Tesla: The Sky's The Limit...Until
I projected Tesla would miss ambitious guidance of 500K deliveries for 2020, which it had targeted for 2018, but it finally came close. Meeting 2021 targets will be harder. First in a 2-Part Series.
The next test of Tesla’s (TSLA) ebullient bull story comes this week with the release of fourth quarter results after the market closes on Wednesday.
This will cap Tesla’s report the first week of January that it delivered 180,570 cars (up 61%) in the fourth quarter, just above the midpoint of a broad range of tempered guidance from management back in September and better versus reduced market expectations.
Market consensus for operating results nudged higher accordingly at $10.4 billion (up 41%) in revenue and $2.2 billion (21.4% margin) in EBITDA.
Results also topped my own forecast for 175,000 deliveries, up 56% (see Tesla to Sell Another $5 Billion in Stock—Might As Well on 12/8/20), but my slightly revised estimates remain below market consensus at nearly $10.1 billion (up 37%) in revenue and $2 billion (20% margin) in reported EBITDA, which includes boosts Tesla adds to juice revenue and margins—energy credit sales, accounting enhancements like convenient reserves adjustments, and pricey stock-based compensation, etc.
Altogether, these boosts can double or more Tesla’s reported EBITDA versus unenhanced core EBITDA. My fourth quarter estimates assume roughly $550 million in boosts from energy credits and unusual items which may likely account for most if not all of Tesla’s reported “profit”—as has happened in each of the past five quarters.
This reflects my ongoing concerns that revenue quality and profitability in core operations continue to erode every quarter from unfavorable mix and persistent same-store demand decline plus new rounds of substantial price cuts and expensive incentives (like up to a year of free Autopilot access offered in the fourth quarter) Tesla increasingly needs to boost sales on top of troublingly persistent problems with production, quality, and reliability which keep Tesla cars expensive to produce and repair.
This, as I long have warned, also further impairs demand as customers discover (and tell their friends) how inordinately expensive are Tesla cars to insure and keep running due to their poor build quality and reliability—and how abysmal is Tesla’s customer service.
In the fourth quarter, for example, Tesla ended its 7-day no-questions-asked return policy on all new vehicles and forced customers to accept news cars without inspection first to prevent delivery refusals—as one does to demonstrate complete confidence in its products.
This becomes a self-inflicted and seemingly perpetual margin squeeze, and why no matter how many billions of dollars of additional revenue Tesla claws in, it still must manufacture a few hundred million extra in boosts every quarter to report “profit.”
Not that any of this concerns ardent Tesla fans who have driven the stock up some 700% over the past year to $880 per share as of this writing.
Still, ignoring Tesla’s problems doesn’t lessen them or make them go away, as I noted again last month in Tesla to Sell Another $5 Billion in Stock—Might As Well:
As I have observed over the past two years, such valuations can't be justified based on Tesla's fundamentals, its problematic prospects, or peer comps for any of its business segments—none of which have produced unvarnished core profits in more than 17 years (see my most recent discussion in Things People Believe: Flat Earth, Faked Moon Landings, and Tesla $2100 on 8/24/20).
This reality gap becomes more consequential when Tesla joins the S&P 500 Index as the sixth largest company, settling between Facebook Inc A (FB US) and Berkshire Hathaway Inc Cl A (BRK/A US). Tesla achieved this by finally reporting four consecutive profitable quarters. The trouble is those "profits" reported in every single quarter were traced entirely to energy credit sales plus non-cash accounting maneuvers and unusual items—none of which are its core business.
The total boost was a whopping $1.6 billion over the four quarters ended September 30th, which worked out to 30% of reported EBITDA. This transformed nearly $1 billion in cumulative net losses to $556 million in reported "profits"—a paltry 2% of revenue.
What? Me Worry? Not Standard & Poor’s
S&P Global accelerated Tesla’s equity trajectory—and its own—when it announced plans in mid-November to add Tesla stock to its S&P 500 Index in December as the sixth more expensive company. S&P’s criteria only requires profitability to exist “as reported” which gets it around Tesla’s core unprofitability versus its astronomical market value which has topped $800 billion—the clear attraction to S&P.
