Tesla (NASDAQ: TSLA) is simply not investing enough cash back into its business in the form of capital expenditures to construct the production lines and build out the service infrastructure necessary for the large-scale manufacturing of commercial vehicles.
The Palo Alto-based automaker has a history of over-promising and under-delivering on new vehicle deliveries, production schedules, technology and profitability targets. Those misses had numerous causes – an overly-optimistic thesis about how much of automotive assembly could be automated; the poorly-timed launch of a mass-market sedan when demand for those sorts of cars is evaporating; and a stubborn insistence on vertical integration.
Recall that Tesla CEO Elon Musk unveiled the Semi at an event in Hawthorne, California in November 2017 to much fanfare, although equities analysts had questions about up-front costs, battery weight versus payload and how Tesla would afford to finance production.
“In essence, all last night’s event did was add to Elon Musk’s shopping list of things he needs to spend money on at a time when the company is having difficulty making its base vehicle (Model 3) and its equity and debt has traded off,” wrote Cowen analyst Jeffrey Osbourne in a note at the time.
That was more than a year and a half ago, but ironically as Tesla ramped up its Model 3 production, its cash burn accelerated, too, with the company posting losses in four of the next six quarters. Tesla initially planned to bring the Tesla Semi into production in 2019. If Tesla cannot improve its free cash flow situation, further delays in Semi production are expected.
Perhaps most significantly, over the past three quarters, Tesla’s capital expenditures have fallen below its depreciation and amortization, a technical-sounding metric that is actually of fundamental importance to any manufacturing growth story. Capital expenditure numbers reflect the amount of money Tesla spends on buying new equipment to build new vehicles, expand its production capacity, and improve the quality of its products. Capital expenditures are distinct from operating expenses in that operating expenses reflect the money spent to run the business ‘as is’ (examples include electricity, labor, materials, insurance and real estate leasing costs).
Depreciation, on the other hand, reflects how the value of a capital asset – like a piece of assembly equipment – goes down over time from wear and tear and general obsolescence. If a manufacturing facility’s capital expenditures are not exceeding or at least matching its depreciation, it indicates that the facility is not maintaining and replacing its equipment on a sustainable basis – its assets are getting worn out and losing value faster than they’re being updated.
A manufacturing company that has aggressive production growth schedules and plans to add new, complex production lines to its facilities should be spending far more on capital expenditures than it is recording in depreciation.
The table and chart below display Tesla’s capital expenditures in relation to depreciation as reported in the company’s publicly filed financial statements.
The enormous costs of ramping up Model 3 production are clearly visible in spiking 2017 capital expenditure levels; so too is the tightening of investment as Tesla began running short of cash in the second half of 2018. By the end of March 2019, Tesla had just $2.2 billion in cash reserves, was burning nearly $1 billion per quarter, and needed to raise capital despite earlier protestations to the contrary.
Tesla ended up raising $2.7 billion through a mixture of equity and convertible bonds, a deal announced on May 2. In a leaked email to employees announcing “hardcore” cost-cutting, Musk admitted that the new infusion of capital extended Tesla’s runway by only about 10 months. After an initial bounce on the news of the capital raise, the price of Tesla shares has dropped a further 22 percent.
The drop in share price after a capital raise seems to indicate that the equities market is beginning to realize what the credit market has long understood – that even billions of dollars in new capital will simply extend the lifespan of a cash-burning machine that cannot find a way to profitability.
For context, the chart below shows the same numbers for Ford Motor Company (NYSE: F). Even though Ford isn’t a ‘growth company’ – this is a century-old original equipment manufacturer that is currently laying off significant numbers of white-collar employees and effectively shutting down North American sedan production except for a few models – its capital expenditures maintain a healthy spread above depreciation.
While Ford is actively investing in electrification and autonomous technology, capital expenditure in excess of depreciation simply means that Ford is a capital-intensive manufacturer constantly investing in itself to improve equipment, facilities and processes. The value of Ford’s assets continues to grow as it invests money faster than its equipment loses value.
Financially healthy manufacturers should have charts similar to Ford’s, not Tesla’s.
On May 22, Morgan Stanley equities analyst Adam Jonas hosted a private conference call on Tesla. During the call he explained the bank’s rationale for cutting TSLA’s bear case price target to just $10.
“Today, Tesla is not really seen as a growth story,” Jonas said on the call. “It’s seen more as a distressed credit and restructuring story.”
Tesla’s debt has sold off heavily this year. Its 5.30 percent coupon bonds maturing in 2025 are now trading at about 80.84 cents on the dollar. The price of a bond reflects investors’ appetite for Tesla’s debt and as demand for Tesla’s debt falls, the price of the bond falls. When bond prices fall, yields – the return an investor realizes by holding a bond and receiving payments – increase. The idea is that risky debt that investors shy away from buying should offer a greater return. Tesla’s 5.30 percent 2025 bonds now have a yield-to-maturity in excess of 9.3 percent, well above most high-yield corporate debt. More significantly, Tesla’s debt has moved against U.S. Treasuries, whose yields have been falling as risk-averse investors buy them up.
But what are the credit markets telling us about the likelihood of a Tesla Semi? Yields on Tesla bonds above 9 percent are a signal that holders of Tesla’s paper are worried about getting paid back and are demanding very high yields in exchange for the risk. The capital raise was not viewed as transformative for the business or viewed as capital that could be put to work buying equipment and achieving scale and perhaps profitability. Instead, it was viewed as a sign of how cash-strapped the business really is. If that’s the case, do not expect Tesla’s capital expenditures to meaningfully exceed depreciation, and do not expect to see production lines capable of building significant numbers of Tesla Semis until the situation reverses itself.