Tesla (NASDAQ:TSLA) may be the most hotly debated stock on the market. And in early 2019, the debate has reached a fever pitch. The company ended 2018 with 90,700 deliveries in the fourth quarter, and it already plans a production expansion in the Chinese market.
As good as growth is, Tesla has struggled to make as much money as it needs to in the long term, and hasn’t come anywhere near making the $35,000 Model 3 that investors were promised. With billions in debt coming due in the next year, Tesla faces a future that is far from certain, and investors have a lot to think about before buying the stock.
The Tesla Model S. Image source: Tesla.
Tesla’s growth machine is in full swing
The ramp-up of Model S, Model X, and Model 3 production has driven a massive growth curve for Tesla, as you can see below. But revenue growth doesn’t mean Tesla is making money.
TSLA Revenue (TTM) data by YCharts
You can see that Tesla has burned through billions of dollars over the past five years, mainly to build the Gigafactory in Nevada and its Fremont, California, factory. If Tesla stopped investing in growth, it could eventually generate positive free cash flow, but here’s where the company’s fundamentals and continued investment complicate the investment thesis.
Tesla isn’t making as much money as it hoped
When Tesla announced that it was laying off 7% of its workforce, it wasn’t the layoffs that worried investors. It was Elon Musk’s admission that Tesla is nowhere near making the Model 3 for a cost that would allow a $35,000 version and/or a 25% gross margin that Musk has long been projecting. You can see below that the ramp-up of the Model 3 has coincided with a drop in gross margins — and that’s despite Tesla selling only high-priced, high-margin Model 3s thus far.
TSLA Gross Profit Margin (TTM) data by YCharts
There are some costs associated with ramping up production, which will keep margins down in the short term. But Tesla has admitted that it’s been focused on the highest priced Model 3s and has to cut costs to get anywhere near selling the lower-price models it has promised. So far, there’s not much evidence it can make money if prices decline.
Without a high gross margin, Tesla won’t be able to generate enough cash from operations to fund expansions in China or develop a Model Y or a semi truck. And with debt hanging over the company, it may face a cash crunch as it’s trying to grow.
Debt is looming
The margin and cash flow picture I’ve outlined above is important when you look at Tesla’s debt. The company has $10.5 billion of debt (including short term), of which $920 million comes due March 1, 2019 in the form of a convertible note. There are mechanisms for converting this debt into stock (which would dilute current shareholders) but Elon Musk has said Tesla will pay off the $920 million of debt with cash.
TSLA Total Long Term Debt (Quarterly) data by YCharts
Add to that $566 million of convertible debt that’s due in November, and Tesla needs to start generating positive cash flow soon or it will massively dilute shareholders. But instead of cutting back on its plans, the company aims to invest $2 billion to $5 billion to expand in China.
Elon Musk has always managed to find ways to fund Tesla’s growth, whether through debt or equity markets, but eventually, he has to prove that the company can make money or markets will quit funding its growing debt load. The risk is that we’ve already reached that point with debt yields rising, making it more costly to take out more debt to fund future growth.
Impressed or scared?
Tesla’s growth path has been astounding, and it’s incredibly impressive how the company has pushed electric vehicles forward. But it hasn’t proven that it can make money in the long term by selling vehicles, and has had to resort to layoffs not once, but twice over the past year to cut costs.
As losses mount, debt maturities move closer and Tesla needs to either become cash flow positive or find ways to finance operations, either through more debt or by issuing shares, diluting current shareholders. Neither is appealing if you’re looking at buying Tesla stock today.
Ambition has gotten Musk a long way in the auto industry. But at this point, I think his company’s inability to become a high-quality, low-cost manufacturer is overriding any awe I have at the company’s growth. Competitors like Porsche, BMW, General Motors, and Jaguar are coming for Tesla’s EV market, and they’ll come with high quality and infrastructure that Tesla can’t match. That’s why I don’t think Tesla is a stock to buy, and I would be a seller right now.