The capital-intensive nature of the auto business is a reality that even Tesla (TSLA 2.70%) can't escape. The electric-car maker's capital expenditures climbed rapidly ahead of the Model 3's launch, and they are set to soar further as Tesla goes through "production hell" amid efforts to increase Model 3 production capacity.
Here's a close look at Tesla's fast-rising capital spend, what's driving it higher, and what investors should expect from the key metric as the year goes on.
Tesla vehicle production. Image source: author.
Capital spending is skyrocketing
In 2016, Tesla's capital expenditures declined compared to 2015, even as its vehicle sales soared. But it was clear that this trend wasn't sustainable. Sure enough, capital spending has spiked in 2017 -- and there's no slowdown in sight.
Going into 2017, Tesla said it expected to invest between $2 billion and $2.5 billion in capital expenditures in the six months leading up to the Model 3's launch. The spending was planned to go toward building out Model 3 production capacity at its vehicle factory in California and its battery factory in Nevada.
Though Tesla's first-quarter capital expenditures of $553 million were only up slightly from its capital expenditures in its fourth quarter of 2016, the anticipated jump in spending started to materialize in Q2. Capital expenditures rose significantly during the quarter, hitting an all-time quarterly record of $959 million, up 73% sequentially and 225% year over year.
Data source: Tesla quarterly SEC filings. Chart source: author.
Sure, Tesla's year-to-date capital expenditures of about $1.5 billion are below management's guidance range for the first half of the year. But this isn't because Tesla has found a way to avoid costs associated with ramping up production. The cash needed for Tesla's "production hell" are as real as ever. Some cash payments have simply been delayed.
"Total capital expenditures of $1.5 billion in the first half of 2017 were lower than expected primarily due to the timing of milestone-based cash payments," Tesla noted in its second-quarter shareholder letter.
Tesla's ramp in capital spending for the Model 3 isn't over yet. The electric-car company guided for capital spending of about $2 billion in the second half of the year, bringing 2017's total expected capital spending to $3.5 billion, more than double Tesla's $1.4 billion of capital expenditures last year.
This $2 billion of capital spending will be driven by milestone-based payments for Model 3 equipment, further Gigafactory construction, and continued expansion of Tesla's Supercharger, store, delivery hub, and service networks, Tesla explained in its second-quarter shareholder letter.
Show me the money
An obvious concern for investors in companies in capital-intensive industries like Tesla's, of course, is whether the company will have enough cash to fund its costly expansion.
For now, Tesla certainly has enough cash on hand. Not only did Tesla wrap up its third quarter with over $3 billion of cash, but Tesla recently raised $1.77 billion of net proceeds from a debt offering. However, Tesla will eventually have to prove that it can generate enough cash from operations to fund its business growth without having to continually return to equity and debt markets for more cash.
To be fair, Tesla's need for additional cash will prove to be worthwhile if the company lives up to its planned expansion. With the help of its aggressive Model 3 program, Tesla believes it can increase its annualized production from a run rate of about 100,000 units today to about 500,000 next year. In addition, Tesla anticipates the Model 3 having a meaty gross profit margin of 25% -- an achievement that could turn the vehicle into a cash cow for the company.
