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Can Tesla Pay Its Debt?

Tesla Gigafactory Shanghai, China. Source: Tesla 1Q20 Update Letter.

Can Tesla pay its debt?

This question may not be relevant because Tesla can always go back to the capital market to raise more funds either through debts or equity even if it doesn’t have the money to pay off existing debt.

Tesla will then use the newly borrowed funds to pay off existing debts that come due.

This is called refinancing and it’s similar to refinancing your existing mortgages with new mortgages, possibly with better rates.

Most big corporations like Tesla are doing this to better make use of money or loans.

Reason? Debts are incredibly cheap, especially in a low rates environment like now.

Besides, debts are tax-deductible for most listed companies.

Additionally, Tesla is getting better return on investment or ROI when it uses debts to fund the expansion and future growth of the business.

For this reason, we should approach the question again by asking, “Can Tesla afford the debt?”.

This question can be answered by digging into Tesla’s interest coverage ratio or the times interest earned ratio.

These ratios measure Tesla’s ability to service its debt with profits and cash flow generated from relevant businesses such as the automotive and energy businesses.

Let’s dive in!

Tesla’s Interest Expense – Quarterly

Tesla interest expense - quarterly

Tesla interest expense – quarterly

Let’s first look at Tesla’s interest expense over the past 6 years from 2015 to 2020 as depicted in the chart above.

The interest expense reflects part of Tesla’s expenses as a result of the company’s existing debt.

As the above chart shows, Tesla’s interest expense has grown quite significantly over the past 6 years.

On a quarterly basis, Tesla’s interest expense reached as much as $246 million as of 4Q 2020.

6 years ago, this figure was less than $50 million, which was about 1/5th of what the company is paying now.

Again, the growth in interest expense for the last 6 years has been largely driven by the growing indebtedness as shown in this article: Tesla debt obligation.

Tesla’s Interest Expense – TTM

Tesla interest expense - ttm

Tesla interest expense – ttm

The quarterly plot may not clearly show the trend of Tesla’s interest expense from 2015 to 2020.

The trailing 12-month or TTM plot is created above to better reflect the long-term trend.

According to the chart above, Tesla’s interest expense has indeed been growing on a TTM basis.

As of 2020 Q4, Tesla’s interest expense totaled as much as $748 million from a TTM perspective.

However, most growth in interest expense occurred in the early years, from 2015 to 2018.

The growth in interest expense has been mostly flat since 2018.

Tesla’s interest expense grew significantly higher in 2020 4Q, due largely to the soaring interest expense in the 4Q 2020 quarter alone.

Tesla’s EBIT – Quarterly

Tesla EBIT or operating income - quarterly

Tesla EBIT or operating income – quarterly

Let’s also look at Tesla’s EBIT or earnings before interest and tax.

The EBIT is also referred to as the operating income in the income statement.

The EBIT is one such important metric when it comes to measuring Tesla’s ability to service its debt because the EBIT comes before the interest expense is deducted in the income statements.

Therefore, by tracking closely the EBIT, we can find out whether Tesla can afford its existing debt or not.

According to the chart above, Tesla’s EBIT or operating income has been mostly negative for the last 6 years.

However, we are seeing a significant improvement to the company’s EBIT in recent years. Specifically, Tesla’s EBIT has been positive over several quarters between 2019 and 2020.

Tesla has managed to generate positive EBIT consecutively for the past 6 quarters from 2019 to 2020.

As of 2020 Q4, Tesla’s EBIT or earnings before interest and tax reached as much as $575 million on a quarterly basis.

Tesla’s EBIT – TTM

Tesla EBIT or operating income - ttm

Tesla EBIT or operating income – ttm

Similarly, the EBIT quarterly plot may not accurately reflect the long-term trend of the plot.

A TTM plot is created above to show Tesla’s EBIT in the last 6 years.

As seen in the plot above, Tesla’s EBIT is clearly seen soaring in 2020 and reached a record high of nearly $2 billion as of 4Q 2020.

While Tesla has operated at a loss in most quarters prior to 2020, the company has been largely profitable in 2020.

In fact, Tesla’s profitability has been rising consecutively throughout 2020.

Tesla’s Interest Coverage with respect to EBIT – Quarterly

Tesla interest coverage ratio to EBIT - quarterly

Tesla interest coverage ratio to EBIT – quarterly

Since we already have the EBIT mapped out, we are now ready to show Tesla’s interest coverage ratio with respect to EBIT on a quarterly basis as depicted in the chart above.

Here is the formula for calculating Tesla’s interest coverage ratio or times interest earned ratio:

Interest coverage ratio = earnings before interest and tax (EBIT) / interest payable

Based on the chart, Tesla’s interest coverage or times interest earned ratios with respect to the EBIT have been trending positively in the last 6 years.

In line with the improving EBIT in recent years, Tesla’s interest coverage ratio reached a positive value of 2.3 as of Q4 2020, indicating that the company’s generated earnings were more than twice the interest expense on a quarterly basis.

In fact, Tesla’s interest coverage ratio has been in the positive regions consecutively in the last 6 quarters from 2018 to 2020, suggesting the improving operation that generated enough earnings to cover the respective interest expenses.

Tesla’s Interest Coverage with respect to EBIT – TTM

Tesla interest coverage ratio to EBIT - TTM

Tesla interest coverage ratio to EBIT – TTM

From a TTM perspective, Tesla’s interest coverage or times interest ratio was seen reaching a new high at 2.7 in 2020 4Q.

