Tesla Raising Prices in China 20% Could Bring More Suffering

Tesla Inc.  (TSLA) shares are rallying on Monday, but perhaps only because it’s had such a terrible week of trading in the first week of July. It’s surely not because of its latest move in a China.

The electric vehicle maker raised the price of its Model S and Model X prices in China by roughly 20% in response to tariffs officially going into effect on Friday. Originally, Tesla slashed the price of its Model X vehicle in China, as the country lowered its import tariffs on foreign vehicles. This was seen as a positive development for Tesla, as electric vehicle demand continues to spike in China, the largest automotive market in the world.

With lower import costs, it should theoretically boost demand — something that Tesla surely wants to see. However, with new tariffs going into effect, Tesla was forced to raise its prices. A standard Model X now costs about 927,200 yuan, or about about $141,000. That’s quite the premium compared to the U.S., where a similar 75 kWh Model X costs $79,500.

For the 75 kWh Model S, Tesla’s website now says it costs 849,900 yuan or about $128,420. For comparison purposes, the base Model S costs $74,500 in the U.S. Talk about a price difference. Chinese buyers are paying more than $50,000 for the same Model S they can buy in the States. The Model X has a similar markup of more than 70%.

While the ~20% price increase due to tariffs aren’t helping matters, these two cars weren’t cheap to begin with. So what does that mean for demand? Just like a falling car price thanks to lower import costs should help boost demand, rising prices should hurt demand. While it may not have much of an impact in the short term, long-term demand should suffer should trade relations between the U.S. and China not improve. 

For the record, about 17% of Tesla’s total 2017 revenue came from China. 

Tesla Model X
Tesla Model X

Tesla is planning to build a Gigafactory and assembly plant in China. It helps that the country also scrapped its requirement for automakers to have a joint-venture partner, meaning Tesla can uniquely own 100% of its Chinese venture. Companies like Ford Motor Co (F) and General Motors Co (GM) certainly can’t say the same, although they seem pretty content with their current arrangement.

Given the demand for electric vehicles and the size of China as a whole, Tesla obviously wants to get moving there as quickly as possible. But it needs to tackle some of its current issues first.

The first is producing high-quality Model 3s and doing so at a rate of about 5,000 per week. If it can do so, it will produce about 250,000 units annually, and take almost two years to work through 420,000 unit backlog. This doesn’t include Model S and X orders.

However, CEO Elon Musk is still estimating that the automaker will be GAAP profitable and cash flow positive in the third and fourth quarters. That will need to come to fruition so that Tesla can raise the capital it needs to in 2019 to build out its Chinese operations and pursue several other projects (such as the Model Y). Of course, Tesla could still raise capital without a profitable second half, but it will be able to do so with stronger investor confidence and likely better terms if its cleans up its financial situation. 

That said, there are some alarm bells going off with Tesla’s current bonds, which mature in 2025. 

Even though Musk has been against raising capital, especially this year, even optimistic cash flow estimates for the second half of 2018 won’t be enough to tackle the multiple projects Tesla wants to pursue. That’s not necessarily a bad thing, it’s just the reality of the situation. As for the tariffs, they should be viewed as a net negative to Tesla’s situation and make the need for an operating facility in China that much more important. The question then becomes, when will Tesla get moving on the new Gigafactory and how much will it cost?

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