Will Tesla Impress In 2016?

As Tesla reports 4Q, the company has the challenge of meeting inflated investor expectations. The company while fascinating and innovative is valued based upon future expectations which are prone to wild swings. Investors will be looking for clues about vehicle deliveries in 2016, Model X production ramp, Model 3 launch and the progress at the battery facility affectionately known as 'Gigafactory'. More importantly, investors will be looking for China update as Tesla recently talked about undercutting competition in the market through aggressive pricing.

Meanwhile, it is worth taking a look at how 2016 could turn out to be for Tesla as the company has multiple targets to meet in the year and beyond.

Model X as a growth driver

Tesla started shipping Model X in the final months of 2015, initially delivering to customers who placed preorders for the vehicle from as far back as 2012. The company produced 507 units of Model X in the last quarter of 2015, but delivered 208 units of the vehicle in the same quarter. Tesla is currently able to produce 238 Model X vehicles every week, but the company is working towards a higher weekly production rate. According to CEO, Elon Musk, they are hoping to enter full production of Model X by the end of March 2016. Overall, the company is looking to produce 1,600 to 1,800 Model X and Model S vehicles every week.

There is strong demand for Tesla vehicles but one of the things holding the company back is strained production. The company manufactures both Model X and Model S at its lone production factory in Fremont, California. In several occasions, Tesla has been unable to deliver vehicles on time because of production delays. As such, efforts to increase production should pave way for Tesla to generate more revenue as it satisfies solid demand for its products.

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Model X is particularly promising to be a major growth driver for Tesla. The vehicle’s innovative body design, with the signature Falcon-wing doors, puts it in a class of its own among the luxury SUVs. The Model X is also the kind of a vehicle that rich Chinese drivers like. As much as Tesla has been selling Model S sedan in China, it has been a bit difficult driving sales, partly because the smaller size of the car doesn’t quite satisfy the ego of many wealthy Chinese drivers. But the Model X do, which should support more accelerated adoption of the car in the country.

Overall, the Model X should help boost Tesla’s brand recognition and pave the way for more solid revenue growth.

Model 3 for mass-market

Tesla has not made a firm promise of when the low-cost Model 3 will come to market. However, a 2017 launch has been widely mentioned. Perhaps a prototype of the Model 3 could be shown off in the latter part of this year or early next year.

Regardless of whether Tesla unveils a Model 3 prototype in late 2016 or 2017, the company has made clear what the car will be all about. The Model 3 is being prepared for the mass-market and it could start at $35,000. At that price point, the vehicle will compete for customer attention with (DE:BMWG) 3 Series and Audi A4, which cost from $32,000.

Tesla is not worried that its low-cost Model 3 will still be a bit pricey compared to closer rivals. The company hopes that Model 3 will displace the competition among customers looking for a true luxury car running on electric engine. Tesla also hopes to build features into Model 3 that will surprise the competition. The basic Model 3 is expected to deliver a range of 200 miles.

Given the stock trades on future expectations, positive comments about Model 3 during the 4Q earnings event should bring some strength to Tesla stock this year.

Gigafactory battery facility

Tesla’s battery facility is under construction. The company has been providing ongoing updates about the facility and 4Q earnings event should see more updates shared with investors.

Gigafactory is one of the major potential growth drivers at Tesla. From the factory, Tesla will be producing batteries to use in its vehicles, allowing the company to eliminate battery supply constraint and reduce the cost of acquiring cells used to power its electric engine vehicles. The Gigafactory will play an important part in making mass-market Model 3 a reality. Ultimately, Gigafactory should pave the way for profits at Tesla as the company cuts production cost because of lower costs associated with battery acquisition.

Tesla energy unit also stands to benefit from the Gigafactory. The company has entered into the business of selling energy storage solutions for homes/office (Powerwall) and utilities (Powerpack). Tesla is targeting revenue of between $400 and $500 million from the sale of the energy backup solutions in 2016. Management believes that the energy storage business could generate “a few billion” next year.

China as an opportunity waiting to happen

Tesla Motors has identified China as a huge growth market. One of the major growth drivers in China for Tesla is the country’s auto policies that favor green energy engines. The other growth catalyst is China’s rapidly expanding middle class population, who are willing to show off their new status with premium brands. With the Model X, the company is hoping to reach drivers who may not have been impressed by its Model S sedan.

Tesla is taking multipronged approach to penetrate China. The company is building more recharging stations for its Chinese drivers and opening more stores for sales. Additionally, Tesla is also planning to price its products competitively to boost sales. The company also has plans to start producing vehicles in China, thus allowing the company to eliminate expenses related to shipping finished products into the country. By producing locally, the company stands to benefit from government goodwill and higher margins as production costs fall.

Potential pressure zones

Falling oil prices: The decline in oil prices tends to favor sale of oil-combustion engine vehicles but hurts the adoption of electric vehicles. Prolonged decline in oil prices could dampen demand for Tesla’s electric vehicles, thus delaying the attainment of certain performance targets.

Delicate reputation: Tesla is battling an established industry and the burden is always on its shoulders to prove a point that would make people love its products. Unfortunate, as much as incidents involving Tesla vehicles have been few and far between, they tend to receive wider press coverage that put the company on its defense. Recently, a Model S caught fire at recharge station in Norway and investors are watching the issue closely. Nonetheless any issues have been far and few between and nothing compared to issues (N:GM)’s ignition switch.

Economic slowdown: Because Tesla targets the luxury market with its electric vehicles, an economic downturn that reduces discretionary spending can limit demand for the company’s products.

Bottom line

Despite the highlighted challenges, Tesla Motors has what it takes to impress in 2016 and beyond. The stock continues to trade at very rich view points based upon what the company will do in the future. There continues to be execution risk that even success may not meet current market expectations.