And just to be sure, S&P also recently bumped up Tesla’s credit quality ratings to within a rock’s throw of investment grade at “BB” in two moves just two months apart near the end of last year: in mid-October and in mid-December, one day before Tesla stock was added to the S&P 500.
Very convenient—and remarkably fast considering that the more typically lethargic S&P had previously kept Tesla at its low “B-” rating for more than five years since its 5.3% senior notes were issued in June 2015.
S&P’s view substantially overstates Tesla’s financial condition and credit worthiness while understating significant risks, in my humble opinion. And I’m not the only skeptic. Moody’s managed only a one-notch increase last summer in its credit quality rating on Tesla’s bonds to “B3”—still firmly in junk territory.
S&P got to its happy place by adding back lease expense of roughly $430 million to simple GAAP EBITDA to get $4.4 billion in lease-adjusted EBITDA and produce a low leverage calculation of 3.4x. While this doesn’t add back excessive stock-based compensation expense as Tesla does, and which I heartily oppose, it does include more than $1.6 billion in energy credits plus unusual and nonoperating items which otherwise indicate leverage on core lease-adjusted EBITDA closer to 6x and my much less generous calculation near 7x on unvarnished EBITDA.
S&P also accepts Tesla’s reported free cash flow which, as I noted again in Tesla to Sell Another $5 Billion in Stock—Might As Well on 12/8/20 (see below), presents more problems since S&P had noted a year ago it needed Tesla to generate at least breakeven cash flow to warrant a credit quality upgrade:
Tesla reported free cash flow at $1.93 billion for the trailing four quarters as of September 30th, but this was boosted by the $1.6 billion noted above and ignored $100 million for solar equipment CAPEX and $1.1 billion in CAPEX funded by leases. With all considered operations actually consumed more than $800 million in cash.
Which is why Tesla borrows every quarter and stretches its payables even as it boasts about growing free cash flow. The entire $9.18 billion y/y increase in reported cash to $14.53 billion as of September 30th can be traced to net borrowing of $1.5 billion plus $7.7 billion raised from selling stock & equity equivalents.
Also, Tesla's actual spendable cash is far less than $14.53 billion as reported. Excluding more than $700 million in customer deposits plus $3.9 billion held overseas brings available cash down to less than $10 billion. Most of that overseas cash is held in China, and that cash is largely restricted and closely monitored by Tesla's Chinese bankers. Keep this in mind as Tesla continues to juggle negative free cash flow despite growing revenue from incremental sales which mask falling same store revenue in every market.
For S&P, all’s well that ends well. Thanks to its inflated stock price, courtesy of Tesla fanbois, Tesla was able to raise another $12.3 billion in cash selling stock in 2020. “The company likely will end the year with more than $19 billion in cash and equivalents,” concluded S&P, “reducing its net debt to essentially zero.” Cool!
Why worry that Tesla could otherwise burn through its actually usable cash in less than two years since it still doesn’t generate profits or cash flow on any of its core businesses after 17 years even as debt balloons to more than $15 billion as of September 30th, up another $1.74 billion y/y and counting. S&P gets a skyrocketing add to its best known equity index while promoting that Tesla “continues to improve operating execution, become more efficient in production, and make strides in its global expansion.”
But does it, really? And for how long?
As I discuss in Part II of this report Tesla: Dont’ Drive Angry, to be published next after this one, troubling signs I warned about last October in What’s Going On with Tesla’s Demand? still are evident in Tesla’s fourth quarter delivery results.
If so, this means Tesla’s most pressing and fundamental struggles continued through the fourth quarter and into this year—threatening already overwrought market expectations for Tesla’s prospects for deliveries, revenue, and profits in 2021 and beyond.
Same as it ever was.
Tesla's 5.3% senior notes due 2025 are little changed since my last report at 104.3 (2.3% ytw; 188 bps), offering no credible upside versus potentially significant downside. The bonds remain excessively valued with yield tighter by 129 bps versus the BoA High Yield general index even though Tesla is a weak B3/BB- issuer. Pricing also indicates a meager 63 bps per turn of leverage on my estimated 2020 reported EBITDA and an appallingly low 27 bps per turn of leverage on core operating—unvarnished—EBITDA. Maintain "Underperform."
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