Tesla: 10-Q Deep Dive

As many of you know by now, the most interesting articles for me are those where I am either writing about crunching through numbers myself or reviewing the work from other organizations.

We are once again ready to crunch through Tesla’s (NASDAQ:TSLA) 10-Q released a short while ago. As we already know Tesla’s loss in Q3 was over $600 million, far exceeding my guess of $450-500 million. The average price per delivered unit dropped by over 13% in Q3. That is a whopping decline in average selling price of over $13,000 per unit.

For this entire article, these two links for Q3 (here) and Q2 (here) 10-Qs should be all the reference sources you will need.

By the zones

Tesla reports global revenues by breaking them down into four zones. The U.S, China, Norway, and all Others lumped into one group. If we subtract out Energy generation/storage, Services and other, and ZEV credit sales, we should have a pretty accurate number of New Automotive Sales for the four regions. We know of little in the way sales outside the U.S. for energy and services, so until Tesla offers us better information, I am giving the U.S. all the credit for these revenues.

What is startling is the decline in growth of new car sales revenue for the U.S. After delivering over 4,100 more units in Q3 over Q2, and increasing revenues by $175 million, why was the U.S. not a bigger participant? Sales only grew by $39 million, which included 220 Model 3 units. Using an average of $50,000 for each Model 3 means Tesla had $11 million in sales. That reduces the Model S and X growth to just $28 million in the U.S. What we find is a slowing increase in sales in the U.S. and strong growth in China and Norway. For Norway, this matches the information in updates I receive from Andreas Hopf for that region. However, the $100 million in new Chinese growth is a bit of a surprise. While numbers are difficult to come by, evobsession.com had Chinese sales at just 2,100 new units in the last month of Q2. At the end of June, the same website was estimating total sales of Model S and X at a combined 9,299 units. If we add the revenues from Q1 and Q2 and divide by the number of units, we arrive at an average sale price of $104k in 1H17. Apply that number to the revenues and we can estimate sales at 5,418 units. Evobsession.com had Tesla sales at 310 units in July and 1,700 in August. That would mean a rough delivery number of 3,408 in September or a 62% increase in sales over Q2. While not out of the question, it may be a better indication of a growing number of used car sales in China.

What do the “deliveries” numbers represent?

Tesla reported an increase in deliveries of over 4,100 units in Q3, but it appears new vehicle revenues only increased $175 million or an average of $42,682 per unit. Something is way off. There are only two explanations.

I have gone back two years through every delivery report. The word “new” is never used. Could Tesla be now (or may have always been) reporting CPO sales in deliveries? (I have not been able to confirm this one way or the other because Tesla has not responded to my questions on the issue.) CPO units are being given the same treatment at the delivery centers as new units. The cars are refurbished to look as close to new as possible (at great expense it would appear). So why would they not be?

The second option is Tesla gave away everything but the sales office furniture to achieve those additional sales in Q3. This is the more probable answer. Jon McNeill was promised a $700,000 bonus in late August if he could “move the metal”. He is doing just that. It would explain the huge average price drop from $103,937 in Q2 to $90,320 in Q3. We also know the Q3 sales exceeded available production by over 2,000 units built before Q3. Where these units are being stashed until sold is anyone’s guess. But my calculations show here are still 6,600 unsold units accumulated just since Q3 last year (see chart below).

The Tesla website currently claims there are no new 75kWh battery pack cars remaining. Sadly, this is not true because it is easy enough to go to the EV-CPO.com website, do an inventory sort for 75kW cars and find direct links to specific cars back on the Tesla website ignored by an inventory search. For a tech company, as Tesla claims to be, its website is amateurish at best, and pretty much useless.

Are increased sales really helping?

Tesla revenues set a new record in Q3 at nearly $3 billion. But is Tesla getting anywhere by growing revenues? It appears not. While revenues increased by just 7%, the costs of goods sold jumped a huge 19%. This slashed gross profit by 32%. Management can make all the excuses it wants but just growing sales is not working.

