The Weaker Dollar May Be Keeping Tesla Out Of The S&P 500
There is so much noise that surrounds Tesla that many “analysts” forget to examine the company’s financial statements. While Tesla’s initial earnings release always presents an incomplete financial picture versus the official 10-Q filing with the SEC (which has not yet been filed for 3Q20) the story for Tesla in the third quarter was China. Incremental capacity from Tesla’s leased production facility in Lingang, China certainly drove the company’s reported 43% growth in unit deliveries in the quarter. But doing business abroad is fraught with both opportunities and challenges. So, while Chinese demand AND the stronger Chinese Yuan combined to help Tesla post above-expectations quarterly revenues, that exchange rate impact has a correspondingly negative impact on the bottom line.
Tesla recorded a $97 million charge for “other expense” in the quarter. That figure, as disclosed in Tesla’s SEC filings is composed:
primarily of foreign exchange gains and losses related to our foreign currency-denominated monetary assets and liabilities and changes in the fair values of our fixed-for-floating interest rate swaps.
That charge took Tesla’s net income down to the $300 million level, and thus well below the $397 million in zero emission credit revenues that Tesla booked in the quarter. So, Tesla once again lost money without ZEV credit sales. By my analysis the strength of the Chinese Yuan hurt Tesla’s probability nearly as much as incremental units sold to Chinese consumers helped it.
Year-to-date Tesla’s reported other expense figure has been negative $166 million versus a positive income figure of $70 million in the first nine months of 2019. Tesla only discloses the mix between foreign exchange costs and interest rate swap costs once per year (in its 10-K) but the quarterly figure gives a glimpse into how this company is transitioning from a Silicon Valley start-up to a global automaker.
Not particularly well.
So, a weaker dollar generally serves to flatter revenues and cash flow but lower reported earnings for a company that uses the dollar as its functional currency, as Tesla does. So, every buffoon hyping Tesla’s above-expectations revenues and cash flow in the quarter was falling into the trap of not analyzing currency. The $97 million in other expenses Tesla recorded in the quarter really served as an offset to strength elsewhere in the P&L.
As stated by management in Tesla’s SEC’ filings, Tesla generally chooses not to hedge its currency exposure. Well, that’s stupid. I have watched this company operate financially with a lemonade-stand mentality for the past few years, and it is fitting that Tesla’s financial ignorance is what is likely keeping it out of the S&P 500.
If Tesla had a robust hedging program—as do all other major auto OEMs through their captive finance subsidiaries—Tesla may have been able to make a profit at some point in the past five quarters without the benefit of selling ZEV credits. That’s an if; it is a hypothetical.
Musk can hype China as much as he wants, but he has to realize that the weak U.S. dollar is making those China sales appear to be less profitable when expressed in dollars. Tesla still uses some North American content in the Made-in-China Model 3, but what I am talking about here is translation, not individual transactions.
Yes, that is really boring, and I spent many years of my life as a sell-side autos analyst looking up such seemingly picayune details. But Tesla’s inclusion in the S&P 500 would not be a small thing. The company’s seeming inability to earn sustainable net profits from its core businesses (including solar and energy storage but excluding revenues from ZEV credit sales to other automakers) is a weakness for those looking to index TSLA stock versus other industrials.
Tesla isn’t valued like any other industrial stock, and not even like many other tech stocks. Tesla is today trading at more than 10x the estimate for next 12 months’ revenue. That’s a ridiculous multiple. Will the earnings be there to back that up? No, and the gap between fantasy and reality will only widen if the dollar continues to weaken. The $97 million that Tesla recorded as “other expense” in the quarter could easily double or even triple if sales in China continue to increase as a proportion of Tesla’s total and the dollar continues to weaken.
It’s not easy selling cars. The looming threat of competition from VW”s ID.3 and ID.4 ZEVs—the ID.3 hatchback is already dominating Tesla’s Model 3 in Europe and the ID.4, an SUV, will be released in the U.S and China in the next two months—should scare Musk, but Tesla’s bean-counters have to be scared by other issues. Selling $7.3 billion of new TSLA shares in 2020 has secured Tesla’s financial needs, but does nothing to insulate the company from accounting charges caused by fluctuations in exchange rates.
So, financial statements are designed to tell the true story of a company’s financial condition. To focus on line-items that are flattered by the weaker dollar (revenues and cash flow, for instance) while ignoring the bottom line, which is hurt by the weakening greenback, is a silly mistake. It is one that the S&P’s U.S. Index Committee did not make in September, causing a shape decline in TSLA in the weeks that followed when it was once again omitted from S&P 500 inclusion. While sell-side analysts engage in hero-worship and non-stop hype (rewarded with lucrative positions for their banks in Tesla’s stock offerings) the S&P’s Index Committee is the closest thing to an independent arbiter that investors have these days.
Tesla is making a serious miscalculation by not hedging its foreign currency exposure. Going global has financial impacts far and above just inflating quarterly deliveries figures.. I will continue to analyze these impacts and hopefully other analysts—including those on the S&P Index Committee—will continue to do so, as well.