. People sit in comfortable seats, allowing electric vehicles to intelligently plan the optimal travel routes. This city is no longer just a vision of the future; it is gradually becoming a reality with the power of electric cars and autonomous driving, and Tesla is at the forefront of this urban vision.

Summary

• Approximately 85% of Tesla's revenue comes from its automotive manufacturing and sales division. This year, Tesla has lowered its prices multiple times to address slowing global demand and intensifying competition in the new energy vehicle market.
• Tesla's Q2 2023 financial report showed a decline in both gross profit margins and operating profit margins. Stable free cash flow income has been continuously invested in R&D department to drive high-end technological innovation.
• It is expected that Tesla will further reduce prices this year to ensure stable revenue growth. The continuous decline in gross profit margins and operating profit margins is a probable event in the short term. However, this pullback also signifies an opportunity for investors.
• Tesla has already deployed two world-class top-five supercomputers and has begun AI video data training on the vast driving data collected from customers to expedite the implementation of the full self driving system FSD V12.
• n the long term, we hold an optimistic view of Tesla's potential to solidify its competitive position through investments in artificial intelligence. Their aim is to leverage their vast data resources, shifting from an electric vehicle manufacturer to a dominant player in the artificial intelligence domain, which could offer compelling investment opportunities for discerning shareholders.

Automotive Business Analysis

Tesla is the largest electric car and solar panel company in the United States, and it collaborates with Panasonic in the battery business. The company manufactures and sells electric cars, onboard computers (FSD driving system), solar panels, and energy storage equipment and solutions.

Tesla operates under four major business segments, including car manufacturing and sales, car leasing, car services, and energy generation & storage. Looking at financial data from the past five years, the majority of Tesla's revenue still comes primarily from car manufacturing and sales, accounting for approximately 85%. The annual compound growth rate is around 31.37%. Tesla's continuous improvement in car manufacturing technology and efficiency ensures its leading position in the new energy vehicle market.

Currently, Tesla offers four different vehicle models for sale, catering to various segments of the market. These include:

• Model S: Introduced in 2012, the Model S is a high-end sports sedan known for its performance and electric range.
• Model X: Introduced in 2015, the Model X is a luxury SUV, featuring distinctive Falcon Wing rear doors and advanced technologies.
• Model 3: Introduced in 2017, the Model 3 is a compact sedan designed to be more affordable and accessible to a broader range of consumers.
• Model Y: Introduced in 2019, the Model Y is a compact SUV, offering a balance between space and efficiency, and it shares many components with the Model 3.
  A screenshot of a car

Some of the upcoming vehicle models and projects in Tesla's future plans include:

• Roadster: Originally introduced in 2008 and discontinued in 2012, Tesla announced the Roadster 2 in 2017. However, there have been delays in its production, and it is expected to commence production no earlier than 2024.
• CyberTruck: The CyberTruck is a groundbreaking electric pickup truck made from titanium materials. Elon Musk mentioned in a July investor meeting that deliveries of the CyberTruck are expected to start later this year, with mass production planned for the following year.
• Semi: Tesla's electric semi-truck, designed to reduce long-haul transportation costs by an estimated 25%. The company delivered its first trial versions of the Semi to PepsiCo by the end of 2022.

In the second quarter of 2023, Tesla achieved record production and delivery numbers, producing a total of 479,700 vehicles and ultimately delivering 466,140 vehicles. The bulk of production and sales came from the more affordable Model 3 and Model Y, which are aimed at the mass market and accounted for 95% of the overall production. Notably, the Model Y also became the best-selling vehicle globally in the first quarter, underlining Tesla's popularity and market demand for electric vehicles.

According to the latest investor conference, Tesla's target to deliver 1.8 million vehicles for the full year of 2023 remains unchanged. However, due to extensive summer upgrades across several factories, production in the third quarter is expected to experience a slight decrease. Tesla currently maintains a dominant position in the EV market. Nevertheless, as the market becomes increasingly competitive, with rising challengers like BYD and the transformation efforts of traditional automakers, Tesla has had to adjust its pricing strategy several times in the first half of 2023 to ensure stable sales growth amidst this evolving landscape.

From a macroeconomic perspective, while our take is that the Federal Reserve has already reached the peak of interest rates, and maintaining the current interest rate levels until the second quarter of next year is a probable scenario. The European Central Bank is expected to raise rates further to combat inflation, while China shows signs of entering deflation. In the face of a sluggish macroeconomic environment and weak global demand, we believe that Tesla will continue to reduce prices to compete for market share with other electric vehicle manufacturers. Elon Musk also has not ruled out further price reductions during investor conference calls. These price reductions are likely to put pressure on Tesla's gross profit margins and operating profit margins in the short term, which could in turn affect financial performance and stock prices. However, this pullback may also present an opportunity for investors to enter the market at a lower price point.

