Digging Deeper into Ford

After my recent Ford article in which I said I thought Ford was a sell, we heard from the company and they wanted to talk through my analysis. I spent an hour on the phone with four Ford executives this week talking about their automotive business, their credit business and the prospects for the company. We covered some important investor concepts on the call and I want to provide some deeper analysis on Ford here today.

To begin with, they made some good points, which I think cleared some stuff up and helped with a deeper analysis here. But I still think the stock is a sell.

The single biggest reason I issued a sell on Ford’s stock in that column was out of concern about the company’s debt load. Ford’s people explained to me that Ford Credit and Ford Automotive are two separate companies, although Ford Credit is wholly owned by Ford Automotive. Their own words explain it:

Ford and Ford Credit are operated as separate businesses. As a consequence, Ford's cash and automotive debt are managed independently of Ford Credit's cash and debt. The level of debt for a financial service company is dependent on the size of its business. As of Sept. 30, 2009, Ford Credit had $103 billion in debt. Ford Credit's debt supports the financing it provides to customers and dealers to buy cars and trucks. Supporting that debt is $23 billion of cash and a portfolio of $93 billion of high quality receivables resulting from its prudent lending practices. Ford Motor Company's Automotive debt at the end of the third quarter was $26.9 billion, as presented on slide 24 of the earnings presentation.

The $103 billion that I cited in my column last week was Ford Credit debt, not Ford Automotive as I had said. To clarify, I’ve seen Ford’s debt reported anywhere between $26 and $130 billion, and on Finance Yahoo, the numbers, which come from Ford’s own filings, were consolidated – sort of. Some might wonder why Ford Auto and Ford Credit are ever required to consolidate their numbers together, which is the root of why Yahoo Finance numbers come out “wrong”, if they shouldn’t be considered the same company, and such a question would be a good one. Read on, because all of this is important to the investment lessons here.

These are all important points, and I don’t argue those facts. But therein lies the most important investor question from this analysis – should investors in Ford the stock care about the debt at Ford Credit? The company rightly points out that the automotive company that Ford stock investors are buying into isn’t liable for Ford Credit’s debt were Ford Credit to run into real trouble. But I countered that Ford, the automotive company, would itself run into terrible financing and credit supply problems were Ford Credit to run into real trouble. Recall that in the last quarter, the company got $400 million in cash remitted to it by Ford Credit so far this year, for example (something I also misreported in my original column, btw, as I had included the total $1.5 billion in remittance by Ford Credit to Ford Motor so far this year in my original cash flow analysis, when in actuality more than a billion of that amount was remitted through things like the purchase of outstanding Ford Motor debt, which was then returned to Ford Motor by Ford Credit). Nonetheless, that Ford’s balance sheet has been helped one way or another by Ford Credit to the tune of $1.5 billion so far this year does underscore exactly my point as to why Ford Motor investors should care about Ford Credit’s debt load.

To be clear here – the company and most Wall Street analysts separate Ford Motor and Ford Credit and their debt loads of about $27 billion and about $100 billion respectively. I question that premise because Ford Motor is so directly and indirectly dependent upon Ford Credit.

Okay, so that established, I want to analyze Ford’s debt including Ford Credit’s debt and let’s see where we land again:

Ford Credit is one of the very few financial firms in the country (nay, on the planet) that didn’t clamor for direct bailout infusions as GMAC, CIT and Goldman Sachs did when they got TARP bailouts, and Ford Credit didn’t even covertly go on welfare by becoming “a bank holding company” and thereby getting access to loan guarantees and access to cheap taxpayer largesse capital from the Federal Reserve like the aforementioned GMAC, CIT and Goldman Sachs did in the past year.

Indeed, Ford Credit’s got a longstanding track record and they didn’t even get much if at all into all the derivatives and subprime games and what not like GE Capital, GMAC and other giant financial firms did. And Ford’s got a reserve ratio of 7.7 or so according to the guys on the call, and that means they have relatively less leverage than most of the giant financial firms do. That said, I’d point out that if the value of those outstanding loans to Ford Credit customers and/or the cash flows from that money that is lent out 7 times over for every dollar the company has on the balance sheet were to decline by just say, 15%, the company’d be in dire straits.

Ford Credit, they explained, has got a nice audible they can call if and when they’d need it as they could stop lending money immediately and continue to take in whatever cash flow they’d get in such a dire economy that would surround a 15% or even a 30% downturn, but that’d still be hell if it worked at all.

And see, I know nobody thinks there’s going to be another credit crisis and/or financial crisis like the one we just got through in 2008/2009. But how many folks were like me and jumping up and down and warning you about the coming problems back before they were here, say just months beforehand in 2007? And even without another crisis, that doesn’t mean that Ford’s outstanding loan portfolio isn’t about to face some serious acceleration in bad loan recognition. 10% plus unemployment rate, up from 6.6% twelve months ago, ain’t gonna be good for loan repayments.

See, no matter what, there’s risk in loaning people money and in owning a company that owns a company that loans people money. Ford Credit charges interest on those loans for a reason, right? Because there’s risk involved in lending out money. Risk. And investors must always consider all risks.

I don’t mean to imply that financial-related companies can’t be invest-able. But again, looking at Ford Motor’s current balance sheet – just the $26.9 billion in debt, that is -- and at Ford Credit’s customers in an economic and unemployment environment like we do, with rates that have to go higher at some point since they can’t go any lower. Just my opinion, but I think there’s too much risk.

How about a bullish counter note for ya though? Think about what would happen if Ford were to see some real unit growth in the next few quarters. I mean, the company’s gotten so lean that it actually cranked out about $1 billion in operating profits in that Ford Motor division in the worst car economy ever. If the company could just take a few percentage points of market share and/or if the market were to actually see demand pick up and growth return, the money would drop onto the bottom line.

I can see that picture, but as an investor, even if you believe that Ford could get unit growth kicking again in coming quarters, you gotta ask yourself if the risk is worth it. Are there better places to “risk” your capital? Think of it this way – Yahoo’s and Ford’s prospects are a lot alike right here in many ways. Both are set to see huge expansion in their operating margins if they can just take some market share in a market that’s likely to grow at least a little bit in the next year. But Yahoo’s got no debt and billions in cash laying around. They can acquire, they can cut deals, they have flexibility and some cushion of safety with that cash. Ford’s got all the debt we just went over, whether it’s in the automotive, or credit arm, and tens of billions of dollars of cash and receivables, but they’re actively trying to raise more capital right now and sell off assets and equity and more debt to do so. Ford doesn’t have nearly the flexibility or cushion that Yahoo does. Which one would you rather own?

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