Tesla Motors: Ramping Up Production

It’s a make or break year for Tesla Motors (TSLA $35.30). The high-end electric car manufacturer is ramping up production on its Model S almost tenfold from 2012, to an expected 20,000 vehicles. The demand is there; the question is whether or not Tesla can keep up with production without hurting margins. We’re estimating that Tesla will post positive pretax margins this year (2%), a first. The company’s guidance suggests that gross margins will approach 25% by the end of the year, not counting the zero-emissions credits it receives from the government.

Right now, about three-quarters of sales are made in North America. Model S sales have been almost exclusively made in the U.S. so far. Elon Musk, the CEO, mentioned in the Q4 earnings release that only two Model S sedans were on the road in Europe at that point. Sales in Asia were almost non-existent. But Tesla plans to market more aggressively in those places this year. 

Tesla will be in a good position if it gets close to its 20,000 vehicle goal. We’re estimating $1.7 billion in revenue for the year, right around 17,000 cars sold. Musk also claimed that the negative review in the New York Times would cost Tesla $100 million this year. The effect remains to be seen, but it seems an exaggeration. The company could withstand a hiccup in production here or there since there isn’t much in the way of direct competition. Fisker, its chief rival, just had its founder step away, the latest in a series of mishaps. Electric cars from major manufacturers like the Nissan Leaf don’t offer comparable performance or luxury to the Model S. There is some competition with gas-powered luxury sedans, but for the most part sales are made to people who are already interested in driving an electric car. Since Tesla is relying on word-of-mouth, it’s got to keep its customers happy. Significant delays would lead to cancelled orders, and some potential buyers would put off buying a Tesla or lose interest altogether.

Shares are likely to post earnings this year. We estimate a $.17 EPS, but that’s achieved by adding back the stock-based compensation expense. Our calculations suggest income of about $30 million. Tesla’s official accounting will be closer to break-even. The stock price is high compared with earnings, and Fisker’s troubles show that there is plenty of risk in electric cars. Tesla will be in a much better spot if it can get through 2013 without any major trouble. The company’s crossover style Model X is due to start shipping early in 2014, and the car is already receiving reservations. Musk thinks the market for Model X will be about 70% that of the Model S.

Tesla doesn’t advertise its cars like traditional manufacturers. The company does have ads, but has gotten the word out principally through its Tesla Stores and word-of-mouth. Most of the Stores in North America are located in malls. This helps to lure in curious shoppers, and the centralized locations are convenient for people who live in the area. There are currently 25 Stores open in North America (24 in the U.S.), with four more opening in the coming months. There are more service centers opening up for customers that don’t live near a gallery. At the moment though, the network is sparse if you live in, say, Cleveland. The closest Store is in Toronto, the closest in the U.S. in Chicago. And the nearest service center would be two and a half hours away in Columbus. For now, the convenience really only applies to people in Southern California and New York/New Jersey. 

The company needs to develop a strategy to deal with bad press. John Broder’s New York Times piece is the most well-known example. He claimed the Model S’s battery struggled during cold temperatures. Musk responded with data logged during Broder’s test drive, and claimed the Times report was dishonest. At its core, it’s a he-said, he-said feud, and all it will do is invite others to investigate the battery’s performance. This post shows cold weather has a significant impact on battery life.

The battery itself has also come under attack recently, from Wall Street Journal opinionist Bjørn Lomborg. We’ll take what he says with a grain of salt, because he is a known green energy nemesis. He argues that electric cars, despite claiming zero emissions, actually leave a greater carbon footprint than gas vehicles. Research shows that it takes twice the amount of energy to manufacture an electric car than a gas-powered one. Most of this energy is spent mining lithium for the battery. Charging the car also uses electricity, which is still predominantly generated using fossil fuels. Tesla’s Supercharger stations are solar powered, but there are only nine of them in the United States. The company plans to install 100 by 2015. The company suggests keeping a Model S plugged in when not in use, because the battery depletes even if the car isn’t running. Unless owners can find a renewable energy source to keep their cars plugged into, the Model S becomes less environmentally-friendly than advertised. Lomborg says government incentives to electric car manufacturers and buyers don’t match the actual environmental savings. This technology is still fairly new though. Lomborg should realize that a true zero-emissions car won’t just appear out of the blue. It’s going to take some work. 

