One way Tesla could go under is when the company can no longer afford to service its debt.
This situation can happen when Tesla either carries too much debt or experiences a drop in profitability and cash flow.
For the former, Tesla’s growing indebtedness will result in rising interest expenses.
When business is good, the rising interest expenses may not harm Tesla in any way as the company can most likely sustain the debt repayment with sufficient profit and cash flow.
However, interest expenses will be a tremendous liability to the company during an economic downturn or bad business environment when people stop buying Tesla’s products.
In this case, Tesla may not be able to service its debt or interest expenses because business operations aren’t generating sufficient profits and cash flow to cover the liabilities.
To fix the debt repayment problem, Tesla can either borrow more as a temporary measure or sell some of the firm’s assets to sustain the interest expense.
Therefore, it’s important to track the interest expense coverage ratio to find out the financial health of a company.
In this article, we will look specifically at Tesla’s interest coverage ratio or times interest earned ratio to find out how the company has been doing in terms of servicing its debt levels.
Let’s dive in!
Tesla’s Interest Expense – Quarterly
On a quarterly basis, Tesla’s interest expense has been on a rise since fiscal 2015 but may have topped out in fiscal 2020 before starting to decline.
For example, Tesla’s interest expense remained mostly flat at $170 million between fiscal 2019 and 2020.
In fiscal 2021, Tesla’s interest expense started to moderate and dropped below the $100 million level in the first 2 quarters.
In subsequent quarters, Tesla’s interest expense continued to plunge to new lows.
For instance, as of 1Q 2022, Tesla’s interest expense declined to only $61 million, a new low that was last seen in 2017.
Tesla’s interest expense correlates closely with the company’s total indebtedness as shown in this article: Tesla debt obligation.
That said, the decline in Tesla’s interest expense in recent years has to do with the declining indebtedness of the company.
Therefore, as Tesla’s total debt drops, it makes sense that the interest expense followed suit.
Tesla’s Interest Expense – TTM
The quarterly plot may not clearly show the trend of Tesla’s interest expense.
The trailing 12-month or TTM plot is created above to better reflect the long-term trend of Tesla’s interest expense.
According to the chart above, Tesla’s interest expense has indeed been rising on a TTM basis prior to 2019.
However, Tesla’s interest expense remained flat at $690 million on a TTM basis between 2019 and 2020.
In fiscal 2021, Tesla’s interest expense started a downtrend and reached only $371 million as of 2021 4Q on a TTM basis.
In fiscal 2022, Tesla’s interest expense on a TTM basis continued to plunge to a new low at $333 million, a level that was last seen in 2017.
Again, Tesla’s declining interest expenses in fiscal 2022 have been a result of the declining debt levels of the company as shown in this article: Tesla total debt.
Tesla’s EBIT – TTM
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 interest expense is deducted in the income statements.
Therefore, by tracking closely the EBIT, we can see how Tesla’s business operation has performed.
According to the chart above, Tesla’s EBIT or operating income has been on a rising trend in the last 6 years.
Tesla used to generate negative EBIT prior to 2019 but the firm’s EBIT has managed to turn around since 2019.
As seen, Tesla has been able to generate positive EBIT consecutively since 2019.
That said, Tesla’s EBIT is not only rising but is on exponential growth.
As of 2022 Q1, Tesla’s EBIT or earnings before interest and tax reached a massive $9.5 billion on a TTM basis, a record high for the company.
The rising trend of the EBIT bodes well for Tesla because it’s vastly contrasting the trend seen in the interest expense.
In other words, Tesla’s business operation generates sufficient EBIT to service its debt.
Tesla’s EBITDA – TTM
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 expenses 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:
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 expenses which usually exist in the EBIT.
In general, EBITDA is a powerful metric that measures not only the profitability but also the “pure” cash flow generated from a business.
According to the chart above, Tesla’s EBITDA has been in much better shape compared to the EBIT.
Since depreciation and amortization expenses are excluded in the EBITDA, the figures in the chart above are mostly in the positive region, showing that Tesla’s core operations can be extremely profitable when adjusted for non-cash expenses.
In fact, Tesla’s EBITDA has been rising steadily and massively exploding when it reaches as much as $14.8 billion on a TTM basis in 1Q 2022, a record high for the company.
Similar to the EBIT, Tesla’s rising EBITDA is at the opposing trend compared to that of the interest expense, indicating that the firm’s generated cash flow should be sufficient to cover the interest expense.
Tesla’s Interest Coverage With Respect To EBIT – TTM
Since we already have the EBIT mapped out, we are now ready to show Tesla’s interest coverage ratio with respect to EBIT as depicted in the chart above.
Here is the formula for calculating Tesla’s interest expense coverage ratio or times interest earned ratio:
Interest coverage ratio = earnings before interest and tax (EBIT) / interest payable
All told, based on the chart, Tesla’s interest coverage or times interest earned ratios with respect to the EBIT have been trending positively.
Prior to 2019, Tesla’s interest coverage ratios were mostly negative, showing insufficient profitability or EBIT coverage for the incurred interest expenses.
However, the tide changed for Tesla starting in fiscal 2020 when interest coverage ratios turned positive.
Since 2020, Tesla’s interest expense coverage ratio has not only turned positive but also rising on an exponential trend.
As of 1Q 2022, Tesla’s interest coverage ratio reached more than 28.0X, meaning that the firm’s EBIT was more than 28X higher than the incurred interest expense.
In short, Tesla generates more than sufficient EBIT or operating income to cover the interest payable.
Tesla’s Interest Coverage With Respect To EBITDA – TTM
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 = 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 years from 2018 to 2022.
Similar to the EBIT-based interest coverage ratio, Tesla’s EBITDA-based interest coverage ratio has not only been on a rise but also exploding into new record highs quarter after quarter.
As of 2022 Q1, Tesla’s EBITDA-based interest coverage reached a massive 44.0X, illustrating sufficient cash earnings for the incurred interest expense.
This figure shows that Tesla’s cash earnings can easily cover multiple times the forward interest payable.
In fact, Tesla’s cash earnings or EBITDA is many times higher than the interest expense, suggesting that the company has no issue with servicing its debt now and even in the future.
In short, Tesla can afford to service its existing debt load not only now but also in the future.
The debt of a company is usually the Achilles heel that could bring down the entire company when the tide changes.
During good times, the debt level or specifically, the interest expense generally poses no issue for a firm because people are still buying.
However, in times of an economic downturn, companies with the most debt or huge interest expenses will suffer and be the first to go down.
In this article, we look at Tesla’s interest expense coverage ratio or the times interest earned ratio with respect to several metrics such as the EBIT and EBITDA.
Accordingly, Tesla’s interest coverage with respect to both EBIT and EBITDA has been rising and reached a record high in the latest quarter.
The growing ratios show that Tesla’s business prospects have significantly improved over the years.
As a result, Tesla generates loads of profits and cash flow and they are more than enough to sustain the incurred interest expenses.
In short, Tesla can afford to 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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