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Morningstar | Tesla Burns Cash in the 2Q but Sees Dramatic Turnaround This Year. See Updated Analyst Note from 01 Aug 2018

Tesla reported another loss for its second quarter (adjusted EPS of negative $3.06 missed consensus of a loss of $2.92) but CEO Elon Musk sounded very upbeat about the rest of the year as Model 3 production has stayed at 5,000 units a week into July and he targets 6,000 by late August and 10,000 some time in 2019. Musk now expects Tesla to be profitable and free cash flow positive on a GAAP basis going forward each quarter barring a recession or other major negative macroeconomic event. Also interesting is that Musk expects to retire, not refinance, debt via internal cash generation as soon as this year when large convertible bonds come due. He also still does not expect to issue equity this year, so we are now giving him the benefit of the doubt and no longer model a 2018 secondary offering but do model one in 2019. We are not changing our fair value estimate. We think the long-term story on what Tesla can achieve in electric cars, trucks, mobility, and energy generation and storage will ultimately determine the value of the company. We believe the stock trades on option value that, if realized, is still many years away, and therefore we do not think any single quarter's results are critical to the investment thesis.

We calculate adjusted free cash flow of negative $706.5 million compared with negative $942 million in the first quarter and negative $1 billion in the second quarter of 2017. This burn could have been worse because Tesla likely incurred large production costs at the end of the quarter to meet the Model 3 production target of 5,000/week yet most of these vehicles were likely not booked in revenue until the third quarter after delivery to the customer. The company finished the quarter with $2.2 billion of cash and management lowered its 2018 capital expenditure projection to slightly below $2.5 billion from slightly below $3 billion. Total vehicle deliveries in the second quarter rose 85% year over year and by 36% sequentially to 40,768.

Gigafactory 3 in Shanghai is expected to start construction "within the next few quarters" but Tesla said its significant spending on the plant won't start until next year. Tesla plans to raise loans from Chinese banks to facilitate construction, and once complete, the plant will have initial capacity of 250,000 vehicles and battery packs and grow to 500,000 over time. Initial production will start in about three years and it sounds like this production will only be for the Chinese market, which frees up the California plant to make cars for markets other than China. Tesla is also going to announce a European gigafactory location probably in 2019. We think Holland or Germany are the most likely places due to their proximity to major demand areas and Tesla already does kit assembly in Holland.

Tesla also had members of its tech team on the call to talk about recent developments including confirming that it is using its own autonomous vehicle hardware. Version 9 of the firm's AV software will be released around September and after that time Musk feels the firm can finally focus on the coast-to-coast AV drive across America that Tesla has talked about for some time. There was no mention of AV ride hailing plans but we remain convinced Tesla will eventually enter this space to compete with the likes of Uber, Lyft, Didi, and automakers such as GM which plans to start its AV ride hailing service at scale next year. Tesla's likely near realization of free cash flow generation, advancement in AVs, and a slew of new vehicles coming over time such as the Model Y crossover, pickup truck, and second generation roadster are exciting and give the stock plenty of option value. However, we believe option value goes both ways and there is also execution risk and balance sheet risk that can only be resolved with time. Tesla will soon have way more competition in the pure EV space too, so it must ramp up production while maintaining good quality consistently.