Is This the Real Source of Tesla's Profits?

Tesla Motors said that it sold more than 4,750 of its electric Model S sedans during the first quarter. Photo credit: Tesla Motors

Tesla Motors is set to report first-quarter earnings after the market closes on Wednesday. What should we expect?

For starters, we should expect a profit - Tesla's first ever.

Tesla said (on April Fools' Day, though it wasn't a joke) that it had exceeded its first-quarter-sales projections and would report "full profitability" when it presented its official earnings report.

That sent Tesla's shares soaring. But it raises a question: Where is that profit coming from?

Tesla says strong sales led to its first profit
Tesla CEO Elon Musk had originally said, back in February, that the company expected to deliver about 4,500 of its Model S sedans during the first quarter. That would be likely enough for a slight profit, if only on an "operating" basis, Musk said at the time.

It's that guidance that the company bumped up on the first of April. Tesla said that deliveries of the Model S had exceeded 4,750 during the first quarter - and that that would be enough for a righteous no-excuses profit.

It's true that sales of the Model S have been strong. The car, an all-electric luxury sedan with sleek looks, strong performance, and range comparable to gas-powered cars, has impressed drivers and critics alike.

But compared to a mass-market automaker, Tesla's sales have been tiny. And that raises some questions as to how it has managed to turn a profit so quickly.

At these prices, how is Tesla making money?
Tesla has said that expects to sell 20,000 cars in 2013. That sounds like a lot, and for a start-up electric-car company, it is an impressive total.

But for some perspective, consider that Tesla's full-year goal represents about two weeks' worth of pickup truck sales for Ford or General Motors - in a slow month.

Tesla's scale is obviously a lot smaller than a major vehicle program at Ford or GM, but still: The Model S required considerable up-front investment to develop. Everything from engineering time to factory tooling cost money - in some cases, big money.

In order to thrive, Tesla needs to recoup that investment and make enough extra to fund development of thenext Tesla model.

And it's not like Tesla's prices are outrageous. The Model S isn't cheap, but its pricing is comparable to similarly equipped luxury cars from BMW or Mercedes-Benz. All things considered, it's a good value for the money as luxury cars go.

But Tesla even lacks anything like BMW's economies of scale, meaning that its costs can't be low. How are they making money on this?

Are tax credits the real secret of Tesla's profitability?
Some analysts have suggested that the source of much of Tesla's profit may be a credit that the state of California offers for "zero emission vehicles" or ZEVs.

Under the state's arcane green-car regulations, Tesla gets a credit for each car sold. Those credits can then be resold to other automakers who aren't selling enough ZEVs to meet California's requirements.

Tesla may be getting as much as $35,000 each for those credits, according to a Los Angeles Times report this week.

If true, that adds a whole lot of profit to each Model S sale - profit that comes from rival automakers.

The upshot: A profit is still a profit
Tesla has downplayed the importance of the ZEV credits to its business in the past. But the issue has come back ahead of Tesla's upcoming earnings report, with one analyst telling the Los Angeles Times that the credits could earn Tesla as much as $250 million this year.

Tesla deserves big props for making it to profitability, no matter how it got there. But still, the idea that it's earning its profits by selling government credits to other automakers might make some investors uncomfortable.

Hopefully, Tesla will address the issue head-on during its earnings call on Wednesday afternoon. After that, we should have a better idea of how Tesla got to profitability - and what its prospects look like as sales continue to pick up speed. Stay tuned.

Near-faultless execution has led Tesla Motors to the brink of success, but the road ahead remains a hard one. Despite progress, a looming question remains: Will Tesla be able to fend off its big-name competitors? The Motley Fool answers this question and more in our most in-depth Tesla research available for smart investors like you. Thousands have already claimed their own premium ticker coverage, and you can gain instant access to your own by clicking here now.

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Motley Fool contributor John Rosevear owns shares of Ford and General Motors. Follow him on Twitter at @jrosevear. The Motley Fool recommends BMW, Ford, General Motors, and Tesla Motors. The Motley Fool owns shares of Ford and Tesla Motors. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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