The world’s largest credit ratings agency, Standard & Poor’s (S&P), yesterday gave a B- credit rating to Tesla Motors Inc (TSLA). The rating, given despite the lack of a rating agreement between the agency and Tesla, is six levels below investment grade. Although the rating does impact the company’s reputation as a reliable borrower, the ratings agency has added that the company's improving gross margins make Tesla bonds "stable".
The B- rating, which essentially is "junk" status, is usually accorded to high-risk investments in companies that may default because of a dearth of liquidity. According to S&P, Tesla’s limited products, which target a niche market and face constrained long-term demand, make the electric automaker’s business profile extremely vulnerable – especially as the company’s scale of operations do not extend as wide as those of other, more established automakers. The agency’s report also critiques Tesla’s Gen III mass-market vehicle plans citing Tesla’s inexperience at handling high-volume production processes simultaneously.
For quite some time, analysts have been concerned about the company’s weak cash flow position in light of its ambitious future objectives, which include plans to mass produce as many as 500,000 battery packs in two high-tech "Gigafactories"; aggressive expansion of super-charger networks in domestic and international markets; and the launch of affordable new vehicles. The new cars to be launched in the future include the Model E, which will be produced in large volumes. That is uncharted territory for the company.
Tesla’s Weak Cash Flows
Tesla has never reported positive free cash flows on an annual basis. Quarterly free cash flows, which were positive in the third and fourth quarter last year, had dipped again to -$80.7 million in this year’s first quarter as capital expenditures nearly doubled on a sequential basis to $141 million. For the coming quarter as well, analysts are expecting the company to report free cash outflows of $44.4 million as capital expenditures are cut to $93.8 million.
As of the end of its first quarter (March 31), Tesla had $2.39 billion in cash and cash equivalents on its balance sheet, but was more than two dollars in debt for every dollar of shareholders' equity. Based on 2014 (estimated) earnings of $340 million and Tesla's current long-term debt levels, the company will be paying $1 in interest expenses for every $22 it earns.
The Palo Alto-based automaker’s problematic cash flows and heavy indebtedness could create difficulties for the company as long-term liabilities, which currently stand at $2.96 billion, become due. The bulk of its debt was raised in March this year through a sale of convertible notes, the proceeds from which will be used to fund the Gigafactory battery plant project. $660 million (22%) of this debt matures in 2018, followed by $920 million (31%) the following year. The remaining $1,380 million will be payable in 2021.
Tesla spokeswoman Liz Jarvis-Shean responded via email to S&P’s rating, saying that it was “developed independently by their [S&P’s] analysts without any feedback from Tesla on our growth plans.”
This marks the first ever credit-rating for the automaker from a ratings agency like the S&P – and it may have a bearing on its future fund-raising initiatives. Bond investors typically avoid bonds with low credit ratings, and those that do invest in them ask for higher returns to compensate for the additional risk they are taking on. For Tesla, this simply means that acquiring debt just became more expensive.
The completion of Tesla’s expansion projects, the main reason behind investors' bullish sentiments regarding its prospects, may be seriously hampered if there is a bottleneck in cash flows. Investors have been relying on the company’s ability to raise funds for its massive projects through partnerships and debt, and now that that has become a little more problematic for the company, investors may find reasons to worry.
Tesla stock closed up 2.05% yesterday at $211.56, but is currently down $4.85, or 2.26% as of 10:48 AM EDT. Year-to-date, the stock is up 38.8%.
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