Tesla's latest battle to win over Wall Street skeptics on the company's outlook

CNBC 0 month ago

Zach Kirkhorn may not be Austin Powers, but to Wall Street, Tesla's new 34-year-old chief financial officer is still a man of mystery.

Tesla's shares faced immediate pressure on the day Tesla announced he had taken over the job held by his predecessor, Deepak Ahuja. The stock quickly recovered, but it would keep falling through the first half of 2019 as the world's largest maker of electric cars had to address its balance-sheet challenges. Wednesday's third-quarter earnings report may offer clues to how Tesla can juggle the competing objectives of fast expansion and turning the corner into profitability that will justify the company's $46 billion valuation.

The initial dive in Tesla shares on the CFO replacement news was never really about Kirkhorn — a Harvard MBA and one of the youngest CFOs at a major U.S. company. It was partially about high-level executive turnover at the company. The departure of long-time Elon Musk confident Deepak Ahuja — who had served as CFO in Tesla's early days and saw it through an IPO, and who had returned to the CFO post in 2017 during a cash crunch — was another surprise for investors.

In the seven months since the new CFO was installed — he was not available for an interview ahead of earnings — Tesla's stock has managed a sizable rebound but has not come close to regaining its all-time high stock price of near-$380. However, the period has seen Tesla keeping its financial act together. Third-quarter earnings, expected after Wednesday's market close, will show how soon that will translate into profits.

Kirkhorn, a former McKinsey consultant who joined Tesla in 2010, was not available for an interview ahead of earnings, but he is the person who, more than anyone other than CEO Elon Musk, may be at the heart of Tesla's campaign to juggle the $10 billion that is estimated will be needed to build out the company's worldwide footprint of factories and other assets.

Tesla cash flow and gross margins

Coming into the year, Tesla's long list of challenges had two at the top: Find a way to finance the capital spending shopping list that will add vehicles like the Model Y small SUV and Tesla's pickup truck to the product line, and figure out how to boost gross margins on its cars close to 25%, up from 18.9% in the second quarter.

In Kirkhorn's first year, the financing issue has been nearly solved, as Tesla raised $2.7 billion in stock and debt in May and closed the second quarter with more than $5 billion in cash. It has completed $1.5 billion to $2 billion of its $10 billion in capital spending, moving more slowly than it had planned in order to conserve cash, CFRA Research analyst Garrett Nelson said. This means with roughly $8 billion to go, Tesla has most of it and can earn the rest as it goes, he said.

When Tesla reports its latest quarterly financials on Wednesday, expectations are for margins to slip to 18.5%, Nelson said. If they improve next year, even if it's not close to 25% yet, Tesla can generate $1.7 billion positive cash flow even after $2 billion in capital spending, according to JMP Securities analyst Joe Osha who is forecasting capital spending at a below-consensus level of $2 billion in 2020.

"If I'm right on the cash flow, the stock will go a lot higher," said Osha, who rates the shares "market perform" partly because of Tesla's checkered history of meeting forecasts.

Tesla being Tesla — meaning a company where Musk is an omnipresent force — it's hard to know how much credit should go to Kirkhorn, Nelson said. The ability to raise capital even when Tesla is struggling -- the big deal in May followed a first quarter in which Tesla had $945 million in negative free cash flow, rebounding to positive $590 million in the second quarter — is about Musk's connection with a network of investors who will follow him virtually to the end.

"He has a cultlike following of investors, especially in Silicon Valley,'' Nelson said.

Tesla shares remain under pressure

In fact, while the capital raise helped with the balance-sheet troubles, it didn't prop up the stock for long. Tesla's shares fell precipitously after it raised the $2 billion in capital in early May, falling to their lowest stock price of the year by July, at under $180. Over the past month, Tesla's shares have been rising, but they are down 23% year-to-date.

Analysts are expecting a loss of 46 cents per share, and $6.43 billion in sales, according to estimates from FactSet, though any single quarter's earnings "print" for Tesla is rarely the make-or-break issue for analysts.

"As always, accurately predicting quarterly results will remain a challenge for the next few quarters, particularly because it's difficult to pinpoint the exact timing of Tesla's new facility in China, not to mention the launch timing for the Model Y crossover. While these initiatives create modeling headaches, we think they will position Tesla favorably in the medium-to long-term," Piper Jaffray's Alexander Potter wrote in a note to clients.

The big picture is coming into better focus as the latest earnings report nears.

The company's new Shanghai factory is expected to begin production by the end of the year, and to have lower operating costs than Tesla's Fremont, California plant. While current plans call for the facility to be used to build Model 3 sedans for the China market, Nelson said the factory could also be an option for Tesla to produce the Model Y crossover set to hit the market in late 2020.

That helps set the stage for Tesla to sell 450,000 cars next year, up from 357,000 this year, Osha said. Combined with progress on gross margins, even staying well short of 25%, that means Tesla can generate the $1.7 billion in 2020 free cash as revenue climbs 22% to just north of $29 billion.

A performance like that would be likely to win the attention of the bond market, where Tesla's paper has a volatile history, with bonds trading for less than 90 cents on the dollar at one point during the past summer.

The key ratios for Tesla are that its free cash flow should reach 5% of its $13 billion debt load, or about $650 million, and that its cash position remain at least 20% larger than its expected cash losses, if any, and capital spending for the next 12 months, said Nishit Madlani, senior bond analyst at Standard & Poor's Global Ratings in New York.

If equity analysts are right about how 2020 goes, the numbers would improve the outlook for Tesla's bond rating, which right now is below investment grade at both Moody's Investor Service and S&P.

"That would lead us to raise the outlook on them to stable from negative,'' Madlani said. "It would depend on the consistency of the cash flow. We're not going to make a decision based on any one period.''

Over time, one of the biggest questions affecting Tesla's stock is whether it can boost gross margins, especially as it ramps up business in the price-sensitive China market, Nelson and Osha said.

Whether it can stand up to rising competition is another big "if."

About 30 models of electric vehicles are expected to hit the market by next year, in new or improved form, highlighted by Porsche's $150,000 Taycan and Audi's $75,000 e-tron crossover, Nelson said. More new rivals are hitting the market just as Tesla buyers' tax credits for buying electric vehicles, which phase out after an automaker sells 200,000 electric vehicles, are going away.

"What we are concerned about is competition, more than liquidity,'' Nelson said. "Virtually all of the new vehicles are eligible for the full federal tax credit.''

The push to boost margins may be where Kirkhorn gets his chance to shine, but even that is a murkier prospect at Tesla than at other companies, Osha said.

One issue is that Tesla culturally is a product-driven company, more than one where the finance department can make engineering adhere rigidly to pre-planned budget targets, according to Osha, himself a former CFO at two start-ups. Another is that Musk is a famous micromanager, and may really be in command of the cost-cutting drives himself.

"Given his age and relative inexperience, he may be more of a figurehead,'' Nelson said. "We know who's running that show. That's how he's seen so far.''


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