Tesla may become the next Apple or Google possibly within the next 5 years.
As such, it may seem like a no-brainer to invest in Tesla’s stocks now while the company is still relatively small in market cap.
However, there is a significant amount of risk associated with stocks, particularly Tesla’s stock.
In this article, we are going to list out and discuss several risk factors associated with investing in Tesla’s stocks.
Let’s take a look.
Risk 1: Tesla has not made a single profit since IPO
One major setback in Tesla is the fact that the company has been consistently unprofitable since its initial public offering (IPO) in 2010.
In fact, Tesla has not been profitable in any single year from 2010 to 2019 on an annual basis.
According to the 2019 annual report, the accumulated losses incurred by the company up until June 30, 2020, totaled as much as $6 billion.
Losses before interest expenses and taxes in 2017 alone amounted to $1.63 billion, the largest since its IPO, due primarily to the company’s ramp-up of the Model 3 production.
However, Tesla managed to reduce losses in subsequent years from 2018 to 2019 by taking drastic measures such as cutting capital expenditures and reducing new store openings while increasing sales through Model 3 record deliveries.
Tesla’s net loss before interest and taxes totaled only -$388 million and -$69 million in 2018 and 2019, respectively, a far cry from the losses incurred in 2017, according to this article: Tesla’s profitability.
While Tesla had successfully cut losses in recent years, it still incurred 3 consecutive years of losses which were still pretty awful, not to mention the losses that the company had suffered prior to 2017.
Risk 2: Tesla does not pay a dividend
While most major automakers such as General Motors and Ford pay dividends, it’s a different story when it comes to Tesla.
For your information, Tesla has never declared nor paid any dividends since its IPO in 2010.
Consistent losses and negative free cash flow over the years have deprived Tesla of its ability to pay out any dividends now and in the foreseeable future.
Furthermore, Tesla also carries a substantial amount of debt.
The respective debt covenants may restrict Tesla from distributing profits, if there is any, in the form of dividends.
Not until the company can consistently and meaningfully make a profit and generate a substantial amount of free cash flow, existing shareholders can only hope for a capital gain in Tesla’s shares instead of a dividend payout from the company.
Risk 3: Tesla is counting on a single product for growth
When this article was published, Tesla was still pretty much relying on its flagship vehicle, the Model 3, to drive revenue growth.
Other than Model 3, the company has no other major products that can generate the kind of sales revenue that Model 3 can achieve.
Tesla may have the Model S and Model X but they are far too expensive for mass-market adoption.
Moreover, Tesla has only recently unveiled the Model Y, a 7-seater crossover that looks like an SUV and is touted as the game-changer for the company.
However, Tesla has only started accepting the order for Model Y in Q1 2020 and began production by Q2 2020.
Besides, Tesla has yet to prove that the Model Y is a game-changer.
Moreover, the recent COVID-19 outbreak may disrupt Model Y production and delivery, thereby further delaying the potential sales revenue generated from the delivery of Model Y.
Not until there is evidence suggesting that the Model Y can successfully garner a mass-market adoption, the fate of the Model Y, whether a game-changer or just another showroom model, will remain as a big question mark to investors.
In additon, as shown in this article – Tesla’s vehicle deliveries, Tesla’s Model 3 delivery as of 2Q 2020 made up nearly 90% of the company’s total deliveries.
In other words, Tesla’s total sales still depend largely on the bulk of the revenue generated from the delivery of Model 3.
The delivery figures show just how intimately the dependency Tesla has on Model 3 for growth. This makes the growth of Tesla extremely vulnerable to Model 3.
The risk here is that any mishap to Model 3 such as a product recall or a change in consumers’ perception towards Model 3 would spell disaster for Tesla.
Therefore, for all the reasons discussed, Tesla is still pretty much relying on the Model 3 for growth as of Q2 2020 and possibly into the end of 2020.
Risk 4: Tesla may not be able to service its mounting debt loads
Like most companies that borrow heavily, Tesla’s mounting debt may possibly put the company at risk of a default due to external circumstances that the company has no control, including the COVID-19 disruption and a deteriorating economy.
According to this article, Tesla’s debt, Tesla’s total debt, inclusive of schedule interest expenses, borrowings and leases, has reached more than $16 billion as of 2020 2Q, a record high for the company.
Tesla’s interest expenses have been steadily increasing in the past 3 years, driven primarily by the increasing indebtedness.
Tesla’s annual interest expenses amounted to $685 million, $663 million and $471 million in 2019, 2018 and 2017, respectively.
In the past 3 years, Tesla’s operating income stood at -$69 million, -$388 million and -$1,632 million in 2019, 2018 and 2017, respectively.
In other words, Tesla has been operating at a loss between 2017 and 2019, resulting in negative operating profits that have been unable to sufficiently cover the respective interest expenses.
Due to unprofitable business operations, Tesla often resorts to the capital market to raise cash to fund its operation as well as to repay the debt.
Under any circumstances, should Tesla fail to get the required capital, the company will go out of business in no time.
Risk 5: Tesla is unable to generate sufficient free cash flow
When it comes to doing business, cash is king. Unfortunately, Tesla has little of it.
According to this article – Tesla’s capital raise, Tesla has been unable to generate sufficient free cash flow to expand its operations.
While the company may have been able to generate positive free cash flow in recent quarters, it was far from enough to be used as working capital as well as for business expansion.
As a result, Tesla has been consistently resorting to the capital market to raise cash.
While a capital raise through external sources is a normal business practice, it’s a very risky move if Tesla does it very often.
Firstly, a capital raise through debt borrowings will result in higher interest expenses.
As discussed, Tesla may not be able to service the growing indebtedness in a deteriorating business environment.
Secondly, Tesla’s existing shareholders will be highly diluted if the company constantly issues equity to raise cash.
Up until now, Tesla relies heavily on external capital injection to fund its operations and expansion.
If Tesla had consistently failed to generate a return on capital that is greater than the cost of capital, the company will simply destroy wealth instead of creating it.
Under this circumstance, Tesla will always be going back to the capital market for more cash.
Tesla has been a great company and in fact, one of the best in class in the automobile industry.
The company has been producing some of the best electric vehicles in the world, one that always turns heads wherever they are.
However, a great company does not necessarily mean a great investment, especially for Tesla.
There are many aspects that potential investors need to look at such as profitability, cash flow and business prospects before deciding on the investment.
For a growth company like Tesla, there are many risk factors associated with buying its stocks and these risk factors have been laid out in the discussions above.
From the discussion, defensive investors especially retirees who are concerned with volatility, and are interested only in dividend income, should probably take a pass on Tesla’s stocks.
References and Credits
1. All financial figures in this article were obtained and referenced from Tesla’s annual and quarterly filings available in Tesla Quarterly and Annual Reports.
2. Featured images in this article are used under creative commons license and sourced from the following websites: Yasunari Goto.
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