As you can read in the chart above, Tesla’s quarterly loss took a HUGE jump in Q3. This was caused by not only a drop in gross profit shown above but also continued increases in R&D and SG&A expenses. Whether the recent reductions in headcount will offer any relief in either direct or indirect labor expense is doubtful since Tesla seems to be planning to replace most of the fired workers.

Inventory

In my most recent article yesterday, I took a lot of flak for my predictions regarding what the new inventory numbers would reveal. I was partially right and partially wrong.

We know that the average unit sold for $90,320 in Q3. We know that the accumulated inventory was reduced by 2,174 units or about an adjusted $147 million by removing at a 25% gross margin.

But we now know finished goods only lowered by $52 million. That should mean Tesla was sitting on about $95 million worth of finished Model 3 units on 9/30. On a cost basis of $35,000 for each retailed $50,000 unit, there should be over 2,700 Model 3 units sitting somewhere as of Sept. 30. But Tesla only claimed to have 40 units sitting on 9/30. Is Tesla now recording 2,600 partially built Model 3s as finished goods? Are they all sitting waiting for their battery packs from the Gigafactory?

The only substantial inventory growth was in raw materials and not in work-in-process (WIP) as you would expect for a new model ramping up production.

So where are these hundreds of thousands of anticipated parts coming from the suppliers? As one commenter suggested yesterday, Tesla should be sitting on trainloads of parts from suppliers by now. The $54 million in raw materials is probably in aluminum and steel needed for all of the cars since they are still building all three models.

Does this mean all of the incoming shipments were not recorded or unloaded in September? If so, we are going to see a huge increase in accounts payable in Q4.

I will agree I may have gotten a bit ahead of my skis on finished goods. But Tesla still needs to explain the $95 million discrepancy. If it is indeed partially completed units that is a big change in its reporting.

Recap

  • Higher sales
  • Lower profits
  • Bigger expenses
  • Higher losses

Add these all up and you have a company that should get out of the car business and stick to “energy generation and storage”. It is the only place Tesla knows how to make money it seems after more than 13 years in business.

Based on inventory counts, it seems Tesla never had any plan to build 5,000 units a week in 2017. It doesn’t have the parts to build that many units a month let alone a week. Unless we see a big leap in inventories in Q4, it will certainly not have the parts to build them in Q1 either.

The conference call struck me as a group of men struggling to find answers to some very basic questions. How do we control costs while selling more product? Why can’t we build a simpler car in less time than it took to ramp up the Model S? Why do we need more people and spend more money to build a car than every other manufacturer on the planet?

Bill Maurer had a great article (here) on the rising guarantee obligations Tesla is facing. Just one more nail in the proverbial coffin.

If it doesn’t figure this out soon, Tesla won’t be around by the end of 2018.

Disclosure: I am/we are short TSLA VIA OPTIONS.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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Equifax clears executives who sold shares after hack

(Reuters) – Equifax Inc (EFX.N) said on Friday four of its executives who sold shares before the credit-reporting firm disclosed a massive data breach that wiped out billions from its market value were not aware of the incident when they made the trades.

FILE PHOTO: Credit reporting company Equifax Inc. corporate offices are pictured in Atlanta, Georgia, U.S., September 8, 2017. REUTERS/Tami Chappell/File Photo

A special committee set up by Equifax’s board to investigate the trades concluded that no insider trading took place and that pre-clearance for the trades was appropriately obtained. (reut.rs/2habhk9)

The company’s shares were up 0.2 percent at $109.10 on Friday at midday, around 24 percent lower than on Sept. 7 when Equifax disclosed that cyber criminals had breached its systems and accessed sensitive information on 145.5 million consumers.

The shares slumped as much as 37 percent in the days after the disclosure.

Atlanta-based Equifax had been aware of the breach since July 29, days before some of its senior executives, including its chief financial officer, sold $1.8 million in shares.

After an investigation that included 62 interviews and a review of over 55,000 documents, including emails, text messages, phone logs, and other records, Equifax said the executives had no knowledge of the breach when they sold the stock.