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Under Construction: The State of Solar

By Eric Ramsley  

The Los Angeles freeway system is in disarray. There is a lot of work that needs to be done. But there is so much traffic that there isn’t a whole lot of time to get anything fixed. Even when roads are temporarily shut down, like the 405 was earlier this year, no discernible progress is made. And by the time any construction is finished it will be time to start all over again. The roadways resemble the handful of Frankenstein cars driving along them: Pieced together with spare parts and clinging to dear life, unrecognizable from what they once were.

Swap out a few words and you’ve got the United States’ power grid. A jerry-built electrical network owned and operated by competing companies that is being stretched to its limit. Improvements have been proposed, but much like the highways in Los Angeles, by the time they are complete it will be time for the next round of emergency surgeries. Some have suggested that the grid’s poor state leaves it vulnerable to a terrorist attack; others argue that it is so shoddy and unpredictable that such an attack might ultimately fail.

Los Angeles is so developed that replacing the highways is highly improbable, if not impossible. But it’s at least conceivable that a new power grid could be built around the existing one, with the old system providing power up until the new system is complete. The benefits should outweigh the costs. The U.S. could have a state-of-the-art grid in place, securely and efficiently meeting increasing demand. This would also keep power companies in control of distribution. As much as some of them seem to want to believe it, the current setup will not be around forever. 

Sevcon ( Nasdaq - SEV ) -- Better Days Ahead

Sevcon (SEV $3.75) reported lower than expected Q1 (Dec.) results.  Sales dropped 22% to $6.64 million.  Earnings slid to a loss of $.39 a share.  Sevcon is a leading provider of controls for electric vehicle engines.  In general, half the business is directed towards off-road work machines.  The rest is used in small city cars, motorcycles, and all terrain recreational vehicles.  Both segments were hit hard in the latest quarter, continuing a slowdown that began earlier in 2012.  European volume nosedived 44% due both to the poor economy and a break in production by Renault of its promising city car line.  U.S. volume declined 18%, mainly due to the election.  The Obama Administration implemented stringent E.P.A. rules that will force a large increase in electric work machines.  Producers of those fork lift trucks and other vehicles delayed implementation, hoping Mitt Romney would be elected and moderate the impact.  Asian demand picked up by 17%, but that represents a small part of the business currently.

Work machine volume is poised to accelerate over the next 3-5 years.  E.P.A. regulations that go into effect in 2015 and 2017 will require less pollution and greater fuel efficiency.  Sevcon is working on a number of programs, mainly in the hybrid engine area.  The electric car segment promises to recover, as well.  Renault built a limited number of city cars to begin with in 2012.  Demand was strong.  Bigger production volumes are slated to begin in March.  Motorcycle and ATV demand has been consistent.

The long term outlook remains positive.  Electric vehicles will remain a niche segment until improved battery technology expands their range.  That's not on the horizon.  But there are millions of short range commercial, industrial, and consumer vehicles that are candidates for hybrid and electric engines.  The share count is low. So any meaningful improvement could support substantial stock price appreciation.

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Power One ( Nasdaq - PWER ) -- Malaise de Europe

Power One (PWER $4.00) appears on track to report lower than expected Q4 results.  The company is the second largest producer of string converters that turn DC power generated by solar panels into AC electricity.  Demand declined dramatically in Q4 following the elimination of key subsidies in Italy and Germany.  Other European nations have imposed reductions, as well.  U.S. business remains good.  Accelerated depreciation rules, federal tax credits, and a range of state and local programs have kept the residential and light commercial segments expanding at a fast pace.  But large installations, which account for half the American market, have slowed due to the recession and more efficient energy use.  Financial performance is likely to fall short of previous targets in the December quarter.  Sluggish results could persist well into 2013 as European declines erase whatever upturn Power One benefits from in the U.S.  Asian solar installations are on the rise.  But those projects are tough to crack due to protectionist schemes.

