Investors have been watching Tesla's (TSLA 0.86%) profits and cash flow closely -- and for good reason: They're both negative. In the electric-car company's fourth quarter, Tesla lost $771 million. That's considerably more than its $219 million loss in the year-ago quarter. Meanwhile, Tesla's free cash flow was negative $277 million, compared with negative free cash flow of $970 million in the year-ago quarter.
Tesla's negative free cash flow and its large losses have worried some investors and analysts. Moody's, for instance, recently downgraded Tesla's junk bonds, from stable to negative, citing Model 3 production delays and the company's negative cash flows. Further, analysts at Jefferies predicted earlier this month that Tesla would need to raise $2.5 billion to $3 billion of capital to help further fund its Model 3 production ramp-up. Godman Sachs similarly expects a capital raise this year.
Image source: author.
But Tesla CEO Elon Musk said the tides are turning. "Tesla will be profitable & cash flow [positive] in Q3 & Q4," Musk tweeted on Friday. "So [obviously] no need to raise money."
Why Tesla needs positive cash flow
The capital-intensive dynamics of the auto industry means every dollar counts -- especially for a young, fast-growing automaker like Tesla.
It takes billions of dollars to build out vehicle production capacity. In Tesla's fourth quarter, for instance, the company spent $787 million in capital expenditures, the majority of which went to Model 3 and Gigafactory production capacity increases. Further, capital expenditures for the full year were $3.4 billion -- more than double the automaker's $1.3 billion in capital expenditures in 2016. And Tesla expects capital expenditures to be "slightly" higher in 2017.
With so much spending, the automaker has unsurprisingly burned through billions of dollars. Tesla's free cash flow in 2017 was negative $3.5 billion -- worse than its negative free cash flow of $1.4 billion in 2016.
So far, Tesla has turned to equity and debt markets to raise capital to help sustain its aggressive expansion. But Tesla said in its fourth-quarter shareholder letter earlier this year that it expected to "begin generating positive quarterly operating income on a sustained basis" sometime this year.
Musk's tweet on Friday morning assuring profitability and positive cash flow in both the third and fourth quarter of 2018 is obviously good news, assuming the forecast proves correct.
Model 3. Image source: Tesla.
Model 3 is key
Tesla's Model 3 is the key ingredient to achieving these milestones. To get to the scale required to begin generating profits, Tesla has said it needs to get to a weekly Model 3 production rate of 5,000 units per week. After Tesla's weekly Model 3 production stabilizes at 5,000 units per week, management said it will target a 25% gross margin for the vehicle, enabling sustained operating profits.
In Tesla's April 3 update on first-quarter deliveries and production, Tesla said it had achieved a production rate of 2,000 Model 3s per week and was still aiming for a target of approximately 5,000 units per week "in about three months." Tesla also said in the update that the momentum in its Model 3 production ramp-up meant Tesla will not require an equity or debt raise this year.
