Alan Cring Productions in association with Emergent Light Studio presents the
Illinois State Collegiate Compendium, academic lectures in business and economics.
This is business finance, FIL 341 for Autumn Semester 2024.
Okay, first we'll have a look at the numbers today and then we will take another look at
cash flow, free cash flow projections.
But before we do that, just a quick look across the numbers for just a little bit here.
You can see that we have, there is not a lot of movement right now.
The markets are in sort of an unexcited territory.
That wait and see attitude that I was telling you about previously is that we are still
sitting there just waiting to see what happens next.
There is a general consensus that the Fed right now is in a difficult position for a
couple of reasons.
One of them is purely pure economics and one of them is political.
The president who is coming into office in his first term, he threatened to fire the
board of governors of the Federal Reserve, which of course he couldn't do, but it was
still something kind of earth shaking.
And the Fed, fortunately they are professional so they are not going to be too scared by
that, but they are going to take it into consideration that the president wields not so much power
over them as a president does over public opinion.
And that could be a problem if they run afoul of what he wants to do.
He could blame them for what is going to happen.
He could say this was all the Fed and his followers would say yeah, I agree, yeah, what
is the Fed?
But that is something that we have got to be, they are a little concerned about.
However, the other part of it is that the Federal Reserve was going to cut the discount
rate one last time before the year is over and now they are taking a little bit, being
a little coy about that because we did have a little bit of an uptick in some of the metrics
of inflation and so we have to take that into account.
The Fed might hold off on another interest rate cut long enough to get that inflation,
those little embers still glowing to go away.
So there you are.
But if the Fed doesn't cut interest rates, well the White House will probably condemn
the Fed and all of that kind of stuff because they want the economy juiced up.
So there is this kind of, well let's see what happens next.
As you can see the Dow started out down but it came back up.
There is really nothing to write home about.
The NASDAQ is, well the S&P 500 and the NASDAQ are doing pretty well today.
Crude is just in a trading zone.
It is comfortable.
We are near a stable equilibrium.
We have got good supply, not just at the refineries and in the gas stations.
We have got a good supply on the high seas and in the reserve tanks at the well heads
across the world.
So there is this sense of calm right now.
And you have noticed that there is not nearly as much news about the Middle East and attacks
on countries attacking each other and bombing each other and all that right now.
That helps the stability of oil prices.
So we are in a very good position right now.
Gold had a pop but it was up a little more than half a percent so that is nothing to
worry about.
Now if we look around here, prowl around just a little bit and I am trying to find something
that is, I hate this, really don't like this presentation style.
But the Nikkei was up today.
Now as far as other markets are concerned, now the Hansang is actually something that
you might want to keep an eye on over the next months because if we do go into a trade
war with China, that is going to be terribly damaging both to our economy and to the Chinese
economy.
And you will see the Hansang begin to slide if there is more than just a little concern
about a tariff war.
If that concern gets more deeply embedded in the Chinese investment community's thinking,
you will see the Hansang just begin to take a spiral downward.
But that is not happening yet.
Now they seem to have changed the way that they are doing the bonds a little bit.
The 10 year is, on this one, this is a quote on the 100.
On this one, that is the yield implied by the quote.
So you are looking at, I think, the same debt instrument from both sides, but I have got
to investigate a little further.
Again, price and yield are inversely related.
So you can see green, red, this is the price and you can do the calculation from my spreadsheet
that I gave you to find the yield to maturity given the price and all that kind of stuff.
So we do not really worry too much about it for the time being.
Try to think here.
What else?
Oh yeah, and you will see other, they are showing other bonds now, but you know, and
then they are showing the commodities again.
Another one that you do kind of keep an eye on is natural gas because it is a major trading
commodity across the world.
Much of Western Europe heats through natural gas.
We do, but not nearly to the extent that Western Europe does.
Russia has a very powerful stranglehold on Europe because Europe gets a lot of its natural
gas from Russia.
