Tesla appears to be leasing more of its vehicles. Could that be a risk to the stock? Not likely. In fact, the way used Tesla vehicles trade, leases look like a bad deal for car buyers, but a great deal for Tesla shareholders.

Tesla (ticker: TSLA) no longer discloses the number of vehicles leased anymore. But during the second quarter, leasing revenue grew 29% year over year while overall automotive sales fell 5%.

More leasing isnt necessarily a surprise. Roughly 30% of new cars in the U.S. are leased. Street estimates puts Tesla leasing as a percentage of vehicle sales at less than 20%.

A lease is, effectively, a decision to rent a car for a fixed monthly payment. At the end of the lease term the lesseeor the driverwill turn a vehicle back into the dealership with no more financial obligations remaining, assuming the lessee doesnt overdo it on mileage. That leaves the lessor with the risk of selling the used car. That is why residual valuesor used-car pricesare such a big deal for car buyers, leasing companies, and even auto makers.

More valuable used cars means less annual car depreciation and lower lease payments. Residual values are critical to avoiding losses for leasing companies. And auto makers derive pricing power based on strong used-car values.

If an auto maker is leasing more vehicles, it could mean that car buyers are doing better leasing a car versus buying a car outright. That situation can arise when used-car values assumed in leases are too high. That doesnt appear to be the case with the Tesla. Its used-car values hold up incredibly well. In fact, the residual values embedded in Teslas leases look too low.

That makes leasing a Tesla a lousy deal for car buyers. Its the leasing companyin some cases Tesla itselfwho benefits from Teslas high used-car values, because theyre the one who get to sell a more valuable asset when the initial lease is done.

Consider a midrange 2015 Model S. In the used car market, its priced at about 54% of its original retail price, according to industry data providers Kelly Blue Book and Autotrader. A higher-end Model S is priced at about 46% of its original selling price.

Autotrader and Kelly Blue Book are both owned by Cox Automotive and are have extensive, national databases of both wholesale and retail used car transactions.

Is half of original value after five years good? Its excellent. Cars, roughly speaking, lose up to about 50% to 60% of their value over the first five years of ownership according to data provided to Barrons by Edmunds. But over five years, the average large luxury carsimilar to a Model Sloses around 70% of its value. Tesla is doing better than average and much better than its competition.

For instance, a 2015 BMW 750i priced with options making it roughly equivalent to a 2015 Model S had only about 25% of its original value left. The BMW 750i seems to be doing a little worse than the category average and worse than its stiffest competition.

There are more examples of strong Tesla residual values.

Looking at sport-utility vehicles, a one-year-old 2019 Tesla Model X is valued at roughly 90% of its original retail price, according Kelly Blue Book. A 2019 Audi etron is valued at about 80%, depending on mileage. Barrons used the 2019 model year, which was the first model year of Audis electric SUV. The average gasoline-powered, luxury SUV loses between 20% and 30% of its value over its first year of ownership, according to Kelly Blue Book.

Then there is the Tesla Model 3. A 2017 used Model 3 can sell for up to 90% of its original value, according to Cox data provided to Barrons. Thats, frankly, incredible. There has been little depreciation over its first three years of driving. The average midsize luxury car loses half of its value over the same span, according to Cox.

There are a few possible reasons for strong residual value.

Reduced supply is one. The population of three-year-old Model 3s on the road is relatively limited. A brand new Model 3 can still take up to a month to deliver.

There are fuel and maintenance savings to consider as well. Teslas are cheaper to runat least based on gasoline costscompared with traditional, internal combustion vehicles.

Tesla also updates its vehicles with over-the-air software upgrades. Its a little like getting new features on your old iPhone when Apple (AAPL) rolls out an operating system update.

Its all of the above, Wedbush analyst Dan Ives tells Barrons when asked about Teslas used-vehicle prices.

Brand, was the one-word answer from Roth analyst Craig Irwin when Barrons asked him about Teslas residual value strength. Ives agrees with that observation too. The Tesla brand and resale value in secondary markets is another huge value [proposition] for a consumer, added the Wedbush analyst.

Ives answer highlights another issue. Residual value strength benefits vehicle owners. Any car buyer knows the total cost of vehicle ownership is ultimately tied to trade-in value.

But even high residual values could be a risk for Tesla stock if high used-car prices were embedded in current lease contracts. In that scenario, monthly lease rates would be low, stimulating demand for new Tesla vehicles. Then if residual values normalize, Teslas finance unit could be left with cars which have values below implicit guarantees. That isnt much of a risk for Tesla stock these days.

Tesla currently assumes normal vehicle depreciation in its leaseson the order of 50% over the first three years of vehicle existence. Thats consistent with industry peers even though actual residual values are holding up much better than that.

For drivers interested in buying a Tesla and willing to take a little more risk, the Barrons leasing analysis means they would do better to buy the car outright. Selling the car for a high price down the road lowers total cost of ownership.

There are very few negatives for Tesla, or any auto maker, from high residual values. Strong used car pricing is a competitive weapon. Tesla, for instance, could embed higher residual value assumptions in its leases, lowering payments and helping it sell more cars.

Tesla didnt respond to question about its leasing practices.

Tesla stock is up about 290% year to date, far better than comparable returns of the S&P 500 and Dow Jones Industrial Average as well as returns of automotive peers.

Tesla shares are up 4.8% in midday trading Thursday, Shares are up 19% since the company announced a 5 for 1 stock split on August 11.

Write to Al Root at allen.root@dowjones.com

See the rest here:

Is Leasing a Tesla a Good Deal? What to Know. - Barron's