Analysis of 23Q2 Financial Report

The 2Q 2023 financial report, released in July, reflects Tesla's performance in a context where the U.S. dollar strengthened (leading to depreciation of overseas income and a $600 million FX loss). Despite these challenges, Tesla achieved record-high revenue of $24.93 billion, marking a year-over-year increase of 47%, which surpassed Wall Street's expectations of $24.47 billion.

In response to the global economic slowdown and a higher interest rate environment, Tesla proactively lowered its prices to stimulate sales, which contributed to its rapid revenue growth. However, the gross profit margin declined from 25% in the same period the previous year to 18.2%. This margin was also below Wall Street's estimated 18.8%. Importantly, this marked the first time that Tesla's gross margin was surpassed by BYD (whose 2Q 2023 gross margin was 18.78%). This drop in gross margin explains why Tesla's stock price didn't see significant changes after the financial report was released.

The operating profit margin saw a sequential decline of 1.8% to 9.6%, marking the first time in recent years that it has fallen below double digits, crossing a psychological threshold. Moving forward, whether Tesla can bring its operating profit margin back above 10% will be a focal point of investor attention. We believe that the decline in the operating profit margin primarily stems from the price reductions in Tesla's vehicles. However, there are other factors contributing to this decline, including increased investments in AI, Cybertruck, new factories, and the 4680 battery.

Taking a closer look at Tesla's income statement, R&D costs have continued to rise steadily over the past year despite the high-interest-rate environment. This quarter, R&D expenses reached a historical high of $943 million, surpassing the market's consensus of $839 million. Tesla's free cash flow remains at the $1 billion level, indicating its capability to plan for long-term strategies.

Overall, Tesla's financials reflect both its efforts to stimulate sales through price reductions and its commitment to investments in future technologies and projects, emphasizing its vision for long-term growth and innovation.

Furthermore, when examining costs, it becomes evident that the average production cost per vehicle continues its descent, serving as compelling evidence of Tesla's readiness to further adjust prices. This cost reduction primarily owes itself to diminished raw material expenses and the accumulation of credits derived from the IRA Act. The former highlights Tesla's strengthened negotiating position within its upstream supply chain, while the latter underscores Tesla's promise in the burgeoning green energy era.

During the first quarter, Tesla's investor conference divulged insights into engineering endeavors aimed at scrutinizing assembly procedures. The proposed novel workflow entails disassembling the vehicle into discrete components such as front and rear compartments, left and right frames, chassis, doors, and more. These components undergo individual painting and interior component installations before being seamlessly assembled and welded together in an uninterrupted sequence. This innovative approach not only abbreviates production timelines but also diminishes the physical footprint required on the assembly line.

Anticipations loom regarding the future production of the next generation of vehicles under this revamped methodology. It is foreseen that Tesla could potentially curtail manufacturing space by up to 40% in comparison to the current production methods for Model 3 and Model Y, leading to prospective cost savings of up to 50%. Nevertheless, as previously mentioned, in the immediate term, profit margins may experience constriction. Realizing significant cost reductions of this magnitude may necessitate an additional two to three years to reach full fruition.

Not only EVs?

Presently, when we assess Tesla's business divisions and financial statements, it remains predominantly a leading player in the electric vehicle industry, with a significant portion of its profits originating from vehicle manufacturing and sales.

However, when we broaden our perspective to scrutinize Tesla's long-term vision as reflected in its balance sheet, it becomes evident that Tesla aspires to transcend the realm of electric cars. In fact, every strategic move made by Tesla since its inception has been geared toward an ultimate objective: establishing itself as a frontrunner in the field of artificial intelligence.

On the 28th of August, Tesla achieved a remarkable milestone by successfully assembling a cluster of 10,000 NVIDIA H100 GPUs. These GPUs, based on Tesla's testing, offer three times the computational power of the A100 chips. This supercomputer boasts an impressive peak computing power of 39.58 INT8 ExaFLOPS, surpassing the capabilities of the world's fourth-ranked supercomputer, Leonardo.

For Tesla, the significance of this H100 cluster extends beyond merely having physical computational power at its disposal, in contrast to leasing resources from other companies. This cluster also serves as a pivotal tool for Tesla to train its extensive repository of driving data collected from users. This dataset surpasses the scale of data used by large language models by several orders of magnitude. Tesla can employ this data to train an entirely new generation of autonomous driving AI through neural network training, thus expediting the implementation of the latest FSD V12.

Elon Musk proclaimed two months ago that the V12 update would no longer be a test version of autonomous driving technology. Just this past week, he conducted a live demonstration of FSD V12 by personally driving a Tesla equipped with the system. Subsequently, on August 29th, he tweeted that there is a possibility for V12 to be rolled out within less than six months. Once the FSD system is successfully developed, all automakers may be compelled to adopt the FSD system to avoid being left behind in the industry. This has the potential to exponentially boost Tesla's profitability. In addition to the FSD system, Musk's Starlink project is also strategically positioning itself to establish a global network. The combination of these initiatives has the potential to effectively monetize Tesla's unique astronomical-scale data into substantial financial gains.

