The Biggest Bomb In Tesla's Earnings Report

The market was not particularly pleased Tesla’s (TSLA 5.29%) Third quarter 2022 earnings report released last week. The company continued to grow, but margins fell and results did not meet analyst expectations. This usually causes the stock price to fall.

Highlighted in the report was a lengthy discussion about Tesla’s inventory and how it will change delivery practices in the future. Management acknowledged that they accelerated deliveries at the end of the quarter to maximize revenue and earnings, which obscured some of the inventory buildup during the quarter. As this will change in the future, some red flags are raising.

Image source: Tesla.

An earnings report with red flags

Last week, inventory challenges something investors should watch out during this earnings season. Increasing inventory and falling margins can be a problem, especially for manufacturing companies. I noticed three red flags in Tesla’s earnings report, all about inventory.

• First Red Flag: Inventory at Tesla is growing rapidly. In the third quarter of 2022, it increased to $10.3 billion from $8.1 billion a quarter earlier and $5.2 billion a year ago.
• Second Red Flag: Tesla’s gross margin fell from 30.5% a year ago to 27.9% in the third quarter of 2022. Falling margins are a sign that companies lack the pricing power, and combined with rising stocks, is a potential problem for the entire auto industry. .
• Third Red Flag: Tesla has publicly acknowledged that it is managing the balance sheet based on quarterly results and will stop doing so, and has openly told investors that inventory will rise sharply as a result.

On its own, none of these trends are worth worrying about. But together, they become a cause for concern for a manufacturing company. And if there really is a recession on the horizon, conditions could get much worse before they get better.

Tesla’s inventory saga

There has long been speculation that Tesla is playing games with inventory to keep its numbers looking good every quarter. But this earnings report outlined the lengths the company will deliver as much inventory as possible just before the end of the quarter. That means Tesla managed its balance sheet to look artificially better at the end of the quarter.

“About two-thirds of our Q3 deliveries occurred in September and a third in the last two weeks,” CFO Zachary Kirkhorn said on the quarterly conference call.

To put that in perspective, that means $7.2 billion in revenue was generated in the last two weeks of the quarter. Assuming deliveries, revenues, and cash paid for products occur simultaneously, Tesla had close to $13.9 billion in cash on September 23, 2022, instead of the $21.1 billion reported on September 20, 2022. End of August could be under $10 billion depending on the amount of inventory to be created.

What impact will adjusting deliveries have on the balance sheet? The figure below was in the Q3 2022 earnings letter, and while it doesn’t have a scale on the y-axis, we can deduce that in the future Tesla will have a higher inventory level than it does today.

Image source: Tesla.

No matter how you look at it, Tesla is telling investors it will have higher reported inventory at the end of the quarter in the coming quarters. This likely means less cash on the balance sheet, which has always been one of the selling points for Tesla stock.

Why might inventory be a cause for concern?

There are three main reasons to worry about inventory in any company:

1. Increased inventory pulls assets from other parts of the business. Potential impact: Less cash.
2. Increased inventory may indicate that demand does not match supply, and a discount may be necessary to move inventory along the supply chain. Potential impact: Bottom margins.
3. Tesla still expects growth of around 50% per year, but rising inventory and falling margins suggest that this type of growth may not be in demand from consumers. Potential impact: Slower growth.

We’re already seeing numbers 1 and 2 happen today, and Tesla tells us that inventory will continue to increase. If margins continue to fall, it could mean that not only profits but growth will be the next drop.

Tesla has benefited for years from the auto industry’s slow adoption of electric vehicles, a shortage of chips and a better business model, but competition may be catching up as the global economic slowdown hits demand for expensive vehicles. These are choppy waters that Tesla hasn’t navigated before, and that’s why Tesla’s inventory releases were such a shock.

Over the next few quarters, we’ll find out if these red flags become bigger problems for Tesla.

Travis Hoium has the following options: Long March 2023 puts $250 into Tesla. Motley Fool has positions at Tesla and recommends it. The Motley Fool has a disclosure policy.