Ford Motor: 2 Companies, 1 Confusing Financial Statement

| About: Ford Motor (F)

Ford Motor (NYSE:F) was the one member of the Big Three U.S. auto producers that did not file for bankruptcy. Its stock has rebounded from a near-death experience in March 2009, and the company is clearly in a strong recovery mode. However, its complexity makes it difficult for investors to track that recovery and may lead to the company being undervalued for some time.

Ford is really two companies: an automotive company and a financial company. Analyzing it is similar to the problems one would have analyzing a company resulting from a merger between Apple (NASDAQ:AAPL) and Bank of America (NYSE:BAC). The automotive company has been doing well and is throwing off considerable cash. Prospects are good largely because the U.S. car fleet is about as old as the College of Cardinals and the need to replace older cars should provide a powerful tailwind to demand. It is facing problems in Europe but booming in Asia, and the overall prospects are very promising. Ford automotive actually has no net debt, has over $9 billion in net cash (total cash minus debt), and is generating cash at a healthy pace.

The other company in Ford is Ford financial; its prospects are a bit less clear. Ford Motor Credit (part of Ford financial) lends dealers money secured by new cars and gets paid when the cars are sold. However, that is not the only activity of Ford financial; it is a bit unclear from public documents exactly what all of its activities are, but it seems to be generating reasonably steady numbers. For example, Ford's annual report describes Ford financial as consisting of "Ford Credit and Other Financial Services," but does not really give much of a description of "Other Financial Services."

Looking at Ford and using my sequential balance sheet methodology, I immediately run into problems because the assets ($101.6 billion) and liabilities ($93.2 billion) of Ford financial swamp those of Ford automotive, while Ford automotive produces the bulk of the company's revenue; in 2011, Ford automotive generated revenue of $128 billion while Ford financial's revenue was $8.1 billion. Large amounts of debt make me nervous, but financial companies tend to operate with considerable leverage, so it is not surprising that Ford financial has a great deal of debt. Ford's annual report discusses the securitization of loans and it appears that a good deal of its debt is the non-recourse debt of Special Purpose Entities (SPEs) associated with that securitization. Accounting rules require that SPEs be consolidated into the financial statements of companies that control them under certain circumstances; this can give a misleading impression about leverage, and Ford should consider producing an "adjusted" balance sheet removing non-recourse debt and assets securing such debt.

If all this was not enough, Ford has complex pension liabilities so that in the first quarter, although Ford automotive produced nice cash flow, net balance sheet cash declined slightly because of a large pension contribution. Ford still does not have stellar bond ratings, with the consensus varying, but with every rating starting with the letter "B." Balance sheet repair and the attainment of an upgrade to at least single A should be management's top financial engineering priority. As a result of this complexity, an investor is left with a situation in which, during any given reporting period, a large write-down in the assets of Ford financial or some other accounting or pension aberration may undermine otherwise solid operating results.

This is generally the formula for producing a chronically undervalued stock, and I think Ford may develop into that kind of a situation over the next couple of years. In the 1990s, there was a period when Ford was very undervalued and engaged in aggressive buybacks and dividend increases, which ultimately paid off for shareholders. It will be interesting to see if that pattern develops again. I am bullish on Ford, but investors will have to be patient.

Disclosure: I am long F, AAPL.