Why Tesla May Be Riding on the Path to Financial Distress

Introduction

2009: Laying the Groundwork Leading to Initial Public Offering:

In 2009, Tesla was still a startup in the process of establishing itself in the market and held a Cash Balance of $70 million. While it was nice for this startup to have a notable cash balance, the accomplishment would be overshadowed by negative Operating Cash Flows topping -$81 million along with operating expenses adding -$12 million to those losses, leaving them with a negative Free Cash Flow of -$93 million. These losses could have been seen as signs of a failing business model, however, the company managed to secure a $465 million low interest loan from the U.S. Department of Energy which marked a pivotal moment at one of the most critical time, providing the necessary funds to develop its first mid-priced production vehicle, the Tesla Model-S, set to begin production in 2011. The pricing of the base model was about $50,000,putting it well below the pricing of the Tesla Roadster which usually came with about a $100,000 price tag, the reduction in pricing of the base Model-S was also assisted by a $7,500 US Federal tax credit, further supporting future growth in Tesla's mission of growing the consumer base outside the existing high premium luxury, in favor expanding into a bigger pool of consumers who were unable to afford the previous models. Though the price tag of $50,000 still priced out a good majority of consumers, this 50% price reduction was a massive step in the right direction, much of which would not be possible without the help from the federal government whose financing enabled Tesla to invest in these technologies and set the foundation for future growth.

2010-2013: Scaling Production and Financial Instability:

The years from 2010 to 2013 were characterized by substantial fluctuations in Tesla's financial performance. In 2010, Tesla went public at $17 a share, raising over $226 million during its initial public offering (IPO). By 2012, the Model S was finally launched after years of development going back all the way to 2007. This generated significant revenue, doubling from $204 million in 2011 to $413 million in 2012, but Operating Cash Flow remained deep in the negative capping in at -$264 million along with the additional hindrance of rising CapEx, which hit $239 million as it expanded the manufacturing capabilities of its Fremont facility.

This focus on investment into expansion would continue into 2013 when they announced that European residents would be getting ample access to superchargers by the end of the year as Tesla began to ramp up their new assembly line in Tilburg, Nederland with the objective of boosting European production of Model-S and Model X models. This obviously led to 2013 being yet another year of high CapEx, which capped at -$239 million, though for the first time, the expenditures were offset by higher Operating Cash Flow of $265 million, thus achieving the first ever positive year of FCF, clocking in at $1 million thanks to rising sales volumes. During this period, Tesla succeeded in raising more funds, this time in the form of convertible bond offering totaling over $1 billion in Q2, 2013. In total, Tesla had managed to accumulate a Cash Balance of $849 million by the end of the year, mainly attributed to the debt issuance raising more capital, thus further illustrating the high costs associated with scaling production and R&D within the company.

2014-2017: The Road to Profitability:

Between 2014 and 2017, Tesla's profitability experienced a significant decline, largely due to the company's aggressive growth strategy. This period was characterized by significant capital expenditures (CapEx) aimed at expanding production capacity and infrastructure and were exasperated by technical issues mainly due to multiple failed attempts at properly automating the Fremont site which resulted in multiple revisions and requiring heavier R&D which drove up cost largely for building out a process for cars that weren't even in production yet, namely the Tesla Model-X and Model-3 which did not launch until 2015 and 2017 respectively, a situation which was partly worsened by notable delays in production of these models as all of the technical issues were sorted out, this led to an overall drop in production, profit, and revenue and an exponential increase in R&D costs contributing to rising CapEx, during this time the company was working on another key initiative, the construction of Gigafactory 1 in Nevada, this factory was designed to domestically produce lithium-ion batteries more cost-effectively and was constructed between 2014 and 2017. The costs associated with building this factory topped $5 billion, though these costs were slightly offset by tax benefits provided by the state of Nevada totaling $1.3 billion dollars, along with being exempt from sales for the next 20 years and 10 years of property tax. As promising of an offer that was, this still unsurprisingly resulted in CapEx escalating in the following years, rising from about -$1 billion in 2014, to -$1.6 billion in 2015, and -$1.281 billion in 2016 to more than $3.4 billion by 2017, placing immense pressure on cash flow and profitability as cash outflows during this time began to consistently exceed cash inflows with FCF between 2014 and 2017 being -$1.027b, -$2,159b, -$1.405b, and -$3.476b respectively this was followed by multiple credit downgrades from Moody's which ultimately ended in Tesla's senior notes being downgraded to Caa1 from B3 and gave the company a negative outlook and planned on lowering Tesla's rating further if the company continued to experience shortfalls in the Model-3 production. Despite these economic issues Tesla was able to get through it, even though it was riding on a direct path to bankruptcy, TSLA managed to secure financing mainly by diluting its shareholders and issuing more shares and convertible debt which were readily bought by investors; if not for this investment capital, it is very likely Tesla would have fallen under.

