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Breaking Down Tesla Capital Structure

A Tesla factory in Fremont, CA. Source: Flickr

Tesla (NASDAQ: TSLA) debt to equity ratio reflects the capital structure of the company in terms of debts and equity. Ideally, the capital structure of a company should be well balanced between debts and equity.

For example, for every 1 dollar of equity, there is 1 dollar of debt. The reason is that it may not be prudent to rely wholly on equity finances as the cost of borrowing (debts) may be cheaper than the required rate of return on equity. This is especially true in a low interest rate environment.

In this article, we will explore Tesla capital structure to find out the company leverages between debts and equity. From the analysis below, we will answer some pressing questions that investors have been eager to find out.

For instance, questions such as what makes up Tesla capital structure, whether entirely from debt or equity, or perhaps a well balanced capital structure between debts and equity, are what we are trying to answers in subsequent discussion.

Therefore, sit tight and keep reading to find out more!

Types of Debts

Before illustrating further, I would like to point out that the equation that I used to measure the debt to equity ratio is shown as below:

Debt to Equity Ratio = Debt / Equity

From the above equation, the equity part is easily understood. Basically, it’s the total equity which can be easily obtained from the balance sheets.

Take note that the total equity includes both shareholders’ equity and minority interest equity. The reason is that Tesla is a holding company of multiple subsidiaries. As such, the balance sheet is consolidated with assets and liabilities of all subsidiaries.

The consolidation has led to the existence of minority interests in the balance sheet because Tesla does not own 100% of some subsidiaries. The following snapshot illustrate the non-controlling interest or minority interest portion in the balance sheet.

Tesla minority interest

Tesla minority interest

Coming back to the equation above, difficulties may arise when we try to figure out the debt part of the equation. There are countless definitions of “debts”. In this case, debts can be derived from long-term or current debts, total liabilities or interest bearing debts only.

For simplicity, I have considered only “debts” that matters most in the analysis of Tesla leverages. Here are some of the most commonly used interpretations of debts which will be used in subsequent discussion:

1. Total debts – debt instruments that include both long and short-term loans as well as finance and operating leases. Basically, total debts are made up of all interest-bearing debt instruments.

2. Long-term liabilities – these are long-term loans and other miscellaneous liabilities such as accounts payable, deferred revenues, leases, warranty reserves and so on.

3. Total liabilities – these are all the liabilities in the balance sheet that consist of both long and short-term loans as well as other liabilities such as accounts payable, deferred revenues and other miscellaneous liabilities.

Chart of Tesla Total Debts to Equity Ratio

Tesla total debts to equity ratio

Tesla total debts to equity ratio

Let’s first look at total debts to equity ratio. As briefly mentioned in prior discussion, total debts consists of only interest-bearing debt instruments such as long and current loans. Moreover, total debts also include both finance and operating leases as these are also interest-bearing debt instruments and have added quite substantial amount of debts to the company as shown in this article: Tesla debts analysis.

The leases represents the total minimum lease payment which also includes the expected interest portion in future. The following snapshot shows an example of the total minimum lease payment disclosed in a financial statement:

Tesla operating and finance leases

Tesla operating and finance leases from the quarterly statement

Other liabilities such as accounts payable, accrued liabilities, deferred revenue, warranty reserves and so on are not included as part of the total debts in the chart above. As such, the plot above illustrates Tesla leverage of only interest-bearing debts with respect to equity.

As seen from the chart, Tesla total debts to equity ratio was the highest back in 2015 when total debts was averagely 4 times more than that of equity. The ratio dropped substantially in 2Q 2016. Upon investigation, Tesla made a very huge equity issuance for capital raise in 2Q 2016 which had significantly increased the company equity. For this reason, Tesla total debts to equity ratio dropped more than double to slightly less than 2.0 in 2Q 2016 from the prior quarter.

After that, the ratio decreased even more but slightly bounced back to 2.0 in 2Q 2018. The ratio stayed at roughly the same number at 2.0 since 2018.

Overall, Tesla total debts to equity ratio of around 2.1 in 3Q 2019 shows that the company is moderately leveraged with respect to equity. At this figure, Tesla has about $2.10 of interest-bearing debts for every $1.00 of equity.

There are quite a few reasons for the ratio to stay at 2.0 over the past 3 years. One of the likely outcomes is that Tesla may have borrowed less debts but issued more equity from 2016 to 2019. The combination of this practice can fix the ratio at roughly the same number.

Tesla Long-Term and Current Liabilities to Equity Ratio

Tesla long-term and current liabilities to equity ratio

Tesla long-term and current liabilities to equity ratio

In the chart above, instead of showing just the long-term liabilities to equity ratio, I have also included the current liabilities to equity ratio. The purpose of the chart is to show Tesla leverage in terms of long-term and current liabilities with respect to equity.

Long-term liabilities are all non-current liabilities such as long-term loans, leases, accrued liabilities, deferred revenues, resale value guarantee and other miscellaneous long-term liabilities. Current liabilities consist of current lease payable, accounts payable, short-term loans, deferred revenue and other miscellaneous short-term liabilities that are due within a year.

As seen in the chart above, Tesla had a vast amount of current liabilities with respect to long-term liabilities. At some time in the chart, current liabilities ratio trended higher and was closing in at the same level with long-term liabilities, indicating that Tesla nearly had equal amount of current and long-term liabilities.

For example, both long-term and current liabilities to equity ratio was close to 2.0 in 2Q 2018 and 3Q 2018.

This pattern may indicate that some portions of long term liabilities being re-classified to short-term liabilities in some quarters when they were due within a year. We noticed that the current liabilities to equity ratio dropped off from its high in 2017 and 2019, signaling that Tesla was capable of resolving and reducing some short-term liabilities, either by paying them off or re-negotiating the terms to push out the due date.