This figure shows that Tesla has nearly 3X the operating income with respect to the interest expense on a TTM basis.

What’s important is the positive trend that the plot is depicting – the growing Tesla’s interest coverage throughout 2020.

The positive trend bodes well for Tesla’s investors who invested in Tesla’s stock for the long haul.

Tesla’s EBITDA – Quarterly

Tesla EBITDA - quarterly

Tesla EBITDA – quarterly

Looking at just the EBIT alone may not be sufficient for the analysis of Tesla’s interest coverage or times interest ratios.

Instead of using only the EBIT, we can enhance our analysis by adding the EBITDA which stands for earnings before interest, tax, depreciation and amortization.

The EBITDA is almost identical to EBIT except that EBITDA excludes depreciation and amortization whereas EBIT includes them.

Additionally, EBITDA can be considered as a form of cash flow that is generated directly from the core businesses.

The following diagram illustrates where the EBITDA is located in the cash flow diagram:

EBITDA

EBITDA diagram

Based on the diagram above, the EBITDA sits in between the EBIT and the cash flow from operating activities.

As illustrated in the diagram, the EBITDA bypasses the depreciation and amortization expenses.

As such, the EBITDA is largely free from distortions that can arise from depreciation and amortization which usually exist in the EBIT.

In general, the EBITDA is a powerful metric that measures not only the profitability but also the “pure” cash flow generated out of a business.

According to the quarterly chart above, Tesla’s EBITDA has been in much better shape compared to the EBIT.

Since depreciation and amortization are excluded in the EBITDA, the figures in the chart above are mostly in the positive region, showing that Tesla’s core operations can indeed generate tonnes of profits and cash flow when adjusted for non-cash expenses.

In fact, Tesla’s quarterly EBITDA has been rising in the last 6 years and reached a record high of $1.85 billion in 4Q20.

Tesla’s EBITDA – TTM

Tesla EBITDA - ttm

Tesla EBITDA – ttm

To smooth out the quarterly plot, the TTM plot above is created to show the true sense of Tesla’s EBITDA long-term trend.

From a TTM standpoint, Tesla’s EBITDA has been increasing for the past 6 years and reached a new high of nearly $6 billion as of 2020 Q4.

In other words, Tesla’s core businesses have generated a cash flow of nearly $6 billion in 2020 Q4 on a TTM basis.

Of course, the cash flow measured from Tesla’s EBITDA still needs to account for the cash paid in working capital such as the accounts receivable, inventories, accounts payable, interest expense, tax, etc.

But the metric shows just how much cash Tesla’s core businesses can generate.

More importantly, the cash has been rising steadily, pointing to Tesla’s improving fundamentals.

Tesla’s Interest Coverage with respect to EBITDA – Quarterly

Tesla interest coverage ratio to EBITDA - quarterly

Tesla interest coverage ratio to EBITDA – quarterly

Since EBITDA is a form of cash flow, we can actually measure the interest coverage or times interest earned ratio with respect to EBITDA.

The formula for measuring the interest coverage ratio with respect to EBITDA is shown as below:

Interest coverage ratio = earnings before interest, tax, depreciation and amortization (EBITDA) / interest payable

This ratio possibly better reflects Tesla’s realistic interest coverage compared to the one using the EBIT as the EBITDA is a more refined version of the EBIT.

Also, the EBITDA focuses on cash flow instead of on earnings.

Coming back to the chart above, we can see that Tesla’s EBITDA-based interest coverage ratio has been largely in the positive region as opposed to the EBIT-based interest coverage ratio.

More importantly, the majority of the improvement in Tesla’s interest coverage occurred in recent quarters between 2018 and 2020.

As of 2020 Q4, Tesla’s EBITDA-based interest coverage reached 7.5, one of the new highs for the company over the last 6 years.

The positive figures indicate that Tesla has the ability to generate sufficient cash flow to cover the respective interest payable.

In fact, Tesla’s cash flow is multiple times higher than the interest expense, suggesting that the company has no issue with servicing its debt.

As such, Tesla can afford its existing debt level.

Tesla’s Interest Coverage with respect to EBITDA – TTM

Tesla interest coverage ratio to EBITDA - TTM

Tesla interest coverage ratio to EBITDA – TTM

On a TTM basis, Tesla’s interest coverage has been soaring to a new high at 7.8 as of 4Q 2020.

The uptrend is clearly displayed in the chart, which shows the growing Tesla’s interest coverage ratio or times interest earned ratio between 2018 and 2020.

The increasing interest coverage ratio points to an improvement in Tesla’s fundamentals all these years.

Tesla’s ability to service its debt grew higher each day along with the improving interest coverage ratio.

In short, Tesla should have no problem servicing its existing debt and can, in fact, take on more debt considering that the company’s cash flow is more than 7X higher than the respective interest payable.

Conclusion

Can Tesla pay its debt? The answer is yes, but the more important question to ask is, “Can Tesla afford its current debt level?”.

From the interest coverage ratio or the times interest earned ratio, Tesla has been able to cover all the interest expenses throughout 2020.

In terms of the interest coverage with respect to EBIT, Tesla may only generate enough operating income to pay for the interest expenses.

However, Tesla has more than sufficient the required cash flow to cover the interest payable as reflected from the higher interest coverage ratio with respect to EBITDA.

In short, Tesla can pay and more importantly, service its debt.

References and Credits

1. All information including financial figures in this article was obtained and referenced from the financial statements available in Tesla Investor Overview.

2. Featured images were used under Creative Commons Licenses and were obtained from Jakob Härter.

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