Focus on margins for Tesla | banks & the consumer recovery | Cloud warfare | Biden's taxes and fund management

Your Daily KnowHow

In today’s KnowHow…

• Focus on margins not volumes for Tesla

• HSBC and UBS both highlight the strength of the economic recovery…

• Cloud warfare… what Google, Microsoft and AWS are doing to get ahead

• Capital gains tax hike would imperil active funds

What happened overnight…

So, Elon doesn’t think Tesla’s just a car company… did he read the Daily KnowHow from a couple of weeks ago… hmmm. Back in the real world and investors are becoming increasingly confident in the economic recovery with HSBC and UBS both expecting a strong rebound (more below)… US futures have erased earlier gains while Treasury yields rose in early Tuesday trading having sold off again in the afternoon session. Commodities continued their fantastic run and are now at highest levels in 3 years while the USD rallied for the first time in three days. 80% of the S&P 500 has beaten expectations so far this reporting season but the muted share price reaction suggests that expectations were already high going into Q1 results.. remember our comment from yesterday.  

Focus on margins not volumes for Tesla

In our note on Tesla two weeks ago, we argued that increasingly the market understood the Tesla volume story and opportunity. Post the Battery Day in September, it was increasingly focused now on profitability at scale in automotive. Investors, needed to start doing the same.

A few charts on why we reached that conclusion. Below shows you the Tesla share price versus Auto volumes delivered to customers.

Stock implies a 1.1-1.6m/yr delivery run rate
Of course, stocks forecast the future. So, we have tried lagging that volume delivery between 6-12mths to see what the stock is actually forecasting. As you will see below, we think our 9mth lag fit well until just after the Battery Day when the company discussed getting costs down to as low as $25,000/car. Still, using the below chart, we think you can guesstimate that the stock is currently implying a 1.1-1.6m/yr delivery run rate by early next year. Assuming an S/X 2-2.4k/week run rate plus Texas and Berlin ramping up, that doesn’t seem like an unreasonable assumptions. And, in the space of just a few years, it would put Tesla in the ball park of BMW, Mercedes and Audi as the largest luxury car brand in the world.

Now over to margins
From here, volumes will of course continue to matter as the company keeps ramping up factories and new lines. However, as we show in our DCF sensitivity below, we think it’s the margin story that investors should increasingly focus on.

Adjusted for one-offs, gross margin improving
And, despite the hysteria around regulatory credits of $518m supporting sales, that margin story was there in the Q1 results in our view. In our schedule below, the Gross Margin % was 21%. That’s an improvement vs Q4 but importantly, the company is carrying around $200m of costs relating to the S/X ramp-up. Adjusted for that, ex any other one-offs, of which they seemed to suggest on the call there were a few, we would already be at a 24% gross margin.

Conclusion: the Tesla results had a lot of moving parts but if you dig beneath the surface, there is a lot going right in this business.

HSBC and UBS both highlight the strength of the economic recovery…

We have heard from both UBS and HSBC this morning and having listened in to the conference calls, we were positively surprised about the speed of the economic recovery and the confident outlook given by both companies. While there were some idiosyncratic disappointments with the Archegos scandal dampening the UBS results, this section will focus on the macro read across from the European banks. The short conclusion for us is that the European (especially UK) recovery is much stronger than expected and consensus expectations for the GDP recovery may still need to rise further. 

Kicking off with HSBC, while Asia was the driver of the outperformance, the company pointed to a faster recovery and stronger UK mortgage business as some of the drivers of the performance in Q1. Noel Quinn, HSBC's group chief executive, said the bank had made a "good start to the year". He said: 

"Global banking and markets had a good quarter, and we saw solid business growth in strategic areas, including Asia Wealth and trade finance, and mortgages in Hong Kong and the UK. 

On top of this, HSBC said that the upturn and greater confidence in the recovery has allowed the banking giant to release $435m (£313m) that had been set aside to cover bad debt, boosting its bottom line despite a squeeze on revenues caused by low interest rates. The bank said that the reduction in expected credit losses (ECL) at the start of this year was "due to an improvement in the forward economic outlook, mainly in the UK". 

The company stated that they are more confident than they were in February and expect GDP to rebound in every economy in which they operate this year, with the US and UK again cited as the keys here. We see this as a clear positive that supports some of the commentary we have heard from housebuilders and other UK domestic banks over the last few months. It is also worth noting that we have seen consensus UK GDP expectations rise over the last few months with leading economists now expect the economy to grow 5.4 per cent this year, much stronger than the 4.2 per cent expected in February, according to Consensus Economics, with many still of the view that expectations are still too pessimistic. .

Much like HSBC, UBS cited a strong rebound in sentiment and economic activity in Q1, pointing to greater optimism regarding the further recovery, supported by mass COVID-19 vaccination campaigns around the globe. Added to this, we thought it was interesting to see the strength of the UBS Wealth management business in all markets. The US is clearly the stand-out here with an extra $17bn net new fee-generating assets but the EMEA and APAC numbers also highlight the very buoyant client mood across all markets. 

What we’re reading

Cloud warfare

Spanish broadcaster, Univision, has agreed a package cloud deal with Google that includes ad services and Youtube. Now, if you have been following the Cloud wars between Google, Microsoft’s Azure and AWS, you’ll know that Google’s been lagging behind. Have a look at this chart from Canalys. The article suggests that the packaging approach used by Google has been the key deal clincher. BUT, the Big 3 cloud providers are determined to grab share and its important to appreciate that none of this comes without lawmakers keeping a very close eye on what sort of package deals are being offered.

Capital Gains Tax Hike Would Imperil Active Funds

A short article but an interesting read and something we are keeping a close eye out on. Actively managed mutual funds have bravely battled the indexing revolution sweeping the financial industry, but Biden’s capital gains tax increase may be the coup de grace…  Investors have known for years that actively managed mutual funds have little to offer. Today, there are investment options across all sorts of thematic funds without having to use active fund managers. Yet, there is still so much more money in actively managed mutual funds. Why? The answer is capital gains. People hate paying taxes, of course. And if they don’t sell, there is no immediate capital gains hit, even if it means tolerating gratuitously expensive and underperforming funds. But if Biden jacks up the capital gains tax rate, many of them will dump their funds to avoid paying a higher tax down the road.