In short, I would start worrying in a situation such as when the short-term liabilities continue to accumulate and grow more than that of long-term liabilities. When this occurs, it may indicate that Tesla has problem managing its short-term debts.

You may notice that the pattern of long-term liabilities to equity ratio was very close to that of total debts to equity ratio which we saw earlier. In fact, both ratios had been very close throughout the shown period, indicating that Tesla’s leverage in long-term liabilities to equity was just as much as in total debts to equity.

Chart of Tesla Current to Long-Term Liabilities Ratio

Tesla current to long-term liabilities ratio

Tesla current to long-term liabilities ratio

Since Tesla current liabilities is worth a bit more discussion, I created the chart above to show the relationship between current liabilities and long-term liabilities which has been briefly discussed earlier.

The ratio in the chart was created by dividing current liabilities with long term liabilities and was expressed in percentage.

As seen from the chart, Tesla current liabilities had been consistently high with respect to long-term liabilities. The average ratio is about 63% which means that in average in every quarter, for every $1 dollar of long-term liabilities, Tesla has about $0.63 dollar of short-term liabilities that will be due in a year.

The results show that Tesla business is extremely capital intensive and requires large amount of working capital to deal with the huge pile of current liabilities.

In some quarters, the ratio has reached 70% which means current liabilities has grown to 70% of long-term liabilities. The growth in current liabilities had been in line with Model 3 production ramp between 2017 and 2019. The plot grew exponentially between 2017 and 2019 when Tesla was ramping the Model 3 production during this period. Understandably, this is the period when Tesla needed a large working capital to deal with the increasing current liabilities.

Chart of Tesla Current Liabilities

Tesla current liabilities

Tesla long-term and current liabilities to equity ratio

Tesla current liabilities

To show the state of the current liabilities in dollar term, I have created the chart above which tracks Tesla current liabilities for the previous 5 years from 2015 to 2019.

As seen from the chart, Tesla current liabilities has increased from just $2 billion in 1Q 2015 to more than $10 billion as of Q3 2019. The 5X increment over the past 5 years in current liabilities translates to a compounded annual growth rate (CAGR) of roughly 38%.

In general, this may not represent a problem if Tesla is capable of making profit to deal with the ever-increasing short-term liabilities. Since Tesla has been operating at a loss, the figures above are worth examining from quarter to quarter to make sure that the current liabilities does not get out of hand and the company has enough liquidity to cover it.

As of now, Tesla certainly needs external capital injection to deal with the ballooning short-term liabilities.

Tesla Total Liabilities to Total Funds Ratio

Tesla total liabilities to total funds ratio

Tesla total liabilities to total funds ratio

Finally, this is probably the most important and easily understood ratio in the chart above that measures the company leverage in terms of total liabilities over total funds.

As briefly mentioned at the start of the article, total liabilities are all the liabilities that you can find in the balance sheet, whether interest bearing or not and they include everything from short to long-term portions as well as the rest of miscellaneous liabilities that are disclosed in the balance sheet.

Total funds are the sum of total liabilities and total equity from the balance sheet. Basically, total funds represent total assets of the company.

Here is the equation that I used for the calculation of this ratio:

Total Liabilities to Total Funds Ratio = [ Total Liabilities / (Total Liabilities + Total Equity) ] X 100%

The above ratio, expressed in percentage, measures the percentage of the balance sheet funded by debts. Instantly, it gives an overall picture of the funding side of the balance sheet, whether entirely from debts or from equity. Moreover, the ratio tells us about the leverage of the company based on the percentage of total liabilities over equity.

Coming back to the chart above, it’s very obvious that Tesla capital structure is entirely funded by debts as the numbers have been on the high side. Throughout the shown period from 2015 to 2019, the ratio has been consistently above 70%, with some quarters even having the ratio at 90% in 2015. This ratio says that as much as 90% of Tesla capital structure was funded by debts in 2015.

The ratio dropped slightly in 2016 to 70% but came back up to 80% in 2018 and 2019. From 2018 to 2019, the ratio stayed at roughly the same figure which was around 80%. Although the ratio has trended lower from its record high in recent years, it’s still considerably high at 80%. The number means that 80% of Tesla assets or capital structure is funded by debts while the rest is acquired from equity.

From this result, Tesla entire balance sheet is almost funded by borrowed capitals, both interest and non-interest bearing. This explains the reason that Tesla’s leverage is high against equity. When you add up the long-term and current liabilities to equity ratio in the latest quarter of Q3 2019, you get a ratio of slightly more than 3.0. At this ratio, Tesla leverage is about $3.00 of debts to $1.00 of equity.

Conclusion

Tesla total debts to equity ratio has significantly declined from its peak value of more than 4.0 in 2015. During 2018 and 2019, the ratio has mostly stayed at 2.0, illustrating that for every $1 of equity, the company has $2 of interest bearing debts. The trend may indicate that Tesla has preferred equity issuance over capital borrowings in recent years so that the ratio can float at a fix value of 2.0.

Tesla long-term and current liabilities to equity ratios tell us that current liabilities represents an increasing pile of debts in its balance sheet. This pattern only means that Tesla needs a lot of short-term working capital to operate its asset heavy manufacturing business.

As of Q3 2019, based on the total liabilities to total funds ratio, Tesla capital structure is made up of 80% debts and 20% equity, which means the company total assets are almost entirely funded by borrowed capital. At 80% ratio, Tesla leverage is about $3 dollars of debts to $1 dollar of equity.

References and Credits

1. Financial figures in all charts above were obtained from financial statements available in Tesla Quarterly Results.

2. Featured image was obtained from mangopulp2008 and Maurizio Pesce.

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