The long term outlook is uncertain.  U.S. subsidies are scheduled to end in 2016.  Tariff wars are cropping up, making it difficult to serve the entire world solar market.  Europe remains depressed, making it unlikely new government subsidies will emerge any time soon.  On the plus side inverter production costs keep coming down.  New products are in the pipeline.  And the cost of solar systems in general remains on a favorable slope, laying the groundwork for broad based adoption over the long haul.

2013 is likely to be a transition year for Power One.  The company is well financed, though.  And its new product pipeline promises to reinforce Power One's competitive position.  Earnings could rebound in 2014, perhaps bolstered by new U.S. government support.  Natural gas remains a huge challenge to the industry.  That lower cost and less polluting fossil fuel has displaced home heating oil and coal over the past five years, lowering co-2 emissions in the United States by 10% over that time.  The lack of electricity demand growth presents another obstacle.  More efficient appliances and lighting have helped keep electricity demand flat in the U.S. despite fast growth in the number of electrical devices.  If total electricity output doesn't improve solar probably will expand less rapidly than predicted.

Long term appreciation is possible in spite of the headwinds.  If the world economy returns to normal and trade obstacles are not created, Power One could rebuild earnings to the $.50-$1.00 a share range within 2-3 years.

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GT Advanced Technology ( Nasdaq - GTAT ) -- Backlog Vanishes

GT Advanced Technology appears on track to report poor Q4 results.  The company is the leading provider of capital equipment for the solar industry.  One set of machines produces polysilicon.  Another converts that into solar cells.  Assembly operations performed by other companies, primarily in the Far East, combine those cells into panels.  GT Advanced entered 2012 with a billion dollar backlog.  Oversupply conditions in the solar industry, brought about by sharply reduced government subsidies in Europe, caused incoming orders to dry up.  The company continued to recognize decent revenues earlier in the year from equipment that already had been delivered and was awaiting final customer acceptance.  New shipments took a nosedive.  And that trend is unlikely to reverse before late 2013.  Low revenues are likely to yield an operating loss in the December period.  A large inventory writedown is anticipated, as well.

A next generation technology is slated for introduction in mid-2013.  That will be a modular add-on unit with a selling price far below that of a complete system.  The new "mono-silicon" approach promises a significant improvement in solar cell performance at a comparable cost to "poly-silicon."  The Far East solar industry is in the midst of a consolidation, however, so few orders are expected right away.  Financing remains hard to obtain and profit margins still are under pressure.  Chinese government subsidies may cause the oversupply situation to persist by propping up weak participants as a vehicle to preserve jobs.  Orders for GT Advanced systems probably won't accelerate until the profit potential from its new machines improves.

The LED segment is under pressure, too.  GT Advanced encounters direct competition in that market.  LED lighting costs far more than conventional bulbs.  Consumer and commercial demand is rising, though.  The current lull in capital equipment orders is likely to end long before the solar industry rebounds.

Our estimates are below the company's official guidance.  GT Advanced predicts income of $.25-$.40 a share in 2013 on revenues of $500-$600 million.  Results could bounce back starting in 2014.  The company remains the only large volume producer of solar manufacturing systems.  Future results might be diluted 20% by a recent convertible bond issue ($7.71 a share).

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Real Goods Solar ( Nasdaq - RSOL ) -- Speculative Turnaround

Real Goods Solar (RSOL $0.85) appears on track to report unexceptional Q4 results.  New management was brought in during the third quarter.  The company's two largest shareholders each contributed $1.0 million in debt financing, as well, to tide things over while operations were straightened out.  Overdue receivables were collected, reinforcing cash flow.  Middle management was streamlined.  New marketing techniques have been developed.  And better supply arrangements were negotiated.  Still, the overhang from earlier mistakes almost certainly kept sales below potential.  Margins probably remained below normal, as well.  Another sizable loss is anticipated.

The solar installation industry is thriving, though.  If Real Goods Solar's new management team can restore operations to normal, profitability could reverse course in a meaningful way.  The company is a leading provider of solar systems for residential (50% of sales) and commercial (50%) customers.  The latter business was added early in 2012 via an acquisition.  The underlying business remains solid but too much bureaucracy was created by the merger.  Most residential contracts provide homeowners with electricity at prices below local utility costs with no upfront investment.  Real Goods Solar engineers and builds the systems, and then sells them to investors who benefit from a raft of tax benefits.  Homeowners either lease the systems and pay a fixed monthly amount.  Or they pay for the electricity they use, subject to a monthly minimum.  The format usually depends on what kind of buy-and-sell deals are available with the local utility.