2018-2019: Setting the Stage for Profitability and Production:

The years 2018 and 2019 were trend shifting years for Tesla, as it had just weathered through the most negative period in the company's life, mainly thanks to the many sources of financial support it maintained throughout. Now that it had completed a painful growth stage, it could now focus on achieving profitability amidst rising production demands. The company ended the year of 2018 with a cash balance of $3.879 billion and operating cash flow of $2.098 billion, though CapEx remained elevated at $2.101 billion, leaving the company slightly in the red with -$3 in FCF during that year, a major improvement over the last few years which had primarily aimed at ramping up Model 3 production and expanding Gigafactory 1. 2019 followed a similar trend, with CapEx falling and Operating Cash slightly rising, due to rising sales volumes and the company being well into the launch of its previous models.

2020-2023: Breakthroughs and Market Turbulence:

The year 2020 marked a significant milestone for Tesla, as it produced and delivered nearly half a million vehicles. The operating cash flow soared to $5.9 billion, while CapEx rose to $3.1 billion; mainly driven by investments into Gigafactory Shanghai and ongoing construction of Gigafactory Berlin and Texas. It was during this period that Tesla would take majority market share in gross margin starting at 17% in 2017 and topping out at around 26% of the world's gross margin by 2022, surpassing the likes of CATL, BYD, and the Major incumbent carmakers which include: BMW, Ford, GM, Honda, Hyundai, Kia, Mercedes-Benz, Nissan, Renault (EPA:RENA), Stellantis (NYSE:STLA), Toyota, and Volkswagen (ETR:VOWG_p).

Source: IEA

During this time, Tesla's stock performance was on a major winning streak rising from about $113 a share in 2020, all the way to the ATH of $1,243.49 a share by the end of 2021. This rise aligns with the sudden boost in venture capital within the sector during those years, as seen in this chart provided by the IEA:

Source: IEA

Investment would begin to slow significantly in 2022 and this slowdown was in alignment with shares of TSLA dropping over 70% from $1,200 to about $300 over the course of just a few months, this drop was paired with rising CapEx which more than doubled in 2021 and 2022 to $7.7 and 6.22 billion respectively though CFO did at least manage to keep pace for those years, rising to about $11.5 and $14.7 billion. The main factors that were linked rising CapEx was the ongoing rollout of Giga Texas which would come to fruition in 2022, but the lack of investor interest within the sector were due to the rising shipping costs, shortages of materials and semiconductors, an overall consensus of falling guidance within the sector by various firms and investors. As a response to the fallen liquidity TSLA announced a 3-for-1 stock split executed in August, 2022 now making the stock $300 per share vs $900 previously; but this only resulted in more selling and bearish positioning on the stock being raised which eventually would lead to the stock falling to $101 by 2023 and followed heightened concerns regarding long-term value, particularly given the pressures from rising CapEx and market competition which had started to surpass Tesla's market share during the year. As illustrated in this stacked chart below we can see a concerning recent trend of slowing Operating Cash Flows, paired with the trend of rising CapEx with the recent 2 data points even showing a falling of cash flows which has led Free Cash Flow to fall in half from $8.5 billion in 2022, to $4.3 billion in 2023, and all the way down to $1.72 billion over the Trailing Twelve Month period, bolstering even higher CapEx and Lower Operating Cash Flow:

Source: Author

This trend of falling spreads between CFO and CapEx can be further simplified by viewing Operating Cash Flow as a percent of CapEx, when it is above 100% it means more money is inflowing through their operations than out, but when it's below it means they are outflowing cash in the form of CapEx at a higher rate than they are inflowing through CFO:

Source: Author

As seen above TSLA is trending towards a dangerously unstable Cash Flow situation where this percentage is about to go below 100% for the first time since 2018 which if left unchecked could lead to much of the progress the company has made over the years being completely wiped out. In the past TSLA has relied on venture capital, low interest loans, and debt issuance to bail it out of these situations, but during this time of rising interest rates, a shrinking supply of available lenders, falling venture investing activity, rising shipping rates, and last but not least, the rebound of inflation which has led to a rise and revival of the rare earth metals as evident by this chart of the rare earth metals price index:

Source: marketvector.com

This rise in rare earth pricing will likely lead to even higher CapEx spend in the future and is likely to drag down not only TSLA but other auto manufactures too such as Ford, who has been going through its own struggles with supply and shipping issues that I'v already covered in detail in my previous coverage of Ford Motors. As for ways of potentially investing into rare earth metals, my stock of choice is SQM, which I also recently covered in detail.

