Tesla Bears Prove Easy Q3 Math Is Hard

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Tesla Model Y Die Cast at Tesla Gigafactory Shanghai.

Note: I own shares in Tesla [TSLA]*. However, nothing below is investment advice of any sort. What you do with your money is your business, not ours.

Congrats to Elon and the workers at Tesla for a record setting Q3, by almost every measure. I’ll cover below what I feel are some of the financial highlights.

First, a royal roasting of Tesla bears is in order. Many are saying that regulatory credits is the sole reason for Tesla’s profit. They claim that without the credits, Tesla’s positive profit goes poof!

Let’s take a look.

On the surface, their argument seems plausible. Under greater scrutiny, it falls apart and seems very silly. To start off, here are some numbers from the shareholder letter:

Easy peasy. First row of credits is more than net income. Ergo, no credits, no profits!

Behold, the power of math!

If you slide over to page 24, you see a detailed breakdown of the numbers.

That puts Tesla’s tax rate for the quarter at 33.5%. Let’s dig further. The regulatory credits are pure profit. Every dollar in regulatory income revenue flows down as 100% income. If we subtract them from our prior income, that leaves us $158 million. Applying the same tax rate, we find Tesla would pay $53 million in taxes. Our adjusted net income is positive +$105 million. Oops. There goes the bear argument, that Tesla has never made positive net income without regulatory credits over the last five quarters.

The only smoke and mirrors is on the part of Tesla shorts and bears. If we look at the trend over the last three quarters, regulatory credits have stayed in a similar range while net income has increased.

Further, Tesla’s record quarter had a larger than expected stock-based compensation due to Elon’s stock award. Without it, net income would have been even larger.

Tesla has a record amount of cash on hand

Tesla didn’t mention cash on hand in the shareholder letter, but it was at a record amount. Free cash flow (a more important metric than profits) was an excellent $1.4 billion in the quarter. This is cash generated by the business and reduced by spending on long-lived investments. This is the highest total going back to the fourth quarter of 2017 (see chart below). This doesn’t mean Tesla isn’t investing in the business. Hardly. According to the Q3 slide deck, Tesla spent $2.4 billion over the last 12 months on new factories, service centers, Superchargers, and other investments.

“Quarter-end cash and cash equivalents increased by $5.9B QoQ to $14.5B, driven mainly by our recent capital raise of $5.0B (average price of this offering was ~$449/share) combined with free cash flow of $1.4B and partially offset by reduced use of working capital credit lines. Since our days payable outstanding (DPO) are higher than days sales outstanding (DSO), revenue growth results in additional cash generation from working capital. DPO and DSO both declined sequentially in Q3 2020.”

Notice the last sentence above. The more revenue Tesla has, the more cash grows. They are using their suppliers’ cash to build cars. They receive the money faster than they have to pay back their suppliers. That’s a great position for any business to be in. It’s a real incentive to expand production.

Tesla’s cash is more than its debt

This is the first time I am aware that Tesla’s cash position is more than its debt. Tesla could pay off all of its debt and have money left over. I expect they will pay it off when the debt comes due, but perhaps not. As long as they are earning more in returns, increasing production, speeding up an important process, or using those funds to reduce costs compared to what they have to pay in debt, it might not make sense to pay off the debt early. That money is being used now to expand factories and create the pilot battery facility at Kato Rd, for example. Those are more useful measures, in line with Tesla’s mission, than some financial engineering.

Tesla’s vehicle deliveries may be between 840,000 and 1 million next year

This is a big item. It’s in line with my last piece on Tesla — on Tesla aiming to oscillate around 50% annual growth in revenue for the next 10 years. Even at the low end, that would be 68% more deliveries, which should lead to a similar surge in revenue. No one is building factories if they don’t expect greater deliveries. That would be reckless and dumb. Tesla is building three new factories. Which leads me to my next point.

Tesla’s P/E should not be the only financial metric used on the company

In my final shot to the bears, if you used a traditional P/E on a fast growing company like Tesla, you might not believe the company could deliver future growth in profits and revenue, that it looks expensive. Many of the bear arguments have been obliterated over the last year. Let’s take a look at two fake companies to tackle another.

Company A is a conservative leader in a hot market segment. It is maximizing profits and looking to slowly expand with good opportunities. It pays a strong, growing dividend to its shareholders to reward them for their trust.

Company B is a scrappy, fast growing competitor in a hot market segment. It is investing every nickel it can to increase production, reduce costs, and expand its market reach. It earns the bare minimum in income necessary to minimize paying taxes and re-invest in business growth. It offers no dividend.

Depending on your age and risk preference, you’ll be drawn to one company over the other. I would say Company B is similar to Tesla. It has a market opportunity valued in the trillions. We have a sustainability and climate challenge that countries around the world are striving to meet. Tesla is creating cutting edge technologies, reducing costs, speeding up deployment times, and encouraging competitors to go “all in” on renewable energy. Bankruptcy risk has been greatly reduced after the successful launch of the 3 and Y.

If you had to value Tesla, look at its P/E, sure, but know that can be misleading. Look at its Price/Sales and compare that to competitors. Or, create a discounted cash flow model under many scenarios and find the current value. Please don’t simply proclaim that because the P/E is such, Tesla is doomed, overvalued, and will never grow into it. Over time, that argument will be shown to be incorrect.

Tesla has a large opportunity in services

I am not talking about traditional services in this final section. I am talking about insurance, which Elon thought on the call could deliver 30% to 40% of the value of the vehicle to Tesla over time. I am talking about FSD subscriptions and robotaxis, about Autobidder in the utility market. All of these non-traditional services can have high margins. Tesla can use those high margins to reduce prices or increase growth, or both. This services revenue would be in line with what you see from traditional software companies, like Microsoft, Apple, Adobe, Salesforce, and Google. We’re at the beginning stages of what Tesla’s non-traditional services growth will look like. It’s hard to measure that opportunity.

What are your thoughts on Tesla’s Q3 call? Any tantalizing insights? Please share them with us below.

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