Model 3 Still Isn't Cannibalizing Demand for Model S and X

On this segment of the Industry Focus: Energy podcast, host Sarah Priestley is joined by Motley Fool contributor Daniel Sparks to talk about the concerns they have about Model 3 cannibalizing sales of Model S and X have proven unfounded so far.

A full transcript follows the video.

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This video was recorded on Feb. 22, 2018.

Sarah Priestley: What about the Model X and Model S? I think there's difficulties on that side, too, with some bottlenecks and issues there. What's demand looking like for these vehicles?

Daniel Sparks: With the Model X and S, they did finish the year slightly above where they anticipated. That's one target they exceeded last year, just over 100,000 deliveries of just the Model S and X combined. That was encouraging. Of course, they had already announced deliveries for the quarter, so it wasn't really deliveries we were looking at, but, yes, demand and what to expect in 2018.

The bottlenecks you mentioned for Model S and X are kind of a chosen bottleneck at this point. What Tesla (NASDAQ: TSLA) wants to do is keep a steady state of production around the 100,000 annual unit rate that they're at right now. They are working with their partner Panasonic for the battery form factor on those. So, the form factor they're using is not the one that they brought to the Gigafactory for Model 3. So, what they've done is, instead of ordering incremental capacity from Panasonic, which would be quite a significant investment, they're hoping that demand for the Model S and X will continue to increase in 2018, and they could really focus on highly optioned vehicles and get that gross margin up on Model X and S from a steady state of around 25% for those two vehicles, to push it higher around 30%.

That's where they're at right now. And actually, they've already sold out of about half of the Model X and S units for the year. So far, it's actually working out the way they wanted, and it's actually been kind of surprising, the Model 3 has been driving a lot of interest to the Model S and X. And of course, that could be partly because of the delays. But they're also putting the Model 3 in stores, and they're seeing a lot of positive traction from that. So, if you put in an order for a Model S and X now, you're actually waiting until June. It's getting closer to the Model 3 at that point. So, that's been a really interesting thing. Now we just need to see Tesla follow through on prioritizing the highly optioned vehicles, work on those gross margins.

Priestley: Yeah. As you said, the Model 3, once you've bought up all of your options to increase the value of it, you're probably looking at getting higher toward there Model S price anyway, I'd imagine. I don't know, necessarily, the upsell there. It'll be interesting to see. I think they're capping the supply of Model S and Model X to 100,000 units in 2018. Is that right?

Sparks: Yeah. They said around 100,000 units. So, what to expect in 2018 is, yes, around 100,000 units, but they do want to push the average selling price on those two vehicles higher. They've done that in the past. And the way they've usually done that is by eliminating features on the base model, including higher-end options on the base model, and simultaneously increasing that price. They could do that, or they could also introduce new features at the high end, they could further prioritize the highly optioned vehicles to give them much faster delivery than the lower-optioned Model X and S. So that's what we'll be looking for, is to really see that average selling price go up this year.

Priestley: And it's really good to see them focus on that, too.

Sparks: It is. It's actually very encouraging. Of course, an extra 5% of gross margin from those two vehicles can contribute significantly to both gross profit and operating income, so that'll be good.

Daniel Sparks owns shares of Tesla. Sarah Priestley has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Tesla. The Motley Fool has a disclosure policy.