Image source: Michael
The second-largest US automaker is facing a number of challenges in its business, and Moody’s recently cut its credit rating to one notch above junk status. Let’s take a look at the factors at play behind the downgrade.
By Kris Rosemann
There are a number of moving parts at Ford (F) these days, and the uncertainty surrounding the uphill climb it is facing has resulted in speculation over a potential dividend cut and a credit downgrade from Moody’s. The company’s plan to cease nearly all production of cars for the US market caught many investors by surprise, and it continues to struggle in multiple international markets. The most recent headline it made was the release of its August sales numbers in China, which fell 36% on a year-over-year basis in the month and are down 27% in the year-to-date period. Management has noted that plans for market-specific vehicles are well on their way, something that will be necessary for the company to regain recent market share losses.
Ford is also facing lower levels of profitability in the ever-important North American market, where its EBIT margin fell 210 basis points from the year-ago period in the second quarter of 2018, to 7.4%, due in part to higher input costs. It also conceded some market share in the region in the second quarter (now just under 14% as of the first half of 2108) as a result of lower sales to rental companies and other fleet. The company is targeting a 10% EBIT margin via cost improvements and a focus on trucks and SUVs, but its first half 2018 mark of 7.6% suggests there is considerable work to be done.
Other international markets are giving Ford headaches as well, including its South American operations, which turned in a $784 million pre-tax loss in 2017 and EBIT of negative $327 million in the first half of 2018. Europe presents its own unique set of challenges as a result of “Brexit” looming over the space, which may only add to recent losses in the region as a result of Ford’s presence in the UK. One factor in our preference of simulated newsletter portfolio idea General Motors (GM) over Ford has been GM’s recent sale of its European operations.
In addition to the aforementioned developments, Moody’s cites multiple weakened credit metrics as drivers in its credit rating downgrade of Ford to Baa3 from Baa2. According to Moody’s, the company’s debt-to-EBITDA has risen to 3.3x as of the end of the second quarter of 2018 from 2.6x at the end of 2016, while its EBITA-to-interest has fallen to 1.8x from 4.5x and its EBITA margin has contracted to 2.0% from 4.2%. Its outlook remains negative as a result of the above challenges.
We recently began calculating an adjusted Dividend Cushion ratio for Ford in an attempt to be less punitive on its financial services operations, and that adjusted measure currently sits at 1.4. However, given the number of challenges facing the business and the uncertainty that lies ahead, the company’s unadjusted Dividend Cushion ratio of -1.26 should also be noted by investors (a dividend cut can’t be ruled out), and its elevated yield of ~6.5% is largely a function of its depressed stock price than any sort of fundamental strength. Moody’s notes that it may be forced to revisit the rating for another potential downgrade should Ford not make clear progress in its Fitness initiatives by early to mid-2019.
We’re keeping a close eye on the developments at Ford, and we continue to prefer shares of rival GM, which we believe is well-positioned to lead the US auto market into the next generation of vehicles with its GM Cruise program. Shares present an interesting valuation opportunity, in our opinion, and the company’s adjusted and unadjusted Dividend Cushion ratio are both considerably higher than that of Ford at 3.5 and 1.58, respectively. Shares of GM yield ~4.5% as of this writing.
Auto Manufacturers: F, GM, HMC, HOG, TM, TSLA
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Kris Rosemann does not own shares in any of the securities mentioned above. Some of the companies written about in this article may be included in Valuentum’s simulated newsletter portfolios. Contact Valuentum for more information about its editorial policies.