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Tesla rides high on cost savings from China's Gigafactory

Global electric vehicle leader on track to generate profit from carmaking

An aerial view of new Model 3 electric vehicles sitting parked at the Tesla Gigafactory in Shanghai, China.   © Getty Images

PALO ALTO, U.S. -- Tesla reported a significant jump in its third-quarter earnings, a testament to the success of its mass-production strategy in China that has enabled the carmaker to rely on local suppliers and slash procurement costs. 

The electric-car maker reported a net income of $331 million for the July-September period, a 130% surge from a year earlier. "I think I've never felt more optimistic about the future of Tesla than I do today," a euphoric CEO Elon Musk said in the earnings announcement Wednesday.

Tesla's bet on its first assembly plant outside the U.S. has paid off. After the Shanghai Gigafactory began operations at the end of 2019, Tesla's local production ratio jumped from 50% to 70%, helping the company lower manufacturing costs. 

Global production forms "a core component of our cost-reduction strategy," Tesla Chief Financial Officer Zachary Kirkhorn said in the earnings call.

Lithium-ion batteries are the most expensive component in electric vehicles, accounting for an estimated 30% of the cost. Tesla in February signed a procurement contract with China's largest battery supplier, Contemporary Amperex Technology, or CATL.

The Gigafactory in the U.S. state of Nevada, jointly run by Tesla and Panasonic, already produces batteries for the American electric- car manufacturer, but Tesla's Chinese operation is expanding the use of locally made batteries.

The launch of an assembly plant in Shanghai at the end of 2019 has greatly improve the automaker's procurement costs.   © Reuters

What makes CATL attractive is not only its low prices, but also the company's advanced technology that develops batteries that eschew cobalt, according to a source familiar with the matter.

Tesla also sources components from China's Zhejiang Sanhua Intelligent Controls, a maker of heat-control parts, according to a Chinese research firm. Xiamen Hongfa Electroacoustic, another Chinese supplier of EV components, supplies Tesla as well.

In September, the company announced plans to switch to in-house production for battery cells. The goal is to produce cells equivalent to 100 gigawatt-hours, or enough to power 1.4 million EVs, in 2022.

Tesla will overhaul the cell design and establish technology to produce electrodes without using a solution to slash the production cost by more than half. 

This quarter's profit marks Tesla's the fifth consecutive quarter in the black. Selling regulator carbon credits to makers of gasoline-burning autos has been a big booster, but the automaker appears to be reducing its reliance. 

Although the company earned $397 million from carbon credits, subtracting that windfall would put it at around a break-even level.

The operating margin stood at 9.2% in the period, more than double the number from a year earlier. California plans to ban new sales of gasoline engines by the year 2035, which has put wind in Tesla's sails. The company's share price has rocketed up by a factor of eight in the past year in real value that takes into account its stock split.

One concern is Tesla's seeming overreliance on Musk, an eccentric entrepreneur obsessed with maximizing innovation. The pursuit of automation at the California factory between 2017 and 2018 led to trouble with mass production of the Model 3.

Critics have said that Tesla's board is staffed with both internal and outside directors who are loyal to Musk, pointing out that the company lacks a governance mechanism to put a stop to Musk's unrealistic business visions.

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