Inside Tesla’s Financials
Here is the video from this transcript: YouTube
Tesla recently overcame Toyota to become the world’s most valuable carmaker, despite selling 30 times less cars than Toyota. Investors are confident in Tesla’s ability to dominate the industry, as the firm started delivering consecutive quarters of profitability. But let’s see what’s behind their financials.
Before taking a look, I laid out a visual representation of their business. Tesla divides its business into the automotive and energy generation and storage division. I am sure most of you have heard about their Model S, Roadster and Cybertruck. These, along with other models, form part of their automotive divisions. Under their energy storage division, they provide their Powerwall and Powerpack products to residential and commercial customers who can store energy for later use. Tesla also provides their Solar Roof, a solar energy system that convert sunlight into electrical current, to complement their Powerwall.
And I think about Tesla’s Supercharger network as a bridge between their automotive and energy storage divisions outside the home setting. The Supercharger network involves a collection of high-speed chargers designed to recharge Tesla vehicles quickly using renewable power. Now, a car is in itself a piece of technology. But Tesla plays on how it uses advanced tech in their cars, such as their powertrain system, autopilot hardware, full self driving hardware, and neural net. All of this, combined with the lower maintenance and other ownership costs, is designed to make people switch to Tesla vehicles.
Now, let’s look at their revenues split by division. Automotive is obviously the biggest component of sales at over 20 billion dollars for fiscal year 2019. I have to say that Tesla did a great job at generating world wide brand awareness through media coverage. I doubt that sales would have increased by that much if it was not for the well played marketing strategy. The revenues derived from the energy generation segment is mostly as a result from Solar City’s acquisition in 2016. Now, I will draw your attention to a sales component, named Services and Other. This consists of after-sales services, sales of used vehicles, vehicle insurance and the likes.
The reason I brought attention to this is because Gross Margin is negatively impacted by that small segment. It is really just a cost center designed to support the main automotive business. Tesla lumps automotive with services and other to get to a blended gross margin of around 17%. We can observe a decline in overall gross margin. This is due to lower Model S and X margins from the lower selling prices. Now, most of you might wonder why gross margins might seem low. Well, it’s not really low. Other car manufacturers like Toyota and Ford report similar gross margin levels, or lower. But one could argue that Tesla manufactures high end cars and thus should command a higher margin. Thing is, investors are banking on the good old economies of scale to drive margins up in the future.
And it’s a really simple concept to get behind. Look at it this way. Cost of sales embeds depreciation. So, when a production line is started, it is probably not running at full capacity producing, let’s say 3,000 cars per week. But the depreciation of the facility is still impacting the profit and loss. When the production facility reaches a sustainable utilization percentage, let’s say 10,000 cars per week, the higher number of cars sold eventually outpaces the depreciation cost. In my opinion, a gross margin of around 25 to 30% is achievable for Tesla in the long term. Tesla factories have a production capacity of nearly 700,000 cars, but it produced only around half of that for trailing twelve months Q1 2020.
Now, let’s turn to research and development. This component has been going down as a percentage of sales, due to operational efficiencies and process automation.
Tesla has also been working to reduce its selling, general and admin expenses through cost optimization. But mind you, deriving efficiencies comes at a cost, called restructuring costs. Tesla has booked a fair amount of those in recent years. This includes things such as termination fees from laying off employees and abandonment of research developments.
After deducting cost of sales, operating and non operating expenses, net income is negative, and has been so for some years. This is why Tesla has a negative effective tax rate, and can carry over operating losses to reduce taxes in future years. But Tesla might be done with losses. The firm reported consecutive profitable quarters since Q3 2019. The business seems to be scaling in the right direction.
Let’s take a look at Tesla’s cash flow situation. Cash from operating activities includes revenues from their vehicles and other sales, offset by cost of sales, operating expenses and interest payments. All of this is also adjusted for working capital. Now, see how operating cash flow turns positive after 2017. That’s a sign that Tesla can generate sufficient cash to operate business activities.
Cash from investing activities pertain to capital expenditures in connection with their Gigafactory construction, business acquisitions, as well as new product lines installation. As for cash from financing activities, it includes things such as inflows and outflows from debt and stock. And Tesla has been tapping into debt markets to finance most of its capital expenditures.
Another way to look at cash flow is subtracting capital expenditures from operating cash flow to get to free cash flow. This is essentially a measure of sustainability. Negative free cash flow means a company needs outside sources of financing to grow operations. Positive free cash flow means the company has enough cash on hand to even repay creditors and issue dividends to shareholders. Not surprisingly, Tesla has been posting mostly negative values for a long time. It just means that Tesla has been investing more in capital expenditures. But the negative values have been less frequent recently.
I have to point out that being free cash flow negative for a long time is not that bad. Do you know why? We can look at other metrics such as EBITDA, Adjusted EBITDA, Operating Margin and so on. But keep in mind that the stock price of a company reflects investors’ expectation. So, the present situation is not really the final destination. That’s why you see stocks dive or skyrocket after they either miss or beat earnings estimates. Tesla’s stock price is up over 7,000% since its IPO. And a lot of people are saying that Tesla’s current financials do not warrant its current valuation. Just keep in mind that investors are expecting a lot of growth from Tesla. If reported metrics show anything to the contrary, the stock price will adjust accordingly.
I hope you enjoyed this article and learned something new. Don’t hesitate to tell us what you think about Tesla’s financials. Do you believe in the company’s long-term prospects? What should they do to maintain their edge? Let us know.