A crucial aspect of Tesla's growth narrative is its shift in focus from high-end consumers to a broader market. Initially, Tesla targeted affluent buyers with premium-priced vehicles like the Model S and Model X, which often had price tags exceeding $70,000. This strategy positioned Tesla as a luxury automaker and established a reputation for performance and sustainability.

However, as the market evolved, Tesla recognized the importance of catering to average consumers. The launch of the Model 3, price starting at around $35,000, aimed to attract a broader demographic, making electric vehicles more accessible. This strategic pivot was essential for driving production volumes and solidifying Tesla's status as a mass-market player.

Summary & Economic Projections

Tesla's story is that of a company that went from a cash-strapped startup to an industry leader in electric vehicles, this growth has been marked by dire whiffs of financial challenges generally followed by worthwhile yet costly achievements. Since 2009, the company has navigated long periods of intense capital expenditures and weak operating cash flow, but has been supported through these times by government financing & incentives, shareholder dilution, and a high supply of venture capital to fund its aggressive growth. Despite overcoming numerous production setbacks and financial strain, Tesla's financial stability remains in question, with recent trends raising concerns.

The latest data points to a troubling shift in Tesla's cash flow dynamics, particularly with the recent narrowing of the gap between Operating Cash Flows and Capital Expenditures. This has led to Free Cash Flow plummeting from $8.5 billion in 2022 to just $1.72 billion over the Trailing Twelve Month period as of Q2, 2024. These issues, combined with the rising costs of raw materials, rising competitive pressures, and falling investor interest, threatens to undo much of the progress the company's made over the years.

Tesla's reliance on venture capital, debt issuance, and government incentives has been crucial during times of financial distress. However, with rising interest rates, constrained lending, and the advent of rising rare earth metals prices that will serve to drive up production costs, the company's ability to navigate future headwinds based on previous trends, appear limited.

Given the above concerns, it is in my opinion that shares of TSLA at the current price of $217.80 are extremely overvalued with a Trailing Twelve Month P/E of 61.18 at an EPS of $3.56 which puts share of Tesla at a worse value than 90.12% of the industry of 982 companies where the median ratio sits at a 15.95 Trailing P/E meaning that TSLA Shares are currently trading at a price about 4x above the industry median which could lead to severe declines in the case of a mean reversion potentially to around $56 per share would put it within fair P/E valuations.

Source: GuruFocus

The company's ability to finance its debts has come to a major crawl as of 2021, with very little growth seen in the year of 2023:

Source: macrotrends.net

This inability to find willing lenders to finance debts with has come in alignment with the accelerating trend of declining EBITDA, falling from the high of $17.40 billion in Q4, 2022 to the current low of $11.60 billion as of the Q2, 2024 report representing about a 65% earnings decline in just the last few quarters:

Source: macrotrends.net

This has also had a very negative on net margins, declining from 31.50% in Q4, 2023, to flatlining to approximately 5.5% in the previous two Quarterly Reports in 2024 putting it even below the lows of 2023:

Source: TradingView.com

These deteriorating earnings, along with the rising costs and the absence of the financing crutch that the company has relied on so much in the past, lead me to believe we will see the stock trade back down closer to valuation metrics. As I mentioned earlier I project it would be likely for TSLA to trade closer to the P/E of the Industry Median of 15.95 which would put it at about 56 dollars a share currently; this would be a better case scenario assuming the company is able to turn things around, but at a worst case scenario I think it could trade towards Book Value. The current Price to Book (P/B) sits at 10.47 meaning that it's trading about 10x above the market value of its Assets. This shows that the market is pricing in future growth, however this is well above many of it's competitors which primarily sit at a ratio below 1x:

Source: GuruFocus

If the TSLA truly were to go into liquidation and have all aspects of future growth priced out we would likely see shares of the stock decline 8-10x which could place the stock at about $20 a share which would bring the marketcap down to around $69 billion, if this were to happen I speculate that a bigger automaker such as Toyota (:TM), who is more established within the industry may look to acquire Tesla's assets and IP at a discount to book.

Technical Outlook

Source: TradingView.com

The above chart a log scale 5-Wave AB=CD structure that terminates approximately at the 4.272 extension around $343, TSLA has already faced one rejection from this level and bounced off of one of the previous support/resistance zones which are marked in green. It has since tried to stage a rally above the zone, perhaps to test out the previous top, but has so far failed to get any meaningful momentum and looks to be staging a 3rd lower high. If the price action continues this trend into the end of the month, we will have a confirmed Bearish Engulfing Candle on the 1-month timeframe. This would act as a strong bearish confirmation and increase the likelihood of price coming down towards the nearby support around $101 again, if this happens it will confirm the bear trend and likely result in the support breaking. From then on, there would not be any real support until it reaches the zones between $32 and $10, which would be in alignment with the projections made based off the financial valuation metrics I'v reviewed today.

This content was originally published on Gurufocus.com