https://www.barrons.com/articles/tesla-debt-upgrade-credit-moody-s-rating-c250b595

Coming into the week, Tesla TSLA +7.82% was a junk-rated credit at Moody’s, even though Tesla’s financial performance justified much better by Moody’s own calculations.

That changed Monday evening after Moody’s upgraded its rating on the electric-vehicle maker. Still, investors might wonder why the rating isn’t even higher. Elon Musk seems to be the reason.

Moody’s now rates Tesla (ticker: TSLA) debt at Baa3, its lowest level for investment grade, up one ratings notch from Ba1, the highest level of speculative grade, or so-called junk-rated debt.

The Moody’s action comes after an October upgrade to investment grade by S&P Global (SPGI) after the EV maker reported its third-quarter delivery numbers.

“We now view Tesla’s credit profile more favorably because it continues to demonstrate market leadership in [EVs], with solid manufacturing efficiency that supports strong Ebitda margins and sustained positive free operating cash flow,” wrote the S&P credit analysts in their upgrade report.

Ebitda is short for earnings before interest, taxes, depreciation, and amortization.

Tesla had an impressive 2022, delivering more than 1.3 million EVs. Operating profit margins came in at about 17%, the best among high- volume car makers. Toyota Motor TM +0.48% (TM), for example, posted an operating profit margin of about 8% for 2022.

At the end of January, Moody’s updated its analysis of Tesla’s credit, leaving the rating at Ba1, the firm’s highest speculative-grade call, even though the ratings company’s analysis of Tesla’s numbers points to a rating much higher than that.

“The scorecard-indicated outcome using Moody’s Automobile Manufacturers methodology is A2, measured for the last 12 months ended September 30, 2022,” reads the update. “On a forward-looking basis, the scorecard-indicated outcome remains A2.”

An A2 rating, five notches higher than the Ba1 rating assigned in January, is in the middle of Moody’s investment-grade scale. The reasons for the gap, according to the ratings company’s report, are Tesla’s narrow product lineup, accelerating competition, and “corporate governance challenges, with considerable latitude exercised by CEO Elon Musk.”

Tesla didn’t respond to a request for comment. Barron’s asked Moody’s about the ratings gap twice, on Sunday and Monday, before the Monday evening upgrade. It didn’t respond to a request for comment.

The current Baa3 ratings is still four notches below the A2 rating Tesla’s financial results implied in January. Some of the concerns Moody’s cited in January may remain, but all car companies have competitive issues to deal with. The market for gasoline-powered cars, for instance, is about 90% of what it was a few years ago. Fully battery-electric and plug-in hybrid cars accounted for about 10% of global light-vehicle sales in 2022.

Qualitative issues have affected ratings for other auto ratings. Based on Moody’s outlook for General Motors GM +4.40% ‘ (GM) financials, for instance, the company deserves a Baa2 rating. Moody’s, however, rates the debt a notch lower, at Baa3, its lowest investment-grade rating.

“Elevated requisite capital spending, R&D and engineering costs related to electric and autonomous vehicles,” are some of the credit challenges listed in the GM report.

Ford Motor F +4.83% (F) is in the same boat as GM. Moody’s rates Ford debt at Ba2, a speculative-grade rating, but the ratings company’s purely financial analysis points to a call of Ba1, one notch higher.

The difference between investment-grade and non-investment-grade ratings can matter, increasing companies’ cost of borrowing by limiting the pool of buyers for their debt. Many pension funds and institutional investors only buy the debt of investment-grade companies.

Split ratings, with one ratings firm calling a company’s credit investment grade and another calling it speculative grade, also limit buyers, according to Alexandra Merz, founder of L&F Investor Services, which advises international investors on the creation or purchase of U.S. businesses. Merz spent years as a credit officer at Moody’s in France.

“They don’t deserve a junk rating,” Merz said of Tesla, adding she believes Moody’s reference to corporate governance is based on volatility in the stock triggered by Musk himself. Musk is a busy individual, running SpaceX and Twitter, as well as Tesla.

Musk’s purchase of Twitter in October has affected how investors view Tesla stock. Shares are still about $42, or 19%, lower than the $225 level just before Musk completed his purchase of the social media platform. The Nasdaq Composite COMP +1.58% is up about 8% over the same span.

Part of the problem is that car-related stocks have struggled as interest rates have risen, threatening demand by making new vehicles less affordable. GM and Ford shares are both down roughly 13% since Musk’s Twitter takeover, but the loss at Tesla has been bigger.

Tesla stock might get a small boost from Moody’s decision to upgrade, given that it appears to be a vote of confidence from a financial market participant. “For me, the upgrade rights a wrong,” said Merz.