On March 15, 2012, Ford Motor Company (F) amended its $9 Billion revolving credit facility, extending the maturity terms from November 2013 to November 2015. The current amount drawn on the facility is $130 Million. This amendment foreshadows two key catalysts that may propel the stock higher in the coming months.
First, under the terms of the amendment, "collateral pledged to the lenders under the revolving credit facility will be released when Ford's senior long-term, unsecured debt receives investment grade ratings from at least two of the three major rating agencies." Second, relating to the treatment of cash upon such a rating upgrade, the amendment provides for the "elimination of the limitation on debt prepayments and dividends upon the release of collateral," thus allowing for potential dividend increases.
Ford has been systematically paying down its debt for the last few years. Currently, its bonds are rated Ba1/BB+ by Moody's and S&P respectively, one notch below investment grade (IG). For comparison, Johnson Controls (JCI) is an automotive stock that has and an investment grade rating of Baa1/BBB+. Below is a chart of the current bond yield curve for F (Blue Line) and JCI (Red Line).
Click to enlarge
Source: Goldman Sachs Securities Division - Credit Sales
Comparing the spread between F and JCI, there is approximately a 180bps difference looking at the 5-year bond. This spread continues throughout the maturity, with the spread narrowing slightly to around 140bps when looking toward the long end of the curve. The implications for F are obvious; a move to IG on their bonds could save them significant interest expense. Looking at comparisons within the credit market as a whole confirm this. Five-year CDS trade at 113 bps for bonds rated Ba1/BBB+; 5-year CDS for Baa1/BBB+ trade significantly lower at 74 bps, or 39% lower. If we just apply some simple math to the 5-year F bond, currently yielding 3.85%, we should arrive at a 150bp savings.
Current, LT Debt on Ford's balance sheet as of December 31, 2011, was $82.060 Billion, with an average effective interest rate of 4.73%. The average effective interest rate reflects the contractual interest rate plus amortization of discounts, premiums, and issuance fees. Therefore, this rate encompasses all interest expenses related to their capital structure. The LT debt as of December 31, 2010, was $88.733Billion.
An upgrade to Baa1/BBB+ is worth approx $2.73 per share to F shareholders; this represents an upside of 22% from last week's closing price. I used the following assumptions to arrive at this figure:
- Ford pays down LT Debt by 50% over the next 30 years.
- IG Rating reduces Weighted LT Avg. Effective Interest Rate by 100 bps.
- Interest Expense Savings NPV discount rate is 6%.
The results show that for every 1bp decrease in its Weighted LT Avg. Effective Interest Rate, the return to shareholders is a PV savings of $0.0273. This savings increases slightly if the debt isn't reduced as quickly over the 30-year period, and conversely the savings decrease slightly if debt is paid off faster. This variance is approx $0.05 for each 10%. For example, if F decreases debt by only 40%, rather than 50% as in the baseline scenario, the total PV savings to shareholders is increased from $2.73 to $2.78.
US Auto Sales
Recently, Morgan Stanley analyst Adam Jones raised Morgan Stanley's total U.S. auto sales forecast to 14.8 million vehicles, an increase of 800K or 5.7% over their previous projection. The expectation is for pretax profit to rise to $6.6Billion, putting their 2012 forward P/E at 7.2x earnings.
F itself expects Q2 auto sales to increase over 8% compared to Q1 auto sales. F is positioned to capitalize on its diverse fuel-efficient fleet of vehicles. As gas prices continue to increase, demand for fuel-efficient vehicles is becoming a top priority for consumers. F has spent much time and effort in retooling its fleet of vehicles with fuel-efficiency in mind over the past few years.
The 2011 market share for F was 16.8%, representing its third year of consecutive market share gain. The last time F experienced this type of market share growth was in the early 70s. Both cars and trucks are seeing sales growth in 2012, with sales through February increasing by 11.4% and 14.5%, respectively, over last year.
F had been range bound since the beginning of the year, trading between $12-$13 per share. The stock has only traded on daily volume exceeding 100 million shares twice since the beginning of 2012. The stock catapulted to the $12 level on volume exceeding 100 million shares in early January and subsequently tested the level later in the month, with volume exceeding 100 million shares. Since then, the trading range has been solidified and consolidation has taken place as the 50DMA crossed the 200DMA during the 3-month period.
I believe the strong US auto sales projections have placed a floor for the stock at $12, coupled with a dividend yield of 1.60%, which has room to grow higher. Meanwhile, catalysts such as a rating upgrade could potentially return in excess of 20% to shareholders for the year. These factors I believe add up to a solid risk/reward ratio for investors.