“The conclusion that the Company executives in question traded appropriately is an extremely important finding and very reassuring,” non-executive Chairman Mark Feidler said in a statement.

Former Equifax Chief Executive Officer Richard Smith, who stepped down in September and agreed to forgo his annual bonus, told lawmakers last month that the executives would not have known of the breach because suspicious incidents are detected every day at the firm and take days or weeks to confirm.

The U.S. Justice Department is conducting its own criminal investigation into the share sales.

The hack, among the largest ever recorded, exposed information that included names, birthdays, addresses and Social Security and driver’s license numbers.

It has also prompted investigations by multiple federal and state agencies as well as scores of class action lawsuits.

The exact financial toll on Equifax is still unknown, and as of early Friday, the company said it still had not set a date to release its third quarter financial results. If the company does not release the results by Nov. 9, it will have to seek an extension from the U.S. Securities and Exchange Commission, which gives large companies 40 days after the close of a quarter to report their financials to investors.

Equifax is also still searching for a replacement for former CEO Smith.

Credit monitoring services such as Equifax collect vast amounts of financial information from consumers, working with banks and other lenders, for example, to track the creditworthiness of individuals.

Reporting by John McCrank in New York and Aparajita Saxena in Bengaluru; Editing by Saumyadeb Chakrabarty and Frances Kerry

Our Standards:The Thomson Reuters Trust Principles.

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Just Another Day In Paradise For Omega Healthcare

Yesterday was a tough day for Omega Healthcare Investors (NYSE:OHI), as shares fell more than 7% after the company’s third-quarter results and earnings call. The day-long trading volume (~13 million shares) resulted in a market cap erosion of some ~$2.50 per share, or around $500 million in market value (~197 million shares outstanding).

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Combined with Q1 and Q2, Omega’s Q3 results were just another “day in paradise” for the nation’s largest skilled nursing REIT. So far this year, shares have declined by almost 8%.

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Here’s how Omega’s YTD performance (Total Returns) compares with that of other healthcare REIT peers:

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So where’s the love? Or shall I say lack of love for this prized divided payer?

What Happened?

The drama has been unfolding for months as operator pressure within the skilled nursing sector has escalated. In a recent article, I explained:

“some of the negative news regarding the reliability of future rents and the ability to continue to deliver dividend growth to shareholders significantly overstate the issues that operators are managing through and ignores the enormous demographic wave that seniors that will have greatly expanded healthcare needs over the next 5 years.”

Several skilled nursing operators have experienced pressure, and Omega has three of them in the Top 10:

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On the Q2-17 earnings call, Taylor Pickett, Omega’s CEO, explained:

“3 top 10 operators are responding to information requests made by the DoJ (Department of Justice) 1 top 10 operator is ongoing discussion for the DoJ with respect to potential settlement. At this time, it’s too early to determine the outcome of this operator’s settlement discussions or any of the other DoJ inquiries.”

As you can see (on the Top 10 list), a new name appears, Orianna, a 42-property operator that was previously referred to as Ark. In a recent article, I explained, “this operator has continued to experience quarterly pressures, despite finally showing signs of operations improvements. As I explained in another article, “My back-of-the-napkin analysis suggests that the worst case for Omega is to reposition all of the Ark properties and rent them out for $35 to $38 million. At the midpoint this re-trade would cost Omega around $.01/share in quarterly FFO.”

Guess what? My “back of the napkin” estimate was spot on! Here’s what Omega said yesterday on its earnings call:

“In the second quarter of 2017, we recorded approximately $16 million of cash and straight line revenue related to Orianna. Placing them on a cash basis and initiating the process of transitioning some or all of their portfolio to new operators required us to test the assets for impairment.

During the quarter, we recorded approximately $204 million of impairments related to our Orianna portfolio, $195 million was to reduce our capital lease assets to their fair value of which $40 million of that change related to writing off the lease amortization or straight-line rent equivalent on the capital lease.

