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Electric cars in China

Tesla basks in Shanghai Gigafactory success but will rally last?

Electric vehicle maker hits $100bn market cap ahead of Q4 earnings announcement

PALO ALTO, U.S./SHANGHAI -- Just over a week after becoming the first U.S. automaker to hit the $100 billion valuation mark, Tesla will report its fourth-quarter results on Wednesday as investors watch eagerly for signs that the electric vehicle maker can keep its hot streak going.

Tesla's share prices has doubled over the past three months, giving it a market cap greater than Ford and General Motors combined. Analysts contribute much of that performance to one factor: the Shanghai Giga factory, which began vehicle deliveries earlier this month.

The recent stock rally began soon after Tesla CEO Elon Musk announced in October that the Shanghai Gigafactory had started trial production, less than a year after breaking ground. The company shares got another push when Tesla slashed the starting price of its Shanghai-made Model 3 sedan to 323,800 Chinese yuan (about $46,400) from 355,800 yuan in early January, which is expected to boost sales in China.

Strong demand in China and the production uplift from the new Gigafactory could lift the share price even further, according to some anaylsts.

"The bull party will likely continue as the aggressive trajectory of Gigafactory 3 production and demand out of Shanghai look very strong out of the gates," said Dan Ives, managing director at Wedbush Securities.

Tesla's ability to ramp production and demand in the key China region this year and next will be the two major swing factors for the stock, according to Ives.

From the recent share price performance, investors seem confident on both those fronts.

"Despite the temporary cool-down of the EV market due to government subsidy cut, the demand for clean-energy cars in China will only go up as the Chinese government raises the 2025 electric car sales target," said a portfolio manager at a major U.S. asset management company who recently increased its holding of Tesla shares.

China aims for more than 25% of new cars sold by 2025 to be electrified, including all-electric, fuel-cell and plug-in hybrid models, according to the country's Ministry of Industry and Information Technology. Electrified cars currently account for about 5% of total auto sales in China.

"In the next two to three years, Tesla has the first-mover advantage in winning high-income customers as the policy tailwind drives the overall EV market to grow in China," the portfolio manager said.

Investors' apparent confidence in Tesla is tied closely to China's world-renowned production efficiency and sophisticated supply chains.

Tesla has been struggling with both production capacity limits and cost efficiency in the past few years.

Prior to the Shanghai plant, Tesla's production was dependent on its Fremont, California, factory, which has a production capacity of 400,000 vehicles per year, according to Tu Le of Sino Auto Insights, an advisory firm in Beijing that focuses on the automotive industry.

"The addition of the Model 3 assembly has pushed the Fremont factory closer to maximum capacity, hence the Shanghai Gigafactory was essential for further international growth," Tu said.

The Shanghai Gigafactory offers Tesla a much-needed improvement in cost efficiency and production.

In a previous earnings call, the company boasted that the new facility was built in just 10 months and cost 65% less than comparable Model 3 plants in the U.S.

"The new Shanghai Gigafactory is different from the Fremont location due to the fact that this was a greenfield site, meaning that the factory was designed from the ground up to be a Tesla factory, including the ability to build battery systems, and didn't have to be retrofitted like the Fremont factory," Tu explained.

"This should in theory help them avoid many of the issues that they had to deal with when Tesla went through it's three months of 'production hell' when it was ramping [up] the Model 3," he added.

Indeed, while the Fremont location was slow to get up and running, the Shanghai Gigafactory hit the ground running, achieving its production goal of 1,000 vehicles per week within three months of trial production starting.

With the Shanghai Gigafactory reaching its production goal, analysts says Tesla is finally on track to deliver the on the goal Elon Musk set last year of producing 500,000 cars annually.

"Hitting the 100,000-150,000 run-rate for units over the next year in China will enable Tesla to hit its key 500,000 annual unit delivery threshold sooner rather than later, which is important as this could significantly ramp the profitability trajectory of Tesla over the coming years," said Ives at Wedbush.

Lower labor costs are another benefit of the Shanghai Gigafactory that will improve Tesla's profitability in the long term. Hourly wages in Shanghai are much lower than in Fremont, making the new facility more cost effective, according to Tu.

However, not everyone is fully buying in the bullish outlook and rosy pictures built upon the Shanghai Gigafactory and China market. The expectations for Tesla stock price continues to rise might be "a stretch because it requires perfect execution, strong electric vehicle demand growth and at the same time failure of the incumbent OEMs to launch competitive EVs," said Patrick Hummel, an auto analyst at UBS.

"Any delay, adverse regulation change or ramp up issue would likely trigger a sharp negative share price reaction," he added.

The major challenges that lie ahead for Tesla include increasing sales enough to keep the plant running at a decent utilization rate, according to Sino Auto's Tu. Because Shanghai Gigafactory was completed unusually quickly, in just 10 months, only 30% of the parts come from local suppliers. The automaker aims to buy 100% of parts from local suppliers by the end of 2020, a not insignificant challenge, Tu said.

"The wildcard is doing this in a foreign country with a mostly new staff in an uncertain economic environment," Tu added.

Another long-term question is whether Tesla can replicate Shanghai Gigafactory's success in other locations.

The company recently announced plans to buy a 300-hectare property on the outskirts of Berlin to build its first Gigafactory in Europe. Tesla has set a less aggressive timeline for the new location than it did for Shanghai, with the Europe Gigafactory expected to begin production by the end of 2021.

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