Investors Aren’t Worried, But Tesla Seems To Be
Investors Aren’t Worried, But Tesla Seems To Be
What Tesla actually does versus what it says speaks volumes.
Tesla Motors (TSLA US)stock is soaring to record heights, again, topping $1800 on Monday. That's up 30% in four days and up 113% since second-quarter earnings were released July 22.
The buying frenzy comes with the latest string of equity analyst upgrades over the past week since the company announced a 5-1 stock split effective August 28th—its latest shiny object.
That action was triggered by the stock rally set off after Tesla reported it's fourth consecutive profit as of the second quarter which made the stock eligible for inclusion in the S&P 500 (SPX INDEX).
It didn't take long to spot what created the profit: a record jump in emissions credit sales which more than offset what would have been another sizable loss, just like each of its previous three "profitable" quarters (as I projected again in Tesla Q2 Deliveries Top Reduced Estimates But Still Down Y/Y on 7/2/20).
Without this and other boosts, revenue fell by double digits, consolidated gross margin was 750 bps lower, reported free cash flow and profit evaporated, and leverage was more than 2x higher at 7.5x as floundering US sales and significant global declines in pricing and mix offset substantial incremental contributions from market expansion into China and Europe.
Tesla seemed unconcerned about the surging global pandemic or continuing economic malaise, which were not even mentioned in the earnings release or conference call versus "super" which popped up eight times; e.g. super impressed, super exciting, super smooth, etc. Instead, it affirmed 2020 guidance for 500,000 deliveries which now calls for a 79% jump in deliveries versus the first half to end up 37% overall for the year.
Tesla's price-to-earnings ratio at 955 says investors aren't worried either, but they also are working without a net.
Because Tesla actually seems very concerned based on what it spins and conjures, what it dangles as shiny objects, what it avoids discussing, and what it hides.
As well it should be.
Back on Earth, Boosts To Revenue Are Most Aggressive Yet
Tesla (TSLA) reported consolidated revenue down 5% to $6.036 billion in the second quarter, tracking my estimate of $6.027 billion. The key driver was the 5% decline in Auto sales revenue (81% of total) to $4.9 billion on a 5% decline in deliveries. Otherwise, Service & Maintenance revenue dropped 20% to $487 million and the meager Energy business revenue was flat at $370 million.
Core results were much weaker, as we've come to expect every quarter from Tesla. Energy credit sales jumped 285% to $428 million, eclipsing the 64% profit-saving increase in the first quarter. This also was far higher, again, versus emissions credits reported as purchased from Tesla by Fiat Chrysler Automobiles NV (FCA IM) which suggests Tesla has pulled sales forward from subsequent quarters.
The 10-Q also confirmed that all of Tesla's revenue growth was generated outside the U.S., with total revenue excluding US sales up 21%. This can be traced to the 58% increase in overseas deliveries mostly due to incremental sales of Model 3 into new markets in Europe and China plus the newly Made-In-China (MIC) Model 3s. Tesla has only two more comparatively easy comps to tap such incremental gains before it begins to lap strong quarters.
US trends demonstrate again how challenging this may be for Tesla. US revenue plunged 26% when I excluded the $530 million in boosts noted above (which topped my estimate for $500 million; Tesla Q2 Deliveries Top Reduced Estimates But Still Down Y/Y). This drop reasonably aligned with the 29% decline indicated in US deliveries, including Model 3 down 67% versus my -65% estimate and Models S+X down 32%. Those declines far outpaced incremental gains from 15,900 deliveries of new Model Y versus Model 3 which came in at just over 15,000.
This continues troubling trends I have been tracking for more than two years which show Tesla struggles to sustain demand strength following new launch surges; e.g. Model 3 supplanted most of the demand for Models S&X. Model Y may replace Model 3 as the new flagship.
Meanwhile, revenue from China was up 103% to now 23% of consolidated revenue owing almost entirely to incremental sales from the Model 3 expansion plus the new Shanghai plant. This cemented China as Tesla's strongest and most important market.
So Tesla is no doubt concerned that it already has been forced to lower prices at least twice this year on its new China models in response to aggressive competitive pressure.
This followed several rounds of price cuts since last year on every model Tesla sells in every other market.
Core Operations Are *Still* Not Profitable
Tesla also relied on the boosts noted above to increase Auto sales gross profit, which actually fell 7.2% otherwise versus the 31% increase reported.
The unenhanced margin was essentially unchanged at 15.3% as a result versus 24.4% as reported which had indicated a 670 bps bump.
Inordinately low, and likely unstainable SG&A and R&D as a percentage of revenue cut another $260 million from expenses. This plus the $530 million in unusual/non-operating boosts noted above is how Tesla transformed a $680 million loss into a reported $104 million profit.
That's apparently good enough for the "end justifies the means" crowd, but it remains problematic that Tesla's core operations remain severely unprofitable no matter many units it sells.
Free Cash Flow? Nope
Tesla reported $964 million (up 12%) in cash flow from operations and $418 million (down 32%) in free cash flow after capex. However, subtracting the $530 million in boosts revealed core operations generated a more sobering $179 million—down 12%. After $546 million in reported capex plus $20 million spent on solar energy systems equipment, operations actually consumed $387 million.
That's not all. Tesla fails to highlight that it now funds a material amount of capex with leases, mostly in China, including $253 million this quarter. That pegs total capex for the quarter at $819 million, nearly double the similarly calculated $435 million spent last year.
