At least one prominent critic has some doubts about Ford Motor Company's (NYSE: F) restructuring plan: Moody's Investors Service cut the Blue Oval's credit rating to junk level on Monday.
Moody's downgraded Ford to Ba1, just below investment-grade status, on concerns that the company's cash flow and profit margins are lagging those of rivals at a moment when Ford is gearing up to spend a lot of money overhauling its global operations.
Ford's stock fell about 3% after Moody's note was released. But are the concerns justified, and what does this mean for Ford investors? Let's take a look.
New-product launch costs might hurt Ford in the near term, but margins on new models like the all-new 2020 Explorer and next year's all-new F-Series should help Ford's cash flow and bottom line. Image source: Ford Motor Company.
What Moody's said
Moody's said that its rating reflects the fact that CEO Jim Hackett's "redesign" effort is likely to cost billions at a time when the global auto market is softening. Ford has said that the redesign effort will result in about $11 billion in one-time charges over the next few years, of which about $7 billion will be cash costs. (The remainder will be noncash accounting charges.)
As Moody's sees it, Ford is taking this on from a position that is weak relative to some of its peers, as its cash generation and operating margins have lagged those of rivals. That has been true for a while -- but now the pressure on margins is likely to rise:
[T]he erosion in Ford's performance has occurred during a period in which global automotive conditions have been fairly healthy. Ford now faces the challenge of addressing these operational problems as demand in major markets is softening, and as the auto industry is contending with an unprecedented pace of change relating to vehicle electrification, autonomous driving, ride sharing, and increasingly burdensome emission regulations.
Moody's acknowledges that Ford is in the early stages of a product-line overhaul that should help its margins, particularly in North America. And it's clear that Ford's balance sheet is in good shape, and the company has plenty of cash to see it through. But -- again, as Moody's sees it -- the restructuring efforts, particularly in Europe and South America, will take several years to complete, and the economic waters are likely to get choppier before Ford's work is done.
Is this downgrade justified?
I can't argue with the facts in Moody's note. It's true that Ford is undertaking an expensive restructuring at a moment when the global auto markets seem to be slipping. And it is true that Ford's margin in North America has lagged its Detroit peers -- though that's easily explained by where Ford is in its product-renewal cycle, as Moody's acknowledges.
But I have to question Moody's conclusion, the credit downgrade itself. The act of dropping Ford's credit rating to junk status suggests that the company's ability to pay its bills is somehow now in doubt. Ford had $23.2 billion in cash available at the end of the second quarter of 2019, and $14.1 billion in additional credit lines, against $14.6 billion in long-term debt, so I find that hard to accept -- especially since Moody's acknowledges that Ford's upcoming new products will likely push its margin in North America back up to around 10%. That should in turn push its cash flow back up to levels comparable with its peers' as well. And there are growing signