Tesla posts record earnings but on one stock market number Elon Musk’s EV company is still disappointing

Environment

Tesla CEO Elon Musk and Christian Democratic Union (CDU) party leader Armin Laschet visit the construction site of Tesla’s Gigafactory in Gruenheide near Berlin, Germany, August 13, 2021.
Patrick Pleul | Reuters

Tesla CEO Elon Musk has said the fundamental good the electric car maker does will be measured in the acceleration of the world to sustainable energy.

Tesla’s role in the auto industry’s move to electrification is undeniable. Many major automakers are now investing billions in EV and battery manufacturing, and consumer interest in EVs continues to grow. While a Pew Research Center survey this summer found only 7% of U.S. adults currently had an electric or hybrid vehicle, 39% said they were considering an electric vehicle to be the next car they bought. 

“One of the many things he did is he pushed the industry toward taking EV seriously,” former Ford CEO Mark Fields said of Musk.

Tesla didn’t surpass 1% share of new car sales until 2018, but during the first half of 2021, Tesla’s share of the all-electric segment of the auto market stood at about two-thirds.

“Profitability as a pure EV maker is an accomplishment in and of itself,” said Driss Lembachar, manager of transportation and infrastructure research at Morningstar’s Sustainalytics.

Tesla‘s stock price, now near-$900, and its rise to a near-$1 trillion company, shows that investors have been rewarded for sticking with a company that five years ago traded under $50 amid constant reporting on financial struggles.

But for ESG analysts including Lembachar, “There is some room for improvement.”

Beyond Tesla earnings and sales

As Tesla gets set to report its latest earnings on Wednesday and demand for its EVs show continued growth, its balance sheet becomes less volatile, and it ramps up manufacturing around the globe — including operations in Europe and China — its success is also an indication that Tesla has passed beyond its roots as a California start-up. It’s becoming a mature automaker. That is one reason ESG experts are watching closely to see how Musk’s company evolves in relation to investor concerns about environmental, social and governance issues.

Yana Kakar, global managing partner emeritus at Dalberg, said when the ESG debate is boiled down to a choice between whether the product a company produces is good, such as a Tesla EV, or the way it produces the product is good, that is a mistake.

“That’s a false dichotomy,” she said. “There is no necessary tradeoff. It is not a zero-sum game.”

How a company produces its products can be a reflection of the same values in the products it creates, and “that is entirely achievable,” Kakar said. 

This debate over Tesla has a parallel to the rise of Silicon Valley companies that are “revolutionizing” industries and, as a result, have to keep their focus on that primary goal and not ESG.

“That attitude has been particularly prevalent in Silicon Valley,” said Jaakko Kooroshy, head of sustainable investment research at FTSE Russell. “But investors have come around to the view that a company can continue ‘saving the world’ and also have decent sustainability disclosures, and those disclosures do matter in the context of the company trying to save the world.” He added, “The line from Tesla for a very long time was ‘we are busy here saving the world so who cares about our emissions disclosures and corporate governance mechanisms.”

Tesla shareholders are pressing company on ESG

The recent Tesla annual shareholder meeting showed how investor pressure is being applied to the company, with a measure for diversity, equity and inclusion reporting approved by shareholders over management objections. The vote came shortly after a legal case in which a former Tesla contract worker sued over a hostile work environment and was awarded $137 million.

ESG experts say it is a sign that Tesla shareholders are making their voices heard, but it will be another year before ESG experts and shareholders can assess any changes made by Tesla in response to the shareholder measure. Shareholder measures are non-binding, and though corporate management often enacts changes in response to shareholder wins, it is not always with the scope or comprehensiveness that shareholders expected.

To date, in spite of all of the “good” the company is doing related to climate change, Tesla has not had the best ESG track record.

Paul Tudor Jones’ ESG firm JUST Capital ranks Tesla among the bottom 10% of all companies on ESG — its ESG methodology is weighted more heavily to broad social issues than climate specifically.

FTSE Russell has Tesla ranked last among carmakers globally on ESG issues.

Tesla did not respond to a request for comment on its ESG philosophy.

Environment and climate

ESG rating agencies, in the early days of the industry, don’t yet agree on how to assess Tesla even on the “E” of environment with which it is synonymous.

Lembachar said on the environmental pillar in ESG, “They are one of the best … it goes without saying they produce only cars without emissions, and they have been credited for that.”

But in 2018, FTSE Russell gave Tesla a “zero” on environment because even though its revenue sources are green and its cars are non-emitting, the company didn’t disclose its own operational emissions.

Historically, Tesla did not provide transparency in terms of reporting its Scope 1 and Scope 2 carbon emissions, water use, or waste management. But Tesla has improved as investors pressed for more information and it has started publishing more corporate disclosures in recent years, said Kooroshy, which has led to an improvement in Tesla’s environmental ranking in the FTSE Russell ESG analysis.

How Tesla deals with the waste it generates and its water usage, particularly as it is starting to scale around the world and provide millions of vehicles, does matter, he said. There are many ways to produce EVs, some cleaner and some more problematic, and supply chains and sourcing of raw materials such as cobalt, which goes into batteries, and human rights and labor issues in regions where minerals are sourced, need to be considered by investors as risk factors.