We also recorded $8.2 million in provision for uncollectible accounts to fully reserve Orianna’s outstanding contractual receivables and $1.3 million to write-off straight line receivables related to their operating lease. It’s important to note that Orianna impairment is a subjective estimate and is subject to change based on the final outcome of the transition.

We believe our estimate is conservative based on our current portfolio analysis. The impairment test for a capital lease is different than that of an operating lease.”

In plain English, Omega has stopped paying rent, and the company is transitioning its assets. This means it is negotiating with Orianna, and it could be either a “friendly” resolution or “not-so-friendly” resolution.

The friendly alternative means the landlord and tenant will be able to work out a new master lease, which includes a rent reduction to $32-38 million (an $8-14 million hair cut). Using my back-of-the-napkin math, and using $11 million as the rent reduction, the new “friendly” deal means Omega’s portfolio leased to Orianna is worth around $120 million less now (using a 9% Cap Rate).

If Omega and Orianna are unable to strike a new deal, the “not-so-friendly” alternative is that Orianna ends up in bankruptcy court, at which time the company will eventually take legal possession of the portfolio and find a new operator. Of course, this will take more time to transition, and the process could take up to a year.

Mitigating Risk Is What Separates the Best from the Rest

As mentioned, Orianna operates 42 properties spread across the southeastern U.S. Several of the properties are located in my hometown of Greenville, SC. Click here for the locations.

I have not visited these properties, but it appears that many of the locations are high quality. Here’s an example of one property in close proximity to my office:

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While the Orianna news is not good, it was certainly not unexpected. I am surprised to see the pullback yesterday, given the fact that Omega had already telegraphed the problems on previous earnings calls. But we all know that a “knee jerk” can often lead to opportunity.

Remember, Omega owns a portfolio that includes 1,004 investments (907 operating properties and 90,949 beds):

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In addition to the US properties (around 850 in US), the company also has holdings in the U.K. that consists of 53 care homes across central London and the southern and eastern regions of England.

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As you can see below, Omega’s portfolio generates around $900 million in annual rental income, and the Orianna “hiccup” is around $11 million (as per above), meaning that the loss of income associated with this “transition” is approximately 1.2%.

See what I mean by “knee-jerk” reaction? Shares slide 7%, and the loss of income is just 1.2%.

Also remember, skilled nursing is not the same as net lease. There’s a reason that Omega acquires properties at cap rates of 9-9.5%. It’s a function of risk and return, and when you buy properties to higher-risk tenants, there will always be operators that get into trouble. At the end of the day, the best risk mitigation tool for Omega is summed up in one word: diversification.

Is the Dividend Safe?

As most know, Omega has an exceptional history of earnings and dividend growth. Just take a look at its dividend history below:

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Clearly, Mr. Market is concerned that the operator issues within Omega’s portfolio could lead to a tightening of the payout ratio. Let’s examine the history of the dividends/share:

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As you see, the company has generated very steady and reliable dividend growth, averaging 9.6% annual growth since 2009. On the recent earnings call, Omega’s CEO, Taylor Pickett, said he “remains confident in our ability to pay our dividend, increasing our quarterly common dividend by $0.01 to $0.65 per share.

We’ve now increased the dividend 21 consecutive quarters. Our dividend payout ratio remains conservative at 82% of adjusted FFO and 89% of FAD, and we expect these percentages will improve as the Orianna facilities return to paying rent.”

Omega’s revised 2017 guidance reflects the impact of Orianna’s cash accounting and the anticipation that no cash will be received for the balance of the year. Yesterday, Omega said it had lowered 2017 adjusted FFO guidance to $3.27-3.28 per share.

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While this news will impact the dividend cushion, the REIT has been reducing its Payout Ratio for many years in anticipation of a hiccup.

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Omega generates approximately $150 million of cash flow after dividends, and even if the company lost all of the Orianna rental income (~47 million), it is well positioned to weather the storm, and it would have another $100 million of cash flow after dividends.

So What About the Other Operators?

