It’s interesting to see how the automotive business of Tesla (NASDAQ: TSLA) stacks up against its bigger rival General Motors (NYSE: GM). We know that Tesla is relatively new to the automotive industry and is a pure player of electric vehicles. On the other hand, General Motors or GM has already been in the automotive industry for more than several decades and has only jumped on the electric vehicle bandwagon as recent as few years ago.
With both companies getting more and more ambitious in the automotive industry, I would like to see how both companies measure up to each other in terms of revenue and gross profitability.
Specifically, I am doing a comparison of both automakers based on revenue and gross margin. The gross margin is a variable that measures the gross profit after deducting the variable cost associated with manufacturing the products.
According to Investopedia, gross margin is a measurement of the efficiency of a company in utilizing its labors and raw materials in producing the goods. Therefore, the more efficient a company utilizes its resources, the higher the gross margin it can derive from the products since it can efficiently control the cost of manufacturing.
Aside from knowing the manufacturing efficiency, the gross margin also tells us about the pricing power of the products. For example, we can have two companies producing goods with the same cost, but one company may have a stronger brand which allows it to put a higher price tag on its products and this strong brand effect produces higher gross margin as well.
With that in context, we could find out a lot of information from just digging into the gross margin alone. Let’s read on!
Apple to Apple Comparison of Automotive Business
Before we proceed further, I want to make it clear that I am comparing only the automotive sector of both companies. Although Tesla and GM are major players in the automotive business, they have non-automotive business segments which contribute significant sales to the company revenue. In order to do an apple to apple comparison, I have stripped out non-automotive revenue when comparing the automotive revenue and gross margin of both companies.
For GM, the GM Financial is a business segment that provides automotive financing services and is not related to any car making activities. As such, I have taken out the GM Financial revenue when measuring the automotive revenue and gross margin in subsequent charts. The following snapshot shows the portion of GM Financial in the income statement in which I have excluded in my calculation of automotive revenue and gross margin.
Similarly, Tesla has non-automotive businesses such as energy generation and storage in which I have stripped off as well.
You may have noticed that I did not exclude the “Services and Other” portion of revenue in Tesla. Although this portion of revenue mainly relates to sales derived from repair and maintenance services, sales of car components as well as sales of used vehicles, it’s included as part of my measurement of automotive revenue and gross margin because General Motors has the same type of revenue segment in its automotive business. The worst part is that GM had lumped this portion of revenue together with its automotive sector which makes it difficult to exclude this portion of revenue segment.
Here is an except from GM financial statement regarding sales from “Services and Other” and “Used Vehicle”:
Proceeds from the auction of vehicles returned from daily rental car companies and vehicles utilized by our employees are recognized in Automotive net sales and revenue upon transfer of control of the vehicle to the customer and the related vehicle carrying value is recognized in Automotive and other cost of sales.
Services and Other
Services and other revenue primarily consists of revenue from vehicle-related service arrangements and after-sale services such as maintenance, vehicle connectivity and extended service warranties. For those service arrangements that are bundled with a vehicle sale, a portion of the revenue from the sale is allocated to the service component and recognized as deferred revenue within Accrued liabilities or Other liabilities. We recognize revenue for bundled services and services sold separately as services are performed, typically over a period of less than three years.
Therefore, for the purpose of comparing similar type of revenue and gross margin of both companies, I have included the “Services and Other” revenue segment in my measurement of automotive revenue and gross margin for Tesla.
Assumptions That I Have Made
In terms of costs and expenses, GM has lumped its research and development expenses under automotive cost of sales as shown in the following snapshot and an except from its financial statement.
Research and Development Expenditures
Research and development expenditures, which are expensed as incurred in Automotive and other cost of sales, were $7.8 billion, $7.3 billion and $6.6 billion in the years ended December 31, 2018, 2017 and 2016. We enter into cost sharing arrangements with third parties or nonconsolidated affiliates for product-related research, engineering, design and development activities. Cost sharing payments and fees related to these arrangements are presented in Automotive and other cost of sales.
On the contrary, Tesla separated its research and development expenses from automotive cost of sales and put it under operating expenses.
In order to compare both companies as similarly as possible, I have added Tesla research and development expenses back to its automotive cost of sales.
