Image: The Valuentum Buying Index almost called the top in Tesla’s shares.
Whenever a CEO comes out saying that the company must engage in “hardcore” cost cutting, bad things happen. Morale is likely in the pits at the car company, and cost takeouts will probably cut more than just some excess fat. The downward spiral at Tesla has been in the works for many months now, but the writing is on the wall for a major disappointment that truly resets reality for shareholders.
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By Brian Nelson, CFA
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I’ve given CEO Elon Musk the benefit of the doubt. As a fellow founder and entrepreneur with skin in the game, I can understand some of the challenges that leaders face. But things just got really bad for Tesla (TSLA), in our opinion. Tesla’s announcement that it will be conducting “hardcore” cost cutting is going to frighten employees, scare away customers and inevitably hasten any permanent and painful decline that, in my opinion, could have been staved off…until now.
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Tesla already should have been laser-focused on its cost structure, so the announcement, itself, is rather surprising. No firm this century can operate with tons of fat on the bone, so the cost cuts that Tesla is now speaking of will likely come with consequences. CEO Elon Musk noted that Tesla has a “$2.2 billion cash reserve,” translating into just 10 months for the company to breakeven on a free-cash-flow generating basis. But here’s the rub. We already thought Tesla was on the road to positive free cash flow. Here’s what the company wrote in its fourth-quarter earnings report, released late January:
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In total, we are expecting to deliver 360,000 to 400,000 vehicles in 2019, representing a growth of approximately 45% to 65% compared to 2018. In this range, we are expecting to have positive GAAP net income and to generate positive free cash flow (operating cash flow less capex) in every quarter beyond Q1 2019. We believe these results will be substantially driven by our restructuring action and the ongoing financial discipline with which we are managing the business.
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The company should already be free-cash-flow positive at this point based on guidance released just a few months ago. What is going on? Many in the past have indicated that Tesla may not be great at hitting operating targets, but now we’re talking about key liquidity metrics. Though Tesla may have considerable opportunities to raise additional capital in the future, it doesn’t mean that existing shareholders will benefit from it. Most any added debt or new equity will just dilute the existing die-hard shareholder base.
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In June 2017, Tesla registered a 2 on the Valuentum Buying Index (1=worst) and has never registered greater than a 4 since then (10=best). It has been painful for shareholders thus far, but the biggest drop in Tesla’s stock could be closer than Tesla investors think. If the market comes around to building in the likelihood of an adverse credit event, the stock could very well find itself in the double digits in short order, especially if the executive team doesn’t start hitting key financial targets in the near term.
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There may be a great opportunity for electric and autonomous vehicles, but for existing shareholders to win, the company must first survive the near term (without serious dilution) to capitalize on any long-term opportunity. From where we stand, the near term just got very serious for Tesla investors, moreso than ever before. We expect to lower our fair value estimate considerably upon the next update. Tesla’s stock page >>
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Brian Nelson does not own shares in any of the securities mentioned above. Some of the companies written about in this article may be included in Valuentum’s simulated newsletter portfolios. Contact Valuentum for more information about its editorial policies.