Tesla Credit Update: Subscriber Concerns Persist, Record Debt
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CreditRiskMonitor published a report on Tesla, Inc. at the end of 2018, which covered the auto giant’s FRISK® score and overall financial condition, as well as risk factors that should be watched by credit professionals. In the 10 months since, Tesla has been trending around breakeven operating profitability. The company’s total debt outstanding, however, has increased to $13.3 billion and the aggregate of CreditRiskMonitor subscribers are still exhibiting signs of concern.
Classifying Financial Stress
The 96%-accurate FRISK® score is calibrated to measure financial risk and predict the risk of bankruptcy within a 12-month horizon. The FRISK® score considers stock market performance, financial statement ratios, bond agency ratings, and CreditRiskMonitor’s own proprietary subscriber crowdsourcing. For nearly one year, Tesla’s FRISK® score has been trending at the risk category of “3,” as shown below:
The FRISK® score is based on a “1” (highest risk)-to-“10” (lowest risk) scale, where any designation between “1” and “5” is in the FRISK® score “red zone.” If a company is trending within the red zone category, we believe that risk professionals must immediately evaluate the company’s financial condition and consider taking measures to reduce exposure.
Companies trending in the FRISK® score red zone usually have characteristics of:
- Weak operating performance,
- High financial leverage, and/or
- Elevated liquidity risk
These concerns appear increasingly prevalent at Tesla.
In the second quarter of 2019, Tesla issued a record amount of debt and equity financing in one singular period, totaling a net $2.1 billion. The MD&A stated that those proceeds would be used for further capacity expansion and automation of current production. The Q2 2019 guidance of capital expenditures (capex) was $2.0 to $2.5 billion spanning over the next two fiscal years, but it was removed. Instead, Q3 2019 guidance has fiscal 2019 capex to be slightly below $1.5 billion, leaving around $500 million in capex for Q4 2019. Fiscal 2020 spending currently remains unknown.
Tesla disclosed that the interest rate associated with its 2024 Convertible Senior Notes, issued in May 2019, are being amortized to interest expense at an effective interest rate of 8.68%. This rate is about 220 basis points above the average effective interest rate of 6.5% across all debt obligations that we calculated in December 2018.
In October, management expanded its “Tesla Beijing” subsidiary’s credit facility agreement up from ¥3.5 billion to ¥5 billion. The revolver was tapped as the company is financing vehicles in-transit from the U.S. to China, building out its Shanghai factory and ramping initial stages of production. Non-recourse debt increased from $3.55 billion in the second quarter to $3.86 billion in the third quarter, or $310 million. According to Q3 2019 figures, total financial debt (including debt, convertible debt, and capital leases) accumulated to $13.3 billion and total liabilities reached $25.3 billion – exceeding tangible net worth by 2.4x and 4.6x, respectively.
Model S and Model X auto deliveries have slowed over the last year, while less profitable Model 3 deliveries have trended higher, becoming much more significant to Tesla’s revenue. As total unit deliveries have broadly run flat to slightly higher, Tesla's operating profitability has been trending near breakeven. TTM revenue was $24.42 billion with an operating margin of 0.6%, when excluding restructuring charges.
Yet a slowdown in deliveries would lead to cost deleveraging and cut into operating cash flows, including what is received from regulatory credits. Regulatory credit revenue totaled $419 million in fiscal 2018, which improved its free cash flow up to negative $222 million during the period. Credits were $461 million in the first three quarters of fiscal 2019, which raised free cash flow up from negative $396 million to positive $65 million. Tesla management stated in its Q3 conference call that incremental tax credits are expected to stay low. Further, U.S. tax credits on Tesla vehicles are anticipated to expire by January 2020.
Tesla’s reduced guidance on capital expenditures will be supportive to cash flow, but this adjustment is likely to negatively impact its long-term competitive positioning versus industry peers. For example, Ford Motor Company and General Motors Company are spending more than $7 billion and $8 billion, respectively, in annual capex. Some of that allocation is tied to existing production facilities, however, incremental allocations also include investment in launches of new hybrid models, electric vehicles and R&D into autonomous driving.
Tesla’s sustained FRISK® score of “3” provides a cautionary sign about the company’s financial risk. So far, the company has been trending around breakeven operating profitability, but margin sustainability remains in question. Additionally, total debt outstanding has reached $13.3 billion and if debt financing costs trend higher, it would place further pressure on pre-tax profit and free cash flow. Credit professionals should remain attentive to the company’s operating performance, leverage and liquidity.