Tesla bonds: a better junk, until the stock market says so
Senior Fixed Income Strategist
Summary: Tesla's credit outlook has improved during 2020 as shares were rising. At the moment, the company's bonds look expensive for its rating and cheap in term of default risk. However, everything can change as soon as the stock price loses steam.
As my colleague Peter Garnry mentioned in his article, Tesla shares continue to be at the forefront of the stock market's noise. Just yesterday, shares were down 6% before the big "Battery Day" when no major news was shared with investors.
However, what is happening with Tesla bonds?
Tesla has four bonds outstanding with the longest maturity being 2025 (USU8810LAA18), which is also the most traded bond. The company's 5-year bond is offering a yield of approximately 3.5% for a B+/B3 rating, which is the lowest that comparably rated bonds can offer on similar maturities.
If we take Ford as an example, which was recently downgraded to junk, we can see that that for a better rating profile (B1/BB-) we get paid more. The Ford bond with maturity 2025 (US59001KAG58) is offering a yield of 4.3% while the one with maturity 2026 (US59001KAG58) is paying around 4.9%.
When investing in bonds is critical to think about the financial position of a company and whether future market events can expose an investor to default. Since May 2019, Tesla's default risk has declined because of improved liquidity and operating fundamental. According to Bloomberg, Tesla looks less likely to default on its debt compared to companies such as Renault, Ford and Fiat Chrysler, which at the moment are offering much lower yields on same bond maturities.
Based on the company's capital structure, Tesla should end the year with a leverage of around 4%. The one of Ford is more than double than that at the moment. Also, in terms of debt structure, Ford has the biggest chunk of bonds expiries throughout all the next year. The majority of Tesla's bonds expire in 2024 and 2025, making Ford very much vulnerable to refinancing amid the second or even third wave of coronavirus pandemic.
Improving default risk and financial leverage has a lot to do with skyrocketing stock performance since the debt-to-market capitalization continues to widen as the stock price rises. This is why Tesla bondholders need to pay attention to price development in the stock market, in order to assess the bonds' risk of default better.
In conclusion, we believe that Tesla improved credit outlook has a lot to do because of its ever high stock price. Within this context, compared to peers, Tesla's bonds looks too expensive for its rating, but much cheaper in terms of risk.
In the meantime, Tesla CDS has fallen to new lows since the beginning of the year. In contrast, the CDX North America High Yield, which is a gauge of overall high-yield corporate risk in North America, has risen in the same timeframe.