Tesla’s Problems In China Highlight Its Biggest Threat: Negative Working Capital
Following Tesla may seem like a full-time job, but the key for an analyst is to focus on the important topics and filter out the noise. As Model 3 sales slow in the U.S., China has become a crucial market for Tesla. That’s where two of my favorite Chinese data sources come into play.
Caixin reported this morning that 1,600 Model 3s are currently being held by customs inspectors in Shanghai, owing to incomplete and allegedly false information on the vehicles labels. Earlier Monday, Gasgoo reported that Tesla had undertaken a massive price cut across the board on its model line in China. Cutting Model 3 prices by an average of 8% was an eyebrow-raiser and clearly annoyed some Sino-Teslaphiles, but cutting the price on the highest-end Model X by 40% was nothing less than a sign of suffering in the marketplace.
From a stock perspective, Tesla’s weirdly-phrased and opaquely-delivered profit warning last Thursday remains the key issue for Tesla shares. Those shares are being sold off heavily again in early trading Tuesday.
In the longer-term, though, for those who believe in archaic concepts such as cash flow and interest coverage ratios rather than moonbeams, fairytales and the cult of personality that has enveloped Elon Musk, Tesla’s working capital is the most problematic issue facing the stock.
That’s where the China news enters the analysis. When I read of 1,600 Model 3s stuck on a dock, I realize that Tesla is not going to receive the much-needed revenues from the cars as quickly as management likely anticipated. That will cause accounts receivable to grow. When I read of massive price cuts on all models–especially on its highest-volume model and one that was just introduced–I realize that Tesla’s revenue per unit will likely fall short of management’s expectations. That is problematic for a carmaker as production costs are baked into cost accounting well in advance. Pricing and mix can deliver a nice profit bonus or a kill margins, and Tesla’s China sales are clearly falling into the latter category.
So, for those grown-ups who worship financials instead of disruptors, Tesla’s consistently negative working capital is a flashing warning sign. As of December 31st that working capital deficit was $1.69 billion, powered by a figure for payables–$3.404 billion, that was nearly 4x the figure–$949 million–Tesla held in receivables.
Every car company gets paid for its cars before it pays its suppliers. This is a phenomenon known as working capital uplift. Tesla’s uplift is much higher than the normal 2-3x though, and that leverage is a scary prospect for a company with chronic liquidity problems. Every car company–other than Tesla–has a fully-fledged dealer network onto which it can dump its cars and maintain the working capital uplift. Without those dealers–and with even most of its low-inventory showrooms now slated to be closed–Tesla doesn’t have that cash flow tailwind.
Bottom line: Tesla needs to sell cars to pay its bills. While there have been rumblings among the supplier community–especially with Tesla’s attempts at clawbacks–I have not heard anecdotal evidence of suppliers failing to receive payment form Tesla. Supplier relations involve a delicate balance that require finesse for any carmaker.
Relations with bondholders are completely different, however, even though those payments call on the same cash pile used to pay suppliers. Tesla’s $920 million payout last Friday–owing to the maturity of its 0.25% convertible notes–was a huge crimp in the company’s liquidity by any estimation.
What analysts–not numbers-blind quasi-futurists–need to focus on is the extent to which that liquidity has been funded by Tesla’s working capital uplift. An analysis of Tesla’s balance sheet shows that an increase in payables added $1.7 billion to Tesla’s operating cash flow in 2018, and a cumulative total of nearly $3 billion for the period 2016-2018. While some of that uplift was offset by increasing receivables and inventories, Tesla realized a net benefit from those three categories in each of the prior periods.
After more than a quarter century of following car companies, I can tell you that it is a very, very scary proposition when working capital shifts from a tailwind to a headwind–i.e. receivables suddenly decline without a corresponding decline in payables. That’s a natural consequence of a sudden decline in sales, a phenomenon that seems to be occurring with the Model 3. Without a bunch of dealers willing to park unsold models on the grass at their lots, Tesla has no natural remedy for such a situation. I saw this with DaimlerChrysler in 1999, Fiat in 2002 and ultimately it was that working capital reversal that sent GM into bankruptcy in 2009.
Working capital should be the focus of every Tesla article you read in the next four weeks between now and Tesla’s first quarter-end. Of course it won’t be–and that’s what keeps it fun–but Musk let the genie out of the bottle with his profit warning last week. Those who only parsed that to the level of adjusting EPS estimates—and not analyzing the corresponding balance sheet impacts–made a huge mistake.