While Tesla has rolled out the H100 GPU cluster, it has also concurrently activated its newly developed supercomputer, Dojo. Tesla has invested a total of $1 billion in research for this endeavor. By early 2024, Dojo is anticipated to rank among the world's top five supercomputers. Official announcements on August 30th revealed that Dojo already commenced model training as early as July this year.

We posit that with the integration of the H100 chip cluster and Dojo supercomputers, the advent of Tesla's fully autonomous driving system (FSD) is forthcoming. However, even though Elon Musk has hinted at a potential rollout within six months, the trial and adaptation period for the system will entail some time-related friction costs. Achieving a fully commercialized and matured system will necessitate patience. In the short term, stock price fluctuations will still hinge on actual electric vehicle sales and hardware-related performance. Tesla's transition into the realm of AI-driven autonomous driving signifies a significant evolution, but its success will be gauged over an extended timeline that transcends immediate market reactions.

Prospects for Future Growth

Below we've compiled a list of Tesla's diversified ventures beyond vehicle sales that have the potential to drive further revenue growth:

Dojo Supercomputer

• Utilized for AI machine learning and computer vision training.
• Essential for training the autonomous driving system (FSD) software.
• Expected to rank among the world's top five supercomputers by early 2024.
• Facilitates the handling of massive real-world datasets, neural network training, and the seamless coordination of vehicle hardware and software.

Full Self-Driving (FSD) System

• Elon Musk, during the recent investor conference, emphasized that the efficiency gains brought by autonomous driving would render current short-term returns insignificant.
• Musk also hinted at discussions regarding licensing early-stage FSD technology to another major automaker.
• Advantages: Tesla possesses a more extensive aggregate of driving data than any other company.
• Introduction of a subscription feature to upgrade to the FSD service at $199 per month, thus bolstering Tesla's revenue streams.

4680 Batteries

• Measuring 46mm in diameter and 80mm in height (a significant departure from the previous 1865 and 2170 batteries).
• These batteries boast high energy density, substantial power output, enhanced safety features, and lower costs, thereby extending electric vehicle range and reducing prices.
• In the second quarter, 4680 battery production increased by 80% compared to the first quarter.
• The Texas factory has produced over 10 million of these batteries, which are being integrated into the production of Model Y vehicles in both the Berlin and Texas factories.

Shared Charging Infrastructure

• Tesla introduced the North American Charging Standard (NACS), which has standardized charging across North America.
• Agreements have been forged with major automakers such as General Motors, Ford, Volvo, and Mercedes-Benz to collaborate on expanding the charging network.
• The global Supercharger network now encompasses 50,000 connectors at 5,000 locations worldwide, providing an extensive and accessible charging infrastructure.

Robotaxi

• Targeted for mass production in 2024.
• The path to commercialization is still evolving, with cost control being a formidable challenge.
• A white car with a black background.
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Optimus

• Priced below $20,000.
• Demonstrates stable walking capabilities.
• Capable of grasping tools and performing basic tasks.
• Development of FSD system is expected to contribute to the advancement of the Optimus robot, further enhancing factory automation.

Investment Ideas

In the macroeconomic backdrop of global demand decline, we anticipate that Tesla will further reduce prices to maintain sales volume and compete for market share with other new energy vehicle manufacturers. However, this price reduction is likely to exert downward pressure on Tesla's gross profit margins and operating profit margins in the short term. Consequently, quarterly financial performance and stock prices may face challenges. Nevertheless, looking ahead, we hold a favorable view of Tesla's strategy to bolster its competitive advantage by investing in the field of artificial intelligence. Leveraging their extensive data resources, we envision a transition from an electric car manufacturer to an artificial intelligence enterprise.

Short-term Strategy: Present market sentiment is relatively optimistic, and any potential market pullback in the future could present attractive entry opportunities.

Cash Equity: We recommend a phased approach to build the position. Consider arranging purchases when the stock price falls below $215. The chance of acquiring it at $176 (50x PE ratio) may be limited.

FCN: Fixed coupon note can offer a steady stream of cash income. If the stock price experiences a decline, investors would have the chance to get the stock at a 60% to 70% discount (quote with Nvidia together can secure a more favorable pricing).

Long-Term Strategy: In the event that central banks initiate an interest rate reduction cycle and global demand experiences a resurgence, Tesla's gross profit margins may have the opportunity to return to a normal range of 25-30%. Furthermore, through the utilization of the H100 cluster and Dojo, achieving commercial implementation of full self-driving technology and monetizing vast datasets becomes plausible.

Accumulator: Consider employing an Accumulator strategy over a duration spanning 9 months to 1 year, consistently purchasing the underlying asset at relative discounts. This prolonged approach enhances the probability of achieving favorable outcomes over an extended timeframe.