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Tesla Breaks Ground in Shanghai: Deliveries Begin in World's Largest EV Market

Orders for Tesla Inc. (NASDAQ:TSLA) vehicles in China are predicted to reach approximately 6,400 this quarter following the company's Jan. 7 groundbreaking ceremony of its Gigafactory in Shanghai and a new purchase tax exemption, which will save buyers an estimated 99,000 yuan ($14,000) on a new Tesla.

Tesla shares were up 3.88% to an all-time high of $469.06 on Tuesday for a market cap of $84.55 billion following the optimism of the groundbreaking ceremony. Analyst sales forecasts are all over the place, ranging from conservative estimates of 21,000 China-built Model 3s for the year (from LMC Automotive) to more optimistic numbers such as 100,000 (from Shanghai-based AutoForesight).

Tesla's price volatility, debt and popularity make the stock a quick responder to news, so any updates to the progress of the Shanghai factor and its sales will likely be priced in quickly. In the U.S., the electric vehicle maker delivered 367,500 cars in 2019 and saw a 26% increase in its share price, but future growth will hinge largely on whether the company can prove its ability to succeed on a more global scale.


The China EV market

Buying a car in China is typically more complicated than in the U.S. and many other countries, especially in heavily populated metro areas like Shanghai.

In Shanghai, buying a license plate comes before buying a car. The city sells license plates by auction, and those who want their own car often spend around two months at the auctions before being able to purchase one for around 90,000 to 100,000 yuan (approximately $13,600), which is almost as much as new car. Beijing, on the other hand, has tackled traffic congestion with a license plate lottery, which was introduced in 2011. A potential car buyer must have success in the bi-monthly lottery drawing before showing up to buy a car with the license plate in hand.

After buying or otherwise winning a license plate, car buyers in China must add 10% to the price tag of any car, since the Chinese government charges a 10% purchase tax on all vehicle sales.

Further impeding growth in automobile sales in China, particularly electric vehicles, is the recent rollback of government subsidies for their purchase. Though Tesla was still able to secure a $3,350 per car handout, the rollbacks will continue, even for the financially-embattled Chinese EV maker NIO Inc. (NYSE:NIO), which is in desperate need of increased sales given that it does not have enough cash to sustain operations for long.

Tesla also has a major pricing obstacle. While it has expanded into China in order to establish itself as a global maker of luxury electric vehicles, the Chinese market may not be able to support the sale of the 1,000 vehicles a week that the Shanghai factory currently produces, much less plans to double and triple production.

More than half of electric cars sold in China cost less than $14,300, while the price tag of Tesla's Model 3 is at $46,400 after a 9% reduction from $51,000. Only time will tell if there are enough buyers to support production. Additionally, around 70% of China's EV sales are to the government and policy-direct consumers such as taxis, which means only 30% is available for the company to appeal to via mass-marketing.

Automobile market decline

Car sales were booming when Tesla CEO Elon Musk decided to build the Shanghai Gigafactory in early 2018, but have been in decline ever since. Global car sales are predicted to drop by 3.1 million in full fiscal 2019, according to economist forecasts from Fitch Ratings, which would mark the steepest auto sales decline since the 2008 financial crisis.

"The downturn in the global car market since the middle of 2018 has been a key force behind the slump in global manufacturing and the car sales picture is turning out a lot worse than we expected back in May," said Fitch Ratings' chief economist Brian Coulton in a statement.

The decline is occurring across most of the world, though it is worse in some countries than in others. Auto sales are expected to decline by 4% overall, 2% in the U.S. and 11% in China. The 11% predicted decline in auto sales in China came from a variety of factors, including the reduction of government subsidies for electric vehicles and the trade war with the U.S.

"It's a distorted need," Robin Zhu, an analyst with Bernstein, said in reference to high estimates of the short-term growth potential of the electric vehicle market in China. "And the market won't change much in the next two to three years."

Potential tailwinds

Despite the general global decline in auto sales and Tesla's high price tag, the company's vehicles do have some promising tailwinds.

China is holding to its decision to exempt purchasers of Tesla vehicles from the 10% purchase tax that is typically attached to all vehicle sales, which would reduce the price tag by up to $13,957.82, according to a post on Tesla's WeChat account.

Additionally, as the first major foreign luxury EV maker to build a factory in China, Tesla has created for itself an opportunity to establish its brand name in the world's largest EV market - an important step given how heavily luxury brands rely on the strength of their reputations. China is a growth market that is critical for Tesla's success.

"We need to bring the Shanghai factory online," Musk said in the company's January 2019 earnings call. "I think that's the biggest variable for getting to 500,000-plus a year."

Disclosure: Author owns no shares in any of the stocks mentioned. The mention of stock in this article does not at any point constitute an investment recommendation. Investors should conduct their own in-depth research and/or consult a registered financial advistor before purchasing securities of any kind.

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