Yes, electric-car maker Tesla Motors (NASDAQ:TSLA) will probably become free cash flow positive in 2016 -- at least according to Tesla management's forecast. CEO Elon Musk even emphasized recently its Tesla's aspiration to become free cash flow positive as early as Q1.
But this is a lot easier said than done. Becoming free cash flow positive next quarter would mark a significant improvement from the $200 million the company burned in operating activities during Q3, along with its negative $600 million in free cash flow in the same period. Can Tesla really improve its cash flow this rapidly? And, if so, how could it get there?
Tesla's path to free cash flow
For Tesla to become free cash flow positive in 2016, it will need to accomplish three major feats: achieve positive operating cash flow, moderate capital expenditures, and boost sales significantly.
Operating cash flow: Tesla is already close to reporting positive operating cash flow. Indeed, adjusting for the impact of its leasing and financing businesses, its core automotive business was actually almost breakeven on an operating cash flow basis during Q3. And Tesla could have made some progress toward positive operating cash flow during Q4, as it said it expected its operating leverage to improve as revenue and gross profit rise faster than operating expenses over the "next several quarters."
Investors will get insight into just how close it came to positive operating cash flow for Q4 when the company reports quarterly results on Feb. 10.
Going into 2016, Tesla's higher sales as it begins to fill its Model X orders should begin to spread out its operating expenses over higher volumes and finally bring this important metric into positive territory. Again, we'll likely get an update on whether it expects this to happen in its upcoming quarterly report.
Capital expenditures: Tesla's biggest contributor to free cash flow during the year, if things go as planned, will be its reduced capital expenditures as a percentage of revenue. During its third-quarter shareholder letter, CFO Deepak Ahuja surprisingly predicted Tesla's capital expenditures in 2016 would be less than they were in 2015. If this pans out, the automaker truly could become free cash flow positive during the year.
Sales: Tesla's third driver of free cash flow -- higher sales -- should come the easiest. After all, its 50% sequential growth in fourth-quarter vehicle deliveries was a clear display of the growing demand for its cars. And once you mix in the 25,000-plus deposit-backed orders for its Model X -- an SUV it has put hardly any effort into marketing -- sales in 2016 should be limited by nothing more than production. And if the past is any indication of the future, production shouldn't be a problem; year-over-year growth in production has been accelerating as the company gets bigger.
But don't expect much
It's not yet clear just how well Tesla will be able to execute on its plans to report meaningful cash flow on the operating level. Without any clear evidence yet that it can grow sales while simultaneously moving into positive territory on an operating basis, investors can only take management at their word.
Sure, in theory Tesla should benefit from operating leverage as it ramps sales and operating cash flow should eventually turn positive, but Tesla's pursuit of rapid growth could bring along with it surprising costs. And investors should keep in mind that it is still a small company in a very capital-intensive industry, so its path to free cash flow may face considerable volatility.