Tesla Motors Inc (NASDAQ:TSLA) shares sank 11.30% to $178.59 on Thursday after the company’s first quarter results. Though results beat the consensus estimates and Model S deliveries were above guidance, soft Q2 guidance triggered the heavy sell-off. But on the ground, Deutsche Bank analysts Rod Lache and Mike Levin see strength in the electric vehicle maker’s business model.

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Tesla has developed significant competitive advantages

To begin with, electric vehicles have significant advantages over other cars such as lower maintenance costs, lower fuel cost, better handling, more interior space and the convenience of home refueling. The EV technology has the potential to revolutionize the automobile industry. One of Tesla Motors Inc (NASDAQ:TSLA)’s biggest competitive advantage is its proprietary battery pack design. The company packs thousands of small lithium-ion batteries, which results into cost efficiency.

While large format battery packs used by other companies cost $500-$600/kWh, Tesla Motors Inc (NASDAQ:TSLA)’s technology brings down the cost to $200-$300/kWh. And the company plans to reduce it further to $175 or less. Elon Musk believes that the battery costs will decline by 30% if the entire battery supply chain is moved to one location. That will help the San Francisco-based company bring down costs and improve margins because the battery pack has been the single biggest factor that led to the premium pricing of Model S.

Moreover, these small batteries are more energetic, giving Tesla Motors Inc (NASDAQ:TSLA) a range advantage that is hard to replicate. Besides, the company has developed a number of competitive advantages such as the Supercharger network and direct distribution margin advantages. Though there is a risk of new competition, Tesla can mitigate them with its growing list of competitive advantages. Even after 17 years of launching Prius, Toyota Motor Corp (ADR) (NYSE:TM) (TYO:7203) has a 60% share in the U.S. hybrid electric vehicle market. Deutsche Bank believes that Toyota’s competitive advantages are much smaller than those of Tesla in the electric vehicle market.

How Tesla can increase the gross margins to 38%

Tesla Motors Inc (NASDAQ:TSLA) intends to increase its sales to 500K units by 2020. Deutsche Bank estimates that more than 40% of those sales would come from the United States. As the chart below shows, the Elon Musk-led company is expected to invest $3.5 billion in the next four years to boost its manufacturing capacity, develop Model X, expand its reach, build the Gigafactory, and develop the Gen III vehicle.

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Rod Lache and Mike Levin estimate that Tesla Motors Inc (NASDAQ:TSLA) has the potential to reduce the cost of Gen III vehicle to about $30,000. And the base price is likely to be in the range of $40,000. That reflects a 25% incremental margin even without options. A well-optioned Gen III car may cost consumers about $48,000, giving Tesla more than 20% gross margin. If you apply the volume leverage and battery cost savings for production of Model S and Model X, Deutsche Bank says that all-in gross margins would go up to 38%.

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