Tesla Production Increases, But 2 Challenges Threaten Turnaround

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It’s hard not to appreciate what the world’s first mass producer of electric cars, Tesla (NASDAQ:TSLA), achieved in 2018. With all the challenges that came with CEO Elon Musk’s peculiar behavior as well as his loose talk on Twitter, the company still made some real progress.

Its sales more than doubled to $7.23 billion in the final three months of 2018, fueled by the steady production of the Model 3. That number beat analysts’ estimates for $7.12 billion. Deliveries of its compact car totaled 63,150 in the fourth quarter compared to 1,550 a year earlier. And for the first time, Tesla delivered two straight profitable quarters.

As Tesla emerges from what Musk called the “most challenging” year in the car maker’s history, one that saw him being removed as chairman after his botched attempt to take the company private, many investors are wondering if this is the right time to make a long-term bet on Tesla shares. The problem we see in 2019 is that Tesla’s troubles are likely to grow as the company struggles to produce its $35,000 version of Model 3 Sedan, which, according to Musk, is crucial to being profitable on a sustained basis and making his vision of producing electric cars for the mass markets a reality.

In 2018, the biggest drag on Tesla shares was the uncertainty about its Model 3 production. While Tesla appears to be overcoming its production challenges, other greater issues are also raising their ugly heads.

First, Tesla needs to undertake a serious cost-cutting exercise to make a car which is fast-selling and also profitable at a time when U.S. tax benefits for energy efficient vehicles are being curtailed. Tesla has already cut prices to partially make up for the halving of a tax credit that proved a great incentive for buyers. That credit will drop again in July, and then stop completely at the end of the year.

Musk is responding to this challenge by reducing Tesla’s headcount. In January, the company announced employee cuts of 7%, a move that sent its shares tumbling about 8% as investors took it as a sign of weakness.

According to UBS Securities’ estimates, Tesla would lose about $4,000 per Model 3 if it were sold at $35,000. At $42,000, Tesla could average about $1,000 in operating profit, with the $49,000 version yielding about $3,000, according to UBS.

For us, eliminating that gap and then making a profit looks difficult, with a long road ahead and many risks lurking. The most threatening of those risks is a potential slowdown in demand in 2019 amid the significant headwinds facing the global economy, especially in China where Tesla is betting big.

The other big hurdle in the company’s way is its cash flow problem. Though the car-maker has shown improvement on this front in the past two quarters, reporting a $3.7 billion cash pile at the end of fourth-quarter, we still think that amount of cash could be wiped out quickly, given Tesla’s grand spending plans and its unstable operating performance.

The company’s cash shrank to dangerously low levels last year amidst its efforts to ramp up production. According to Musk, Tesla has enough cash to make a $920 million debt payment tied to the company’s share performance. Tesla will need to pay this debt in March if its stock remains on average below the strike price of $359.87.

Even if the company is able to successfully ride through its tight cash situation, its $10 billion in long-term debt is a constant source of pain that will constrain its growth and keep serious investors at a distance.

Tesla Production Increases, But 2 Challenges Threaten Turnaround

Tesla weekly, 3-year chart

Bottom Line

Tesla shares closed at $298.77 yesterday, a second day of gains following three days of losses. Tesla shares continue to show an extremely volatile trading pattern which doesn’t suit long-term and serious investors.

There’s no doubt the company showed improvements in its key performance metrics last year, but we see that turnaround as being on very shaky ground. A small setback on production and cash flows could see Tesla stock diving further into negative territory. Waiting on the sidelines is the best strategy when it comes to Tesla.

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