In addition to Orianna, Omega continues to experience specific operator performance issues, as discussed in the last several calls, including Signature Healthcare, another top 10 operator. Similar to Orianna, liquidity issues are impacting the ability of these operators to pay rent on a timely basis.

Signature Healthcare has also fallen further behind on rent in the third quarter, predominantly as a result of anticipated tightening restrictions upon its borrowing base by its working capital lender, thus reducing availability. The vast majority of Signature’s past due rent balance is covered by a letter of credit in excess of $9 million.

Keep in mind, Omega is continuing to grow its platform. The company said it had completed two new investments totaling $202 million, plus an additional $36 million of capital expenditures. Specifically, it completed $190 million purchase lease transaction for 15 skilled nursing facilities in Indiana, and as part of that same transaction, simultaneously completed a $9.4 million loan for the purchase of the leasehold interest in one skilled nursing facility with an existing Omega operator.

Omega is well positioned to grow, as the company has approximately $910 million of combined cash and revolver availability to fund future investments and provide capital funds to the existing tenant base. The balance sheet remains exceptionally strong. For the three months ended September 30, 2017, net debt-to-adjusted annualized EBITDA was 5.46x and the fixed charge coverage ratio was 4.2x.

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As noted above, diversification matters, and Omega is in excellent shape to continue to diversify its holdings. I consider the strength of the balance sheet and exceptional diversification to be the biggest risk mitigators for the company to insure the safety of the dividend and to protect the future profits of the enterprise.

OHI can still make accretive investments today (~9% cost of equity / ~5% cost of debt), which, at 60/40 (equity/debt), generates 100 to 150 bp spread to acquisition yields. Combined accretive investments and active portfolio recycling could mitigate skilled nursing industry pressures on earnings.

I’m Maintaining a Buy

Yesterday, I spoke with Omega’s CEO, and I’ll provide you with a few of his comments:

“This is the beauty of a big portfolio, you can sustain”.

“The dividend is completely secure with room to grow it”.

“The dividend is pretty attractive as you want on demographics”.

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He’s right – 8.4% is a decent dividend yield to get while you’re waiting.

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There’s no question shares are cheap…

Could they get cheaper?

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Sure. But it simply boils down to managing risk, and the primary reason that I am hanging onto my shares in Omega is because I believe in the management team. Companies aren’t going to bat 400 every quarter, and when I see a “knee jerk” like I saw yesterday, I am reminded that there is always a silver lining. That’s what the other Buffett (Jimmy) means when he sings, “It’s just another day in paradise.”

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Note: Brad Thomas is a Wall Street writer, and that means he is not always right with his predictions or recommendations. That also applies to his grammar. Please excuse any typos, and be assured that he will do his best to correct any errors, if they are overlooked

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Sources: F.A.S.T. Graphs and Omega Investor Presentation.

Other REITs mentioned: LTC Properties (NYSE:LTC), Ventas, Inc. (NYSE:VTR), Welltower, Inc. (NYSE:HCN), National Health Investors, Inc. (NYSE:NHI), HCP, Inc. (NYSE:HCP), Senior Housing Properties Trust (NYSE:SNH), Global Medical REIT, Inc. (OTC:GMRE), Medical Properties Trust (NYSE:MPW), Healthcare Trust of America (NYSE:HTA), Healthcare Realty Trust (NYSE:HR), Physicians Realty Trust (NYSE:DOC), New Senior Investment Group (NYSE:SNR), Sabra Health Care REIT (NASDAQ:SBRA), OHI, Community Healthcare Trust (NYSE:CHCT).

Disclosure: I am/we are long APTS, ARI, BRX, BXMT, CCI, CHCT, CIO, CLDT, CONE, CORR, CUBE, DLR, DOC, EPR, EXR, FPI, GMRE, GPT, HASI, HTA, IRM, JCAP, KIM, LADR, LAND, LMRK, LTC, MNR, NXRT, O, OHI, OUT, PEB, PEI, PK, QTS, RHP, ROIC, SKT, SPG, STAG, STOR, STWD, TCO, UBA, UNIT, VER, VTR, WPC.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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