The difference is even more startling over time. Tesla reports $900 million in free cash flow for the trailing 12 months ended in June, based on $2.7 billion in CFFO less $1.8 billion in capex. Accounting for the $108 million spent on solar energy capex plus $943 million in capex funded by leases reveals Tesla actually consumed $144 million over the past 12 months—weaker by $1.04 billion. Stripping out boosts from energy credits, deferred income, and other unusual items reveals Tesla's core operations consumed more than $1.8 billion—$2.7 billion lower versus reported.
Cash Actually Available? Not So Much
Tesla reported $8.6 billion in cash on hand, up $2.3 billion versus yearend. However, that included $713 million in customer deposits it can't spend.
Nearly half of that, some $3.6 billion, is held in foreign currency overseas—mostly in China where it's probably stuck. The $4.3 billion remaining in effectively available cash is down nearly $1 billion versus the second quarter and essentially unchanged versus yearend even though Tesla has increased debt and leases by $305 million and raised $2.5 billion selling stock since then—nearly $3 billion raised.
Where did it go? Core operations burned through $2.4 billion in the first two quarters, masked by $962 million in unusual items. The rest went to overseas cash—mostly in China where Tesla's cash and assets are held in unrestricted subsidiaries not available to US investors and creditors (see Tesla - Shanghai Surprise, 1/29/19). Remember, the lion's share of Tesla's expensive debt and purchase obligations are supported by its significantly unprofitable —and heavily cash-burning—US operations.
Credit Quality? Much Weaker
Tesla's dramatically higher cash burn than reported also explains why it increases debt and leases almost every quarter. It explains why Tesla fails quarter after quarter to pay off even seemingly small amounts of debt due. It explains why, every quarter, Tesla continues to "generate cash" by inflating working capital; e.g. excessively stretched accounts payable.
Tesla's mysteriously bloated accounts receivable jumped 29% y/y versus the 5% drop in revenue which is almost completely generated by sales to customers that pay cash upon delivery of their cars. For the second straight quarter, some "entity" comprised more than 10% of total accounts receivable. The last time this happened was Q3 2018 when accounts receivable jumped substantially—and has remained inordinately elevated ever since.
Not only are total debt and leases relentlessly higher every quarter, EBITDA is substantially overstated. Boosts from emissions credits, deferred revenue, and unusual items like timely adjustments in reserves and accounting treatment account for $2.46 billion (56%) of $4.4 billion Tesla reported in trailing EBITDA as of June 30th. In addition, Tesla now adds back material stock-based compensation expense which contributed another $1.04 billion (23%) to EBITDA (see Clearing Up Tesla Q419 Results, 1/30/20).
This indicates trailing core EBITDA actually generated from operations at just $2.03 billion, with leverage alarmingly high at 7.5x versus 3.4x on the drastically overstated figure.
So, Wall of Worry. Now What?
It's tough to keep the carousel going, and Tesla has done it every quarter for more than two years in the wake of dozens of exiting executives working in Tesla finance, accounting, manufacturing and production, supply chain, technology and other key functions. It's a bad look.
To keep the magic going, we see Tesla pull sales forward plus credits presold, eleventh-hour fleet sales, conveniently timed accounting and reserves adjustments, and more.
These are not sustainable strategies but they nevertheless contribute increasingly to Tesla's reported growth and "profit."
Tesla's botched launches when it tries to ignite excitement in a hurry also have become the norm; e.g. Tesla Insurance, Autopilot Summon, Model 3 expansion into Europe and China, Model Y, CyberTruck, Online-only Sales, etc.
There are consequences, of course. Serious quality and reliability problems that continue to plague Model 3 have been amplified in Model Y which shares 20% of M3 components and systems.
Critical design flaws like Model Ys integrated hatch and current efforts on the fly to produce a single casted piece as its underbody also result in a finished car potentially even more prohibitively expensive to repair and insure than other Tesla models already are.
As I have noted for more than a year (Tesla's Plan B 2.0; Y Not, 3/10/19), such problems can impair demand as much as, and perhaps even more than, uncompetitive pricing.
Never mind that, Tesla accelerated the Shanghai plant, and it's doing the same thing now with the plant under construction in Germany and a new one just underway in Texas where it plans to produce Model Y and the CyberTruck. But that's next year's business.
In the meantime, I remain concerned that it can deliver 321,000 cars in the second half of the year versus 179,000 through June, and indications are Tesla is too.
I'm having trouble justifying even 420,000 deliveries for the year, adjusted for the accelerated launch of Model Y, given the pandemic induced economic recession which likely will persist through next year and potentially longer.
This indicates 2020 estimates only slightly higher versus my previous projections with reported annual revenue at $27.6 billion (up12%), reported EBITDA at $4.7 billion (16.9% margin), and leverage on reported EBITDA at 3.8x—7.9x on core operating EBITDA (see attached model).
Unlike the stock, Tesla's bonds are comparatively little changed since my last report in July at 103.5 (4% ytw; 375 bps), up 1.5 points. However, the meager yield is 165 bps tighter versus the BoA High Yield general index even though Tesla is a Caa1/B- issuer. It also indicates a meager 98 bps on 2020 reported EBITDA and an appallingly low 53 bps per turn of leverage on core operating EBITDA. Such levels are priced for perfection with no margin for disappointment, and when Tesla finally hits reality we're looking at a trail of tears. Maintain "Underperform."
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