Will Ford's Debt Make It An Attractive Auto Sector Investment?

| About: Ford Motor (F)
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After the doldrums of 2009 and a difficult economic climate, Ford Motor Company (NYSE:F) is slowly but surely steering itself in the right direction as investor confidence is regained and new, extremely competitive car models are put on sale for 2013. Ford took out a $23.5 billion loan in 2006 for which all of the company's assets were put up as collateral, including its trademark. The final payment of that loan was made earlier this year, resulting in the company's debt rating being upgraded to investment grade.

There has been plenty of discussion about the high (or not so high) debt on the balance sheet, including some discussion in my recent article. The driving force behind Ford's payback was strong sales in North America. Should investors expect Ford's solid run of growth to continue for the coming year?

Tracking Financials

Much has been said about Ford's startling debt figures, but they are not even half as bad as they appear. The company is currently said to hold $72 billion in long-term debt. When compared with its American rival General Motors (NYSE:GM), which has $12 billion in long-term debt, this amount seems preposterous. Ford's automotive debt stands at $14.2 billion and the remaining amount lies with the company's financial arm, Ford Credit.

However, contrary to popular belief, in Ford Credit's case debt is good for the company because having more debt means credit-yielding loans are being made. All of this translates into a higher revenue pool for the company to play around with. Bearing this in mind, Ford's debt/equity ratio of 3.8 becomes somewhat irrelevant and a subjective analysis is required to assess the company's performance, which will be done later.

Ford Motor's Total Debt (in millions)

Short -Term Debt


Long Term Debt


Total Automotive Debt


Ford Credit's Total Debt (in millions)

Short-Term Debt


Long-Term Debt


Total Financial Debt


Ford's revenue for Q3 2012 was $32 billion compared with $33 billion in Q3 2011. More importantly, the company is showing signs of stability in producing consistent net income while increasing its assets. Its liabilities and debts have been kept in check over the past year due to the consistent inflow of cash from its operations. Thus, it has maintained its level of current liabilities in Q3 2012, in comparison with Q3 2011. Ford also looks well in control to reduce its debt. The company's automotive gross cash was $22.9 billion at the end of 2011, which is $9.8 billion more than its debt. Furthermore, Ford has a healthy interest coverage ratio of 10 times, ensuring enough money is available to make interest payments on time.

Stock Performance and Competition

Breakdown of the American automotive sector puts General Motors in the lead with 17.9% year-to-date market share, Ford is second with 15.4% year-to-date market share and Toyota Motor (NYSE:TM) is third with 14.2% year-to-date market share. While General Motor's lead is encouraging, all is not well behind the scenes. The company's lead is on a downward slope as it faces difficulty in finding an edge in the sedan category of the market, with Japanese imports offering much better alternatives. Furthermore, its trucks are challenged by Ford's flagship F150. Toyota Motors has been challenged by quality control issues with several of its cars, which has seen its popularity drop. So far, the F150 is the top seller in November and Ford continues its renaissance despite suffering consecutive losses in money-strapped Europe. GM, Ford, and Toyota all have sizable amounts of debt, but their obvious ability to pay interest payments makes their debt act like an additional asset without particular repercussions -- as long as sufficient finances are redirected toward their car manufacturing later on.

Ford's interest coverage ratio is 10, with a current ratio of 1.6. This makes it a safe bet for investors despite its high debt amount. From an investor's point of view, Ford's debt has a few more benefits. Shareholders' value will not become diluted as financing is done by taking on debt and not cutting back on the shareholders' equity. A seemingly detrimental effect of this is the higher interest expense. However, since interest is charged before tax is applied, a higher interest rate translates into lesser tax and, therefore, higher profits. Higher profits along with lower share counts translate into higher earnings per share. Ford's TTM EPS stands at $4.40, while Toyota's TTM EPS is $474.62 and GM has a TTM EPS of $2.65.

Ford's debt is undoubtedly sustainable. Its "all-in" mortgage strategy of 2006 allowed it to have capital to go through its restructuring plans, and also to let it have enough cash on hand to hold its own during the financial meltdown in 2009. During this time, Ford's competitors went bankrupt. Furthermore, more than 70% of the debt is there because of its lending arm, so that debt is actually making a profit for the company, just like the debt at Toyota and other car manufacturers. But when assuming debt, it is pivotal to check if the returns from investments are higher than the cost of the debt itself. In Ford's case, this obviously holds true.

What Does the Future Hold?

Ford's struggles in Europe are well-documented. It is aiming to cut 1,100 jobs in the U.K. alone as it considers the Southampton plant to be non-profitable. The company has tremendous potential in respect of profit earnings if it can replicate its North American success in Europe, too. North America continues to be the savior of Ford. Despite a $ 468 million pre-tax loss in Europe, Ford's overall pre-tax profit in the quarter was $2.2 billion, or 40 cents per share.

With continued profits, Ford has effectively managed to downsize its debt. In 2010, the company reduced its automotive debt by $14.5 billion, a 46% reduction, and another $4 billion in Q1 2011. I believe Ford will continue to effectively reduce its outstanding $14.2 billion automotive debt over the next year. While sustaining this amount of debt is well within the company's capacity, its reliance on Ford Credit should leave no debt on board for the automotive department altogether. I am sure of this because the company's product outlook for 2013 is extremely aggressive. The Toyota Prius will have its first real test as Ford pins its new C-Max against it in a battle of hybrids. New Focus and Fusion are primed for innovative fuel-efficient technologies that give Ford a competitive edge over its rivals.

However, Ford's primary competition still lies with Toyota and challenging its growing market dominance will determine Ford's North American siege. In Europe, the car manufacturers are quick to adapt and respond to market conditions, an area where Ford has suffered over the years. Ford will need to market its new products with much more success if it wants to start cutting back on European losses. In addition, perhaps discounts and credit availability for European customers will provide positive results as it is a tried and tested policy for the U.S. market.

Make or Break for Investors

Morningstar holds similar views about Ford's stock. After dissecting the stigma of debt associated with Ford, all five analysts at Morningstar gave Ford a "Buy" rating, which only underlines growth potential for Ford in 2013. As of Nov. 21, 2012, Ford's opening price was $10.85, which makes it extremely undervalued. I believe Ford's strong presence in North America will not be challenged by the local manufacturers or the Japanese imports just yet, due to the impressive new line of cars being put on sale by the company. Keeping in mind how the company has twice been guided out of extremely difficult financial situations, it's safe to presume that it is in safe hands.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.