U.S. tax credits offset 30% of a system's cost.  The law actually allows higher credits based on a "market value" formula, although that approach has been subject to abuse and now is being investigated by the government to identify possible fraud.  State and local governments provide additional payments.  And many utilities are forced to offer incentives of their own.  On top of that the I.R.S. permits 60% first year depreciation, and 100% after five years.  Low interest rates facilitate financing options further.  As a result installation companies like Real Goods Solar can sell systems at a hefty mark-up to the financing companies. The trick is to keep marketing, management, and regulatory costs to a minimum.

A large debt payment comes due next April.  Sales expansion is likely to be held back until that obligation is refinanced.  The bank is sure to require evidence that margins are returning to normal.  Despite that constraint on selling expense, sales promise to improve at an above average rate.  Panel costs continue to fall.  Installation methods have become increasingly efficient.  And the tax incentives will remain in place until 2016, if they aren't extended.  Climate change has been identified as a top priority by President Obama as he begins his second term.  Additional boosts could emerge.

We estimate Real Goods Solar will return to profitability this year.  In 2-3 years sales could reach $150-$200 million.  At 5% pretax margins fully taxed income could attain $.15-$.20 a share.  Higher margins appear possible, especially if the regulatory climate is simplified.  Obtaining permits and hook-ups now accounts for 25%-40% of a deal's total cost.  Aligning local utility interests with the solar industry could yield further benefits.  New solar technologies are in the pipeline which could double price performance of the panels themselves in 2-3 years.  That rate of improvement could be sustained for several iterations, making solar a mainstream technology.

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Enphase Energy ( Nasdaq - ENPH ) -- Price Pressure Persists

Enphase Energy (ENPH $3.75) appears on track to report unexceptional Q4 results.  Enphase is the leading provider of microinverters that convert DC power generated by solar panels into AC electrical current.  Most of the solar industry uses string converters.  Those are large units that sit on the ground and convert an entire string of panels.  Microinverters are attached to each individual panel.  The string units are less expensive.  And their prices are declining quickly in response to engineering improvements and relentless competition.  Microinverters generate more electricity output, typically 10%-15% more.  String converters are limited by their worst performing panel.  If a single panel becomes impaired -- for instance by leaves, shadows, or debris --the entire system is affected.  Microinverteers enable each panel to produce at maximum output.  New financing arrangements in the U.S. residential solar market are encouraging system installers to emphasize price more than output.  Those schemes are cutting into Enphase's potential market, thwarting the company from growing as rapidly as it might.

A next generation product line could open up the commercial sector.  To date Enphase has serviced the residential market.  New systems slated for introduction early in 2013 promise to address the small commercial area.  Even larger units are planned for 2014.  Commercial building owners are likely to be more alert to the energy savings Enphase devices produce.  So even though lower initial prices for string converters will remain a competitive issue, acceptance could prove high.

Expansion outside the U.S. offers further potential.  Enphase concentrates on the U.S. market presently.  More than 90% of sales are to domestic customers.  Much of the rest is made in Canada.  New distribution channels are being developed to enter Europe and Asia.  The European market contracted markedly in 2012 due to the economic crisis, which caused subsidies to vanish.  Asian demand is picking up, although tariffs are on the rise to prevent imports.  Enphase is beginning from virtually a zero base, though, so at least some incremental benefit is likely.

We estimate 2012 earnings finished around minus $.80 a share.  Next year margins could improve as fixed costs are spread over a broader base, and direct costs are reduced consistent with selling price declines.  Our estimate is a loss of $.25 a share.  A move to profitability could occur in 2014.  The long term outlook remains uncertain.  U.S. tax subsidies equal to 30%-40% of a solar system's cost are scheduled to disappear in one fell swoop in 2016.  Further improvements in solar technology are likely to offset some of that.  But unless regulatory costs are brought down and electric utilities are given incentives to embrace solar, profitability might remain challenged well into the decade.

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