So we are going to have to see what is going to happen if Russia decides to play that game
again and cut off supply of natural gas to Western Europe.
That is going to make it very miserable in Western Europe and it is also going to, oh,
forgive me, I forgot to turn off my phone.
Bear with me here.
I apologize for this.
Okay.
Now again, Brent, now apparently crude, this quote right here is not including Brent.
This is more, apparently, this has been, and I was mistaken about this, this is more of
a composite.
Brent, the light sweet stuff, the super light sweet stuff is a little bit higher, but it
is part of the crude oil and it is better to look at this one if it is a composite of
oil prices than to look only at the Brent sweet because that is not the only one that
is in the refineries.
I do not know what to say about these.
I am just not used to this whole thing at all.
Of course, if you are into Bitcoin or cryptocurrencies, there you go.
There is your stuff.
But let me take you over here just for a minute to Tesla, TSLA.
Now Tesla, as you can see, very high beta, price earnings ratio is pointing to great
overvaluation of the stock, possibly as much as three times what it should be.
More likely, I would grant it is probably about double its actual intrinsic value right
now.
That does not mean it is going to crash any time soon.
These are long haul years, months, years, decades to find intrinsic.
For the time being, it is going to be on the north side of intrinsic by a good amount.
Now we take that and look at it one year just to have a quick look and you will see that
it has had a substantial spike.
Interestingly before the election, but since the election, it has spiked dramatically on
investors' assumptions that Elon Musk will use the levers of power he has in the White
House as an official to benefit Tesla.
That is just how it is.
They see that he is going to be able to make Tesla a fortune by being in the White House.
The ethics of that notwithstanding.
Now let me take you on a journey here just for a few minutes.
We are going to go over here and I am going to go to the SEC, sec.gov and pull in search
of filings and we are going to look at Tesla, TSLA.
And while I am thinking about it, I have opened a quiz for you.
It is due Thursday night.
That is quiz seven.
Just get it done.
Don't forget to.
And you notice that if you do this long enough, it just gets to be second nature how you get
to the financial statements.
Now this is Tesla.
And I am going to find the balance sheet.
You are going to see the same routine every time.
And I am going to prowl around for the statement of operations.
Nope, that is not it.
I don't want that.
Statement of operations.
Oh, there it is.
So there is the statement of operations and I am going to drag that over to the balance
sheet.
Consolidated balance sheets.
Put those together and I will need one more for what I am going to do here.
Consolidated statement of comprehensive, statement of cash flows.
There we go.
I am going to drag that one over to here and put that with the statement of operations.
So we have these three statements that we are going to work with.
And I am going to expand those so that I can see them.
You may be able to see them, but I can't.
So well, no that will be okay.
And then we are going to come back over here.
I will let you catch up if you want to for just a minute.
Come on.
I want to get rid of these.
So now, a couple of highlights that you will want.
Make sure that you have your operating income.
Operating income.
They call it income from operations.
And again, there used to be hard standards for what you named each line and that is just
gone now.
That is just gone.
To Tesla's credit, at least they report gross profit, which a lot of companies just breeze
right by.
Now, the research and development.
This is a difficult one for dealing with free cash flow analysis.
Because R&D is to some extent a capitalized expense.
It's capitalized over a period of years.
But that might not be the case with the company that you have under consideration.
They may have some way by accounting rules to expense the whole thing in the year in
which it occurs.
Now you will notice one thing though that there is no depreciation expense here.
So we have to go over here to the statement of cash flows and make sure that we've got
it right here.
In some companies you have it both on the income statement and in the statement of cash
flows.
It will always be in the statement of cash flows.
Now one thing that you have to watch out for though is that the statement of, the income
statement, the depreciation expense might be different from what it is on the statement
of cash flows.
That can happen.
And if you are going to make a choice of which one that you use, you use the statement of
cash flows, not the one on the income statement.
So that takes us up here.
Operating income.
What is going to be your revenues minus your operating expenses minus your depreciation?
That's a problem here because we don't see depreciation expense being listed in the income
statement.
