Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. Importantly, Tesla, Inc. (NASDAQ:TSLA) does carry debt. But the more important question is: how much risk is that debt creating?
What Risk Does Debt Bring?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.
What Is Tesla's Debt?
The image below, which you can click on for greater detail, shows that Tesla had debt of US$10.3b at the end of December 2020, a reduction from US$11.8b over a year. However, its balance sheet shows it holds US$19.4b in cash, so it actually has US$9.06b net cash.
A Look At Tesla's Liabilities
According to the last reported balance sheet, Tesla had liabilities of US$14.2b due within 12 months, and liabilities of US$14.2b due beyond 12 months. On the other hand, it had cash of US$19.4b and US$1.90b worth of receivables due within a year. So its liabilities total US$7.18b more than the combination of its cash and short-term receivables.
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$610.1b 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 2,108% gain in the last twelve months. There's no doubt that we learn most about debt from the balance sheet. 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, a company can only pay off debt with cold hard cash, not accounting profits. While Tesla has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Happily for any shareholders, Tesla actually produced more free cash flow than EBIT over the last two years. 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$9.06b in net cash. The cherry on top was that in converted 180% of that EBIT to free cash flow, bringing in US$2.7b. So is Tesla's debt a risk? It doesn't seem so to us. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Tesla is showing 4 warning signs in our investment analysis , and 1 of those is significant...
If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.
If you decide to trade Tesla, use the lowest-cost* platform that is rated #1 Overall by Barron’s, Interactive Brokers. Trade stocks, options, futures, forex, bonds and funds on 135 markets, all from a single integrated account.
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.
*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.