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Breaking Down Tesla Capital Structure

A Tesla factory in Fremont, CA. Source: Flickr

Tesla (NASDAQ: TSLA) debt to equity ratio is an important metric that reflects the capital structure of the company. From the ratio, investors and analysts can find out how Tesla funded its balance sheet, whether by debts or by equity or both.

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. In this case, the debt to equity ratio will be a 1.

However, in real life, this balanced debt structure scenario is not always the case for most companies. The reason is that it may not be prudent to rely largely on equity finances because the cost of borrowing, debts in this case, may be much 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’s capital structure to find out how the company leverages between debts and equity. From the analysis below, we will answer some pressing questions that investors have been eager to find the answers.

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.

So, let’s have fun and keep reading!

Types of Debts

Before illustrating further, I would like to say that the equation that I used to calculate 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.

In Tesla’s case, the equity part 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 only debts.

For simplicity, I have considered only “debts” that matters most in the analysis of Tesla’s leverages. Here are some of the most commonly used interpretations of debts which will be further illustrated 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 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. Only the long-term portion is measured in this case.

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 long and short liabilities such as accounts payable, deferred revenues and other miscellaneous liabilities.

The subsequent debt to equity ratio discussion will revolve around the 3 types of “debts” definitions mentioned above.

Chart of Tesla’s Total Debts to Equity Ratio

Tesla total debts to equity ratio

Tesla total debts to equity ratio

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

The leases, both operating and finance, 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 one of Tesla’s 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’s 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 to only 1.8. 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’s total debts to equity ratio dropped more than double to only 1.8 in 2Q 2016 from the prior quarter.

Since then, the ratio further declined to a record low of 1.4 in 4Q 2016 but slightly bounced back to 2.0 in 2Q 2018. The ratio stayed at around the same level at 2.0 since 2018.

As of 1Q 2020, Tesla’s total debts to equity ratio declined to one of its lowest figures of 1.5, illustrating that the company has, once again, issued a significant amount of equity in 1Q 2020. Further investigation revealed that Tesla has indeed issued 3 million of shares in March 2020 to raise $2.31 billion of cash.

Tesla’s total debts to equity ratio of around 1.5 in Q1 2020 shows that the company is moderately leveraged with respect to equity. At this figure, Tesla has about $1.50 of interest-bearing debts for every $1.00 of equity.

There are a few reasons for the ratio to decline steadily and reached the lowest at 1.5 over the past 2 years. One of the likely outcomes is that Tesla has borrowed less debts but issued more equity between 2018 and 2020.

As you may have already known, equity is less risky compared to debt borrowings because Tesla literally does not have to repay the capitals obtained through equity. The only downside of equity is that it dilutes the control of the company.

Tesla Long-Term Liabilities to Equity Ratio

Tesla long-term liabilities to equity ratio

Tesla total liabilities to equity ratio

Tesla long-term liabilities to equity ratio

The current chart shows Tesla’s long-term liabilities to equity ratio between 2015 and 2020.

As mentioned, 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.

As shown by the chart above, Tesla’s long-term liabilities to equity ratio plot looks very similar to the total debts to equity ratio plot mentioned in earlier discussion. In fact, the trend of current plot looks exactly the same as prior chart.

For instance, Tesla was highly leveraged back in 2015 when long-term liabilities to equity ratio was averaged around 3.8. The ratio significantly declined in 2016 but had slightly ticked up during 2017 to nearly 3.0.

Since then, the ratio declined steadily and reached the lowest figure at only 1.4 as of Q1 2020. Tesla was minimally leveraged in 2020 when long-term liabilities to equity ratio was only 1.4, meaning that Tesla has about $1.40 of long-term liabilities to $1.00 of equity.

Similarly, the decline of the ratio has been largely attributed to the increasing issuance of equity between 2018 and 2020 considering that equity issuance is less risky compared to debt offerings.

Tesla Total Liabilities to Equity Ratio

Tesla total liabilities to equity ratio

Tesla total liabilities to equity ratio

The chart above shows Tesla’s total liabilities to equity ratio over the past 5 years from 2015 to 2020.

Total liabilities are basically all long and short-term borrowings and whatever the company owes to 3rd parties in the balance sheets.

As seen from the chart, the trend of Tesla’s total liabilities to equity ratio also looks similar to prior charts. The only difference is that the leverage ratio has been much higher in current chart. This is expected as all liabilities are included in the measurement of debt to equity ratio.

Again, similar trend is observed when the ratio slowly declined from its peak of roughly 4.3 recorded in 2Q 2018 to only 2.5 in 1Q 2020. Tesla’s total liabilities to equity leverage ratio of 2.5 reported in 1Q 2020 was the lowest over the past 5 years.

In other words, Tesla has the lowest leverage between total liabilities and equity as of 1Q 2020 despite record amount of debts in the same quarter.

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 ratio among all other ratios that have been discussed. The total liabilities to total funds ratio measures the company leverage in terms of total liabilities over total funds. Total funds are the total assets of the company. Basically, total funds are the sum of total liabilities and shareholders’ equity.

On the other hand, 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 sheets.

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

Total Liabilities to Total Funds Ratio = [ Total Liabilities / Total Assets ] 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 how much of the total assets are being funded by debts and how much of that comes from equity.

Coming back to the chart, it’s very obvious that Tesla capital structure has been entirely funded by debts as the numbers have been on the high side. Throughout the shown period from 2015 to 2020, the ratio has been consistently above 70%, with some quarters even having a ratio exceeding 90% in 2015. This ratio says that as much as 90% of Tesla’s 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 was 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 by equity.

Slowly, Tesla has been reducing its dependency on debts and instead turned to equity as an alternative source of funding for the company. This scenario is seen from the decreasing ratio above in recent years. As of 1Q 2020, Tesla’s total liabilities to total funds ratio has dropped to its lowest at around 70% and the figure was the lowest since 2015.

The result in the chart above is expected because we have seen from prior debt to equity ratios that they have all reached the lowest numbers in the latest quarter of 1Q 2020.

In short, Tesla’s entire balance sheet is 70% funded by borrowed capitals as of 1Q 2020, both interest and non-interest bearing. This explains the reason that Tesla’s leverage is still moderately high against equity even though the total liabilities to total funds or assets ratio has reached the lowest as of 1Q 2020.

When you take into account of all the liabilities in the balance sheets, Tesla’s debt to equity ratio in the latest quarter of Q1 2020 totaled 2.5. At this ratio, Tesla’s leverage is about $2.50 of debts to $1.00 of equity.

Conclusion

To recap, Tesla’s 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.

However, total debts to equity ratio dropped to the lowest as of 1Q 2020 at only 1.5. The trend may indicate that Tesla has preferred equity issuance over capitals borrowing in order to reduce the company’s debts leverage in recent years.

As of Q1 2020, based on the total liabilities to total funds ratio, Tesla’s capital structure is made up of 70% debts and 30% equity, which means the company’s entire assets are almost funded by borrowed capital. At 70% ratio, Tesla’s leverage is about $2.50 dollars of debts to $1 dollar of equity.

References and Credits

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

2. Featured image was used under Creative Common Licenses and obtained from mangopulp2008 and Maurizio Pesce.

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