Product liability. It is most likely the least understood, or followed, anyway, factor in valuing stocks in this market. As I noted in Thursday's Real Money column, we are in a Kevin Bacon market (as his character in Animal House famously yells "nothing to see here, remain calm"). With a financial media/analyst community full of apologists for any factor that could lower a stock's value, product liability is lumped in with a whole host of other factors that are irrelevant, as long as a company is deemed to be "disruptive." It's idiocy, but it gives me a reason to write these RM columns.
Two companies potentially facing current product liability issues are Peloton Interactive (PTON) and Tesla (TSLA) . As a veteran car analyst, I am wise to the ways of automotive liability issues with "sudden acceleration" burned in my brain from bouts encountered by VW (VLKAF) and Toyota (TM) . Neither of those claims was ever conclusively proved, but it takes at least half a decade and billions of dollars to ride out the legal process. The actual hit to reputational damage is much more difficult to quantify.
Tesla has been the subject of constant scrutiny for build quality issues. The company was forced by NHTSA in February to recall 134,951 Models S and X due to touchscreen failures. More importantly, Tesla was forced in February by Chinese regulator SAMR to recall 36,126 Models S and X due to the touchscreen/memory card issue. This recall followed closely on a separate recall in November 2020 that covered 48,442 S and X models owing to the infamous "whompy wheels" issues with S and X suspension systems. So, essentially, every car Tesla had sold in China from 2012 until the February 2019 introduction of the Model 3 has been recalled at least once.
As China has been key to the growth story at Tesla and it was no doubt horrifying to the bulls to see this video. I am blessed with an in-house Chinese interpreter (she also makes great dumplings) and she confirmed that the woman appears to be yelling "the brakes don't work" in Mandarin. Of all the issues Tesla has had with quality -- the paint issues, the whompy wheels, the Autopilot, as seen again this week in Texas -- braking has been one that had not been raised, at least repeatedly. Until now. So, get ready for more bad publicity in China, Elon, just as VW finally brings its ID.4 Models (ID.4 X and ID.4 Crozz) to full production levels after a very slow ramp-up owing to semiconductor shortages.
One has to look at Tesla's 10-K to find out if its balance sheet is properly steeled to handle such potential claims. Tesla's warranty provision stood at $1.468 billion at Dec. 31, after $625 million of warranty provisioning in 2020. Now, I can get really nerdy and go into details on why I believe that figure -- charged mostly into COGS and thus negatively impacting Tesla's gross margin, as it does for all automakers -- is lower than it should be, but that's a very technical conversation. A billion and a half covers "day-to-days" but would never cover Tesla for any broad-based recall facing its newer, higher-volume models, the 3 and Y. But it's a billion and a half dollars.
Peloton, on the other hand, seems to barely have any warranty reserve at all. Peloton's most recent 10-Q notes that: The Company offers a standard product warranty that its Connected Fitness Products will operate under normal, non-commercial use for a period of one year covering the touchscreen and most original Bike, Bike+, Tread, and Tread+ components from the date of original delivery.
Yet, against those potential costs, Peloton carried $13.7 million in reserves, as shown as a provision against its inventory value in the "Note, 6 Inventory" section of the Q. That is a drop in the proverbial bucket.
Peloton noted it has 4.4 million users in its most recent shareholder letter and 1.67 million subscribers to its Connected Fitness product. Peloton's reserves, depending on how you measure it, and how much sharing of equipment you assume, probably amount to two or three dollars per unit (bikes and treadmills).
Are you kidding me? That's a reserve? It's not. I will NOT link to the video of the child and the Peloton Tread+ (because it horrified me), but I am convinced that this company has a potentially major product liability issue that is NOT comprehended in the $30 billion market valuation accorded to its stock.
I bought some Peloton weekly puts this week and sold them for a nice gain, and I will continue to do so. Tesla reports earnings Monday, and I will probably bolster my short ahead of that, but Peloton is the real wounded soldier here. The market is ignoring the obvious. Always take the other side of ignorance, especially on PTON.