Tesla Inc. (TSLA) is headed into unknown territory. The electric vehicle company was much smaller a decade ago, when it last faced a cyclical economic downturn. As the EV maker continues to plot a course for exponential growth, it will eventually have to contend with a harsher economic reality.
Delivery downturn
Tesla managed to surprise to the upside on April 3, when it reported its vehicle delivery numbers for the first quarter. The company claimed 88,400 total deliveries, which narrowly beat the (much reduced) analyst consensus estimate. Wall Street analysts had not been terribly enthusiastic ahead of Tesla’s first quarter delivery report, having slashed their estimates substantially in the weeks ahead of the release, and Tesla had been working hard in the days running up to the deliveries print to manage expectations downward.
Tesla focused on the positives, calling it the best first quarter in the company’s history. This spin on things certainly seems to have worked in the short-term, as the stock has surged in the days since deliveries were announced.
However, deliveries were down a whopping 23% sequentially, a dangerous sign for a company with a stock price predicated on massive growth. Moreover, the delivery beat appears to have had a helping hand from wholesale buyers, which represented a substantial portion of the company's March sales in China. Wholesale or consignment sales bring less cash in the door initially, as well as lowering final per-unit revenues.
With its Fremont, California factory idle, Tesla is not currently making cars. Given the state of the economy, demand has likely suffered as well.
Balance busted
Automakers have been tapping credit lines in recent weeks to pad their balance sheets to weather the Covid-19 storm. Tesla has a $3 billion asset-backed lending facility at its disposal, but it has frequently drawn on this in normal times to pad its balance sheet ahead of quarterly earnings reports. Unless it issues new debt or raises new equity capital, Tesla will have to rely on its current cash resources to see it through to the other side of the downturn.
Tesla reported having $6.3 billion in cash at the end of 2019. It added further to this balance through a stock sale in February that grossed a further $2.3 billion. Yet, even with capital expenditure cut to zero, Tesla faces quarterly operational cash burn of about $1 billion in the absence of any production and sales.
That burn rate will not endanger Tesla’s survival directly, at least not right away. But if the shutdown persists, cash burn will become increasingly troublesome for the company, and will eat away from its ability to undertake the billions of dollars in capital expenditure it has promised – and on which its bulging valuation is predicated.
Cost control
With its Fremont and Nevada factories shut down for the foreseeable future, Tesla has moved to reduce its cost profile in earnest. On April 7, the company furloughed its manufacturing employees and cut the salaries of remaining employees. Tesla has also turned to the landlords of its various brick-and-mortar locations in search of rental relief. Unfortunately, Tesla has limited additional tools for reducing costs. The company simply has less wiggle room than its peers, as auto analyst E.W. Niedermeyer observed on April 14:
“Raising a couple billion and having a new crossover launching right now does help Tesla, but being in the middle of a manufacturing footprint expansion, having a poor profitability record and a relatively weak balance sheet are major points against them. People still don't seem to understand what surviving a major downturn means for auto manufacturers.”
All automakers must contend with a highly capital intensive, deeply cyclical industry, and Tesla is no exception. Yet, the EV company was unable to operate sustainably even in good economic conditions. With the economy in recession, it will face a far tougher challenge.
Squeezing suppliers
Tesla has spent years twisting the arms of its suppliers to secure discounts, almost always at the cost of long-term purchasing agreements. Now, with recessionary pressures biting deep, Tesla is the one facing the squeeze, as Niedermeyer pointed out on April 14:
"Tesla has been squeezing its major suppliers for years to print thin quarterly profits, meaning that one of its major downturn survival levers is already used up. If Tesla has squeezed its suppliers too hard and these smaller, more vulnerable companies run into trouble it could easily create holes in their supply chain. As Musk says, one missing part can bring production grinding to a halt. Suppliers are the canaries in the coal mine."
Unable to squeeze suppliers further, Tesla is pulling its last few cost control levers. These will help somewhat, but cannot alter the underlying economic problem.
Verdict
Tesla faces several tough months ahead. Yet, so far, the market has chosen optimism over realism, in my opinion. As other auto stocks have slipped, Tesla has surged. It is Tesla that is most vulnerable among its peers to the damaging impact of a lengthy shutdown. That will begin to show over the next few quarters. Investors hoping for another sustained upward surge in share price should probably think again.
Disclosure: Author is short Tesla.
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