The problem is that not all research and development expenses were spent on automotive sector. Some of the R&D expenses may have been spent on the energy business. As such, I have derived a percentage that is consistent with the ratio of automotive revenue to total revenue. This figure comes out to be around 80%. In other words, Tesla automotive revenue as a percentage of total revenue is around 80%.
Therefore, I have made an assumption that around 80% of research and development expenses were used in the automotive segment. This 80% of R&D costs were then added to Tesla automotive cost of sales to arrive at a gross margin that is consistent with that of GM.
Finally, it seems like we are all set with the numbers and assumptions. Let’s continue!
Automotive Revenue Comparison: Tesla vs GM
The above graph shows the comparison of adjusted automotive revenue between Tesla and GM over the past 5 years from 2015 to 2019. As discussed in prior paragraphs, Tesla automotive revenue has been adjusted to include the “Services and Other” business segment to match that of GM for an apple to apple comparison.
It’s very clear from the chart that GM automotive revenue is much higher than that of Tesla. In fact, in the latest quarters of Q3 2019, GM automotive revenue is about 6 times bigger than that of Tesla. 5 years ago, the difference was roughly 35X and 5 years later, Tesla has managed to close the gap with GM. That has been a remarkable feat for Tesla over the 5-year period!
Over the past 5 years, GM quarterly automotive revenue has actually declined quite significantly from its high of $40 billion during 2016 to about $30 billion in Q3 2019. Throughout 2018 and 2019, GM automotive revenue has stayed relatively flat at $30 billion. Looking at the trend of the plot, GM automotive sales will most likely remain flat at the $30 billion threshold without much upside.
On the other hand, Tesla automotive revenue has grown from a quarterly revenue of roughly $1 billion in 2015 to about $6 billion in 2018 before slightly going lower to about $5.4 billion in Q3 2019. Over the course of the 5-year period, Tesla quarterly automotive revenue has grown at a sequential rate of roughly 500%.
Despite the revenue difference of about 6 fold, Tesla is trading at about the same or larger market capitalization of GM which is about $50 billion. As a result, investors are putting a very high expectation on Tesla in terms of growth and expect Tesla to grow even further in the future.
Gross Margin Comparison: Tesla vs GM
The chart above shows the comparison of adjusted gross margin between the two companies. As discussed in prior paragraphs, Tesla cost of revenue has been adjusted to include a partial portion of research and development expenses to match that of GM for an apple to apple comparison.
As seen from the chart, Tesla adjusted gross margin has been much worse than that of GM from 2015 to 2017 before improving remarkably in 2018 and 2019.
In Q3 and Q4 of 2018, Tesla adjusted gross margin was close to the 20% level which was much higher than that of GM. The reason for the remarkable performance was the record delivery of Model 3, Tesla mass produced flagship vehicle, in 2018. The good sales performance during 2018 has bumped up the gross margin significantly and has resulted in Tesla making a profit in two consecutive quarters.
During these two consecutive quarters at Q3 and Q4 2018, Tesla gross margin of almost 20% has surpassed that of GM significantly.
Moving forward to 2019, Tesla adjusted gross margin was getting close to the level seen in GM and has grown higher than that of GM which is at 15% adjusted gross margin in the latest quarter of Q3 2019.
In short, Tesla is seen improving its gross margin starting 2019 but still lags behind the gross margin of GM.
To answer the question of whether Tesla is catching up with GM in sales and gross margin, there is still a lot of improvement to be done for Tesla especially in revenue growth. Since GM revenue is roughly 6X that of Tesla, there are still rooms for growth for Tesla.
Tesla is basically fast catching up with GM in sales as seen from its growth rate of over 500% from 2015 to 2019. In contrast, GM revenue has been stagnant and has shown sign of declining since 2017. I believe it is just a matter of time before Tesla finally reaches the size or even outgrows GM in sales.
In gross margin comparison, at a revenue of 6X less than that of GM, Tesla has already achieved a gross margin which is about the same as GM in Q3 2019. Tesla gross margin was much higher than GM in 2018 when its revenue reached $6 billion in those quarters.
As seen from its historical results, Tesla has the capability of surpassing the results of GM. If history repeats itself, Tesla will eventually achieve a gross margin that will be higher than its competitor when sales grows higher in the future.
Therefore, the valuation of over $50 billion in market capitalization that investors have put on Tesla as of this article is written is more or less justified judging from its growth potential in the future.