Tesla (TSLA) reported a seminal quarter in its history with not only record deliveries but meaningful free cash flow of $881 million. That figure is a $1.6 billion improvement from the second quarter of 2018 and a $2.2 billion improvement year over year. We have been skeptical of Tesla's ability to execute but we did expect positive earnings surprises in the back half of 2018 as Model 3 volume ramped up. However, we did not think the free cash flow movement would be this large this fast. We expect the Model 3's momentum to continue into 2019 so we plan to raise our fair value estimate by about 20% to account for about 7.5 million vehicles (of all models) delivered through 2027 instead of about 6.7 million previously. We also are giving Tesla more scale in research costs.
Tesla delivered 56,065 Model 3s in the quarter, up from 18,449 in the second quarter. Total company deliveries were 83,775, more than triple the prior-year's quarter and a 105% rise from the second quarter of 2018. Tesla also reported adjusted diluted EPS, which excludes stock-based compensation expense, of $2.90, crushing consensus of a loss of $0.19. GAAP diluted EPS came in at $1.75. CEO Elon Musk reiterated second-quarter call comments by saying he expects the company to be self-funded going forward, retire rather than refinance upcoming debt maturities, and be free cash flow-positive other than for large debt payoffs. The Model 3's demand looks excellent with Tesla reporting order cancellations from the August 2017 reservation count of 455,000 of under 20%. Anticipation should continue to build for the company after it unveils the Model Y crossover next year, though it's not expected to be available until 2020. Most interesting to us is Tesla saying that over 50% of vehicles traded in for a Model 3 were vehicles priced below $35,000 when they were new. This suggests many consumers are paying more than normal to buy a Tesla Model 3, which is a good sign for brand equity and future demand.
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David Whiston does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.