Tesla may take on even more debt

The external fund manager backed by Berkshire Hathaway’s Charlie Munger, Li Lu, makes no bones about it when he says ‘The biggest investment risk is not the volatility of prices, but whether you will suffer a 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 should shareholders be worried about its use of debt?

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. Part and parcel of capitalism is the process of ‘creative destruction’ where failed businesses are mercilessly liquidated by their bankers. 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. Having said that, the most common situation is where a company manages its debt reasonably well – and to its own advantage. When we think about a company’s use of debt, we first look at cash and debt together.

View our latest analysis for Tesla

What Is Tesla’s Net Debt?

You can click the graphic below for the historical numbers, but it shows that Tesla had US$1.52b of debt in June 2023, down from US$3.15b, one year before. But it also has US$23.1b in cash to offset that, meaning it has US$21.6b net cash.

A Look At Tesla’s Liabilities

Zooming in on the latest balance sheet data, we can see that Tesla had liabilities of US$27.6b due within 12 months and liabilities of US$10.8b due beyond that. On the other hand, it had cash of US$23.1b and US$3.63b worth of receivables due within a year. So its liabilities total US$11.7b 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$842.0b 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.

And we also note warmly that Tesla grew its EBIT by 18% last year, making its debt load easier to handle. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Tesla can strengthen its balance sheet over time. 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. 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. Over the most recent three years, Tesla recorded free cash flow worth 65% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

We could understand if investors are concerned about Tesla’s liabilities, but we can be reassured by the fact it has has net cash of US$21.6b. And we liked the look of last year’s 18% year-on-year EBIT growth. So is Tesla’s debt a risk? It doesn’t seem so to us. There’s no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For example – Tesla has 1 warning sign we think you should be aware of.