David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that Tesla, Inc. (NASDAQ:TSLA) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?
When Is Debt Dangerous?
Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.
How Much Debt Does Tesla Carry?
The image below, which you can click on for greater detail, shows that at September 2020 Tesla had debt of US$12.3b, up from US$11.8b in one year. However, its balance sheet shows it holds US$14.5b in cash, so it actually has US$2.21b net cash.
How Healthy Is Tesla's Balance Sheet?
We can see from the most recent balance sheet that Tesla had liabilities of US$13.3b falling due within a year, and liabilities of US$14.9b due beyond that. On the other hand, it had cash of US$14.5b and US$1.77b worth of receivables due within a year. So it has liabilities totalling US$11.9b more than its cash and near-term receivables, combined.
Having regard to Tesla's size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the US$608.3b company is short on cash, but still worth keeping an eye on the balance sheet. While it does have liabilities worth noting, Tesla also has more cash than debt, so we're pretty confident it can manage its debt safely.
Pleasingly, Tesla is growing its EBIT faster than former Australian PM Bob Hawke downs a yard glass, boasting a 1,039% gain in the last twelve months. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Tesla's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Tesla may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the last two years, Tesla actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.
While it is always sensible to look at a company's total liabilities, it is very reassuring that Tesla has US$2.21b in net cash. And it impressed us with free cash flow of US$1.8b, being 144% of its EBIT. So we don't think Tesla's use of debt is risky. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 3 warning signs for Tesla you should be aware of, and 1 of them makes us a bit uncomfortable.
Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.
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This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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