Is it hidden in there someplace?
That is a practical consideration.
And since you're going to, this is where you'll probably, you hit the wall with how to actually
do this in practice here in this class.
We have to make a decision.
Another one.
Restructuring and other.
What in the hell does that mean?
Again, you're running into questions, more questions than you have answers for in this
income statement.
That's not some deviance or anything like that.
They're trying to hide something.
It's just how this company reports.
And if the SEC says it's fine, if their outside auditors say it's fine, then we have to live
with it.
The question is that restructuring and other, is that an operating expense?
Research and development, that is definitely not an operating expense.
So we have two of the three that probably are suspect as being included.
So we probably are going to want to take operating expenses and then add back restructuring,
which is fortunately, thank God, zero.
But we're also going to probably have to recover that research and development before we go
any further.
But we will have to subtract the depreciation expense.
And the only place we see that is on the statement of cash flows.
So we've got a more complicated situation than just a simple textbook here.
We'll get through it though.
The first thing that I'm going to do, and I've told you this before, is we are going
to want to make a sheet right here.
Insert a worksheet.
And we're going to call that thing free cash flow.
This is where we'll do the heavy lifting for we're pulling numbers from other places to
get them into alignment here.
And remember, the entire goal is to get to a place where we can run that equation right
there.
So we're going to put the numbers in here, especially because that means we don't have
to clutter up the financial statements very much.
We will in one place.
But from there, we have a place where we can just do these calculations.
And if something doesn't look right, well, we're going to work on that.
So I'm going to put here operating income.
And of course, I have kicked, unplugged it.
Operating income.
And then we will do some magic with that.
We're going to report equals, oh, I should put in, I apologize, insert a line here, 2023,
and 2022.
Apologies for that.
Now the operating income, we're going to get statement of operations.
So free cash flow equals for this purposes, we're going to go over here to operating income
and we're going income from operations.
But we're not finished here.
Plus research and development plus or minus, I'm sorry, less depreciation expense.
Because it's not listed in that income statement, we need to get it in there.
Because it does serve as a tax shield.
So first thing we'll do is we'll put in equals consolidated statement of operations.
We'll put in that research and development.
And then we will subtract out depreciation expense if we can find it.
There it is.
I put that in as a negative.
I might want to change that to absolute value.
So I can do.
So then we finally have net operating income.
Which would be equal to this plus this minus this.
And so there is their real operating income.
Less taxes at 21%.
So we take this line equals that times taxes.
Try that again.
Boy, that was a mess.
Equals net operating income times 21%.
We'll fix all these.
And that is notepad.
Net operating profit after taxes.
When we take equals that minus the taxes they paid.
And we get that.
So their notepad is $6.472 billion.
Let me do something here.
Format these.
Currency zero decimals.
Okay.
Now it gets a little bit better from here.
Plus depreciation expense minus capital expenditures.
Less, well, sorry, less capital expenditures.
Less change in net operating working capital.
And if we get through all that, we get free cash flow.
But we have to go back here.
First thing we're going to have to do is get change in net operating working capital.
Now you're going to go here to your balance sheet.
Now we have to calculate net operating working capital.
So the first thing we are going to do is look at the current assets.
Remember working capital is current assets minus current liabilities.
Well we have to peel out anything that is non-operating.
In this case, we have two items.
Equals the total current assets minus the prepaid expenses and minus short term investments.
And we do that for both years.
Now the current liabilities.
We're going to go down here to the current liabilities.
Start with them and now we're going to peel out the non-operating.
So we'll start with total current liabilities.
Now we're going to subtract out current portion of debt and leases because they're not operating
expenses.
And then we're going to subtract out deferred revenue because that's not operating, it's
deferred.
And we're going to subtract out accruals.
So basically we're going to subtract everything except your accounts payable.
Because free cash flow is going to pay for the others.
Those are non-operating, those are bills that are paid out of your free cash flow.
So keep that in mind always.
