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Tesla (NASDAQ:TSLA) recently received a positive report and upgrade from Moody’s Investors Service, which changed its outlook towards the electric car maker from “Negative” to “Stable.” In its report, Moody’s affirmed Tesla’s ratings, including the company’s B3 Corporate Family Rating (CFR) and Caa1 senior unsecured ratings. Tesla’s speculative grade liquidity was also changed from SGL-4 (Weak) to SGL-3 (Adequate). 

According to the financial firm, Tesla’s B3 CFR reflects the company’s achievements in the production ramp of the Model 3, whose output is “now in line with Moody’s earlier expectations.” This, according to the firm’s report, should allow Tesla to “achieve production efficiencies, lower costs, and strengthen automotive gross margins.” These improvements are also key to offset the losses generated by the company’s automotive service operations, which could then push Tesla towards profitability. Moody’s added that the sale of regulatory credits is expected to give a boost to Tesla’s finances as well. 

“An important contributor to achieving net profit will be the sale of regulatory credits, which represent no incremental cost to the company and fall directly to earnings. We expect these sales, which accounted for over $400 million in revenues/earnings during 2018, will continue to grow as emission regulations become more restrictive in all major markets,” Moody’s wrote. 

Moody’s stated that it still expects Tesla to generate modestly negative free cash flow of around $500 million over the next 12 months, though the firm expects the electric car maker’s capital expenditures to decrease over this time, thanks to the company’s growing experience in its automotive production business. “Tesla’s increased experience with its production processes have significantly reduced the level of capital expenditures needed to support its growth plans, with annual CapEx falling from approximately $4 billion in 2017 to a current run rate of $1.5 to $2 billion, thus providing a significant boost to expected cash flow,” the firm noted.  

Impressively, Moody’s noted that Tesla’s liquidity position is now “Adequate.” The company’s $5 billion in cash, for one, is expected to give the electric car maker a generous cushion to address maturing debt obligations through 2021, as well as address potential operational challenges that it could face in the coming year. Moody’s explains its positive outlook on Tesla’s liquidity as follows. 

“Tesla has an adequate liquidity profile supported primarily by its $5 billion cash position. After giving consideration for approximately $1 billion in cash needed to fund normal ongoing operations, and $566 million to cover a November 2019 convertible note maturity, Tesla has incremental liquidity of approximately $3.4 billion. This affords the company an important cushion to contend with potential stress arising from softness in US demand, operational challenges accompanying its European and Chinese expansion plans, and the time that will be necessary to implement additional efficiency-enhancing initiatives,” the firm noted. 

Nevertheless, Moody’s argued that Tesla still has notable areas of improvement, particularly in terms of its corporate governance. The firm cites the significant turnover of the company’s senior management ranks including JB Straubel’s recent decision to step aside from his CFO post; the actions of Elon Musk which have resulted in conflicts against the Securities and Exchange Commission; and a board of directors that has “not demonstrated meaningful oversight over the CEO’s activities” as areas of improvement for the electric car maker. While Tesla has been making efforts to improve this, such as the appointment of two new members of its board, Moody’s argues that “Tesla retains a very weak corporate governance structure” nonetheless. 

Tesla’s updated rating with Moody’s could be upgraded or downgraded in the future, depending on the company’s performance. The firm noted that it could upgrade Tesla further if the company could demonstrate “sustained profitability and positive free cash flow in the face of rapid expansion plans in Europe and China,” as well as a capability to maintain an adequate liquidity profile. On the other hand, Tesla’s rating could be lowered if demand for its vehicles begins to soften in the United States, or if the company makes missteps in its China and Europe ramp. A downgrade could also happen if Tesla is unable to remain on a clear path towards strengthening margins in its automotive business, while narrowing losses in its other endeavors. 

Moody’s full report on Tesla’s recent upgrade could be accessed here.

Disclosure: I have no ownership in shares of TSLA and have no plans to initiate any positions within 72 hours.