“What is clear is that Tesla has made some improvements, but compared to many of its peers in the auto industry, its environmental reporting is still fairly rudimentary,” Kooroshy said. “They are conscious of, and made commitments to disclose more data points in future, and as they do, when they do, we will see it reflected in those ratings.” 

Labor

On balance, social and governance issues remain the major hurdles for Tesla. MCSI places Tesla above average in its rankings, but not as an ESG leader.

“If you look at labor management or product safety quality, we see some issues there,” said Arne Klug, vice president of ESG research at MSCI. “We couldn’t say that the company’s programs, in terms of labor management, or product safety, quality, are really aligned with its growth strategy based on our assessment.”

In March, the National Labor Relations Board ruled that Tesla violated federal labor laws while United Auto Workers and other unions tried to organize at its original plant in Fremont, California. The NLRB also found Tesla guilty of “coercively interrogating” three employees over unionizing activities, illegally firing another and disciplining another.

For JUST Capital, worker issues are one of the primary reasons Tesla gets “tripped” up in its rankings, Whittaker said. How a company supports local communities, what is it doing on diversity, and what it is doing on fair pay and worker issues, are all issues that JUST weighs more heavily than climate alone in its overall ESG rankings because Whittaker said, “the public weighs them highly.”

The labor issues will pose a material risk to Tesla as it expands around the world, Lembachar said, as they do for any company with global operations where a confrontation with a labor force at one site can increase the risk of more general strikes.

“Workforce issues can have more of an effect now that the company is getting out of this start-up stage and expanding around the world and in Europe, where there is a really strong union tradition,” he said. “The company must be prepared for labor-related risks and, according to us, must have stronger labor-related programs prepared to tackle issues related to the expansion of its workforce engine around the world.”

Autopilot as an ESG issue

Tesla is facing investigations from the National Highway Traffic Safety Administration regarding Autopilot, the automated driving technology currently in Tesla’s Models 3, S, X and Y in 2021.

While it may at first not seem obvious how self-driving is an ESG issue, it in fact falls within traditional categories that date all the way back to the days of Ralph Nader and “unsafe at any speed”: product safety and passenger safety.

Lembachar said Tesla’s full self-driving (FSD) is something his firm receives a lot of questions about as an ESG scoring metric, but he says it is simple: “Anything related to passenger safety is product governance and falls under the ‘Social’ pillar. Everything related to recalls, accidents, defects, responsibility of company is product governance.”

He was quick to point out that if self-driving works it may ultimately cut down on accidents by as much as 90%, and Tesla is potentially far ahead of competitors with the technology. But in a period of time when it is being scrutinized as the cause of accidents and fatalities, self-driving remains a product governance negative, and that metric has a heavy weighting for the auto industry. That hits other companies, too, such as GM after its recent recall on electric cars due to battery fire risk. And Lembacher said these issues have a material cost: for GM, more than $1 billion in the case of the recalls. “That is a very material issue,” he said.

Corporate governance and Tesla’ ESG future

Even though tweets may seem ephemeral, Musk’s confrontation with the Securities and Exchange Commission over controversial tweets can negatively impact the company’s corporate governance score.

“In terms of corporate governance, we see the confrontation between Musk and the SEC as problematic,” Lembacher said. “Tweets are problematic when they change the share price and that can be harmful for shareholders … and that’s why the SEC has been flagging it. There is a risk that the regulator at some point will sanction the company and since we are running a risk rating product, we have to flag this issue.”

Questions also remain about the company’s acquisition of SolarCity, which was controlled by Musk’s cousins (a legal case is ongoing brought by shareholders).

The corporate governance issues raise a bigger question about Musk’s impact on ESG ratings.

“It is not enough to say the company is being run by a ‘genius’ and as a result, ‘please don’t ask us too many questions,” Kooroshy said. “There is no doubt about the achievements of this company, particularly about accelerating the transition to sustainable energy. This is stuff for the history books, but at the end of the day, for investors trying to understand how much of a portfolio to invest in this company … not enough, he said. “It’s still not a free pass. … Making these disclosures doesn’t stop them from innovating.”

Kakar said Tesla’s mission of accelerating the transition to sustainable energy, and its focus on that as an argument in its defense, is implicitly a relative statement comparing itself to other automakers, and that is where the false tradeoff comes in. “It is terrific they are making EVs … but relative to the next guy is not the important point, and doesn’t obfuscate responsibility.” 

Many ESG investors and ESG investment products today accentuate the “E” and climate specifically. “That’s where the action is at and investors have seen it as a good story, and if you think about environmental performance and climate as the big opportunities, you see Tesla as a big solution and will be attracted to it,” Whittaker said.

But as any company grows in scope and scale, the range of issues they have to contend with changes and investors will ask more about the “how” behind the growing business.

“That’s what is going to happen with Tesla as people become more aware of the social risk of how it operates,” Whittaker said. “It is bound to become more of an issue for investors and more of an operational risk for the company if it doesn’t perform well … more prominent in the overall calculus of company competitiveness and success.”

“That is not to say it won’t do well,” he added. “Musk is an incredible entrepreneur and business leader and I am sure if it becomes an issue he thinks will affect the value of the company or brand, he will respond accordingly. I expect it will become more of an issue for the management team to have to deal with.”

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