Free cash flow is telling you what you have to cover all that mess that's on the balance
sheet.
Most of it anyway.
So then we will get, and we mark this one over, and we get the net operating capital
for each year.
Equals that minus that.
And then we're going to move that over to this.
So you can see that their net operating working capital changed by less than $800 million.
That's still a lot, but it's not a very big change.
So now we can go over here to this calculation of free cash flow and we can say equals the
change which is going to be that minus that.
Really?
Let me try that again.
Oh, I'm sorry.
I thought those were in the same 19 and 16.
So before we go any further, you see that positive change that is a drain on free cash
flow.
When the net operating working capital goes up, that means that your current structure,
part of that capital structure, is absorbing cash.
It went from 16 to 19, 16.7 to 19, something like that.
So that is a drain on free cash flow.
And that is a pretty substantial, that's $2.3 billion got sucked up into inventory and all
that kind of stuff.
Net of other things.
So that one, so now we can go back up here.
We're going to say equals and we're going to go over here to the statement of cash flows
and pick off that depreciation.
Now we're going to pick off the capital expenditures.
Now the only, you've got to watch it here.
This is reported as a negative number.
So you put absolute value before you go over here and grab it, go to investments.
Where the hell?
From investment activity.
Oh, where the hell?
There it is.
See, it's a negative number.
You want to make it a positive number so you can subtract it by the formula.
And that is a whopping $8.9 billion in capital expenditures.
So now we can finish and get free cash flow.
Equals, no pat, plus depreciation expense, minus capital expenditures, minus the change
in net operating working capital, Tesla has a negative free cash flow.
It does not have enough from internally generated operations to pay.
Let me show you what can't pay from what its operations have delivered.
It cannot pay.
Where the heck?
Interest expense.
Where you say, well, it got interest income.
Glory be.
Fine.
But let's look at its capital expenditures.
Free cash flow capital, capital expenditures, $8.9 billion and free cash flow was negative
71 million.
Those capital expenditures could not have been paid by the operations of the company.
So what we look over here, and let's have a look to see where in the hell they got the
money to do this.
So if we look down here, the first place we're going to look is for debt.
Debt went up by $1.3 billion.
That's not enough.
So let's look to see if they sold more stock.
Come on.
They did sell $2.7, $2.8 billion in new common stock.
So what else happened?
Where in the hell did this retained earnings jump by $15 billion?
The question is how?
And that's the subject of a night with a good single malt whiskey and a good conversation
around a fire.
Where did the retained earnings leap by that $14 billion?
That's how they paid.
They did not have enough money from operations to cover their non-operating expenses.
They certainly don't have anything for dividends.
They paid their interest expense, but how?
It's not clear on these financial statements how this magic is occurring.
From a basic financial standpoint, their operations lost $71 million last year, and yet they were
able to pay for research and development.
They were able to pay their interest expenses.
They were able to pay for a massive increase in their capital expenditures, $8, almost
$9 billion worth of new factories and whatever.
But we don't see how it happened.
That's what we have to ask.
And we dig in deeper.
We start making phone calls.
We start looking at any other possible way they could have done it.
But it is clear that the financial statements are telling us how they did it, how they're
still in business.
That's what we do.
We go in with an objective eye.
If the numbers look good, well, we're happy.
But if the numbers look like this, we've got a question mark that is the size of a continent
about what's going on here.
That's what we do in financial analysis.
And I could break down the ratios of this.
Ratio analysis is good.
And just some qualitative, well, they have a great car and all that kind of stuff, and
he's a super guy, and he sure does know how to run a business.
But that's not explaining how this happened.
And that's where we come in as professionals.
Now as students, you can do this too.
You'll get by with a lot less heat than I will as writing about this.
But that's what we do.
We break these numbers down, and we've got a number there.
Now you could quit with some of the ways that I calculated it.
But there sure is hell no way that I'm going to recover all those billions of dollars that
seem to have come out of nowhere to keep that company rolling.
Anyway, that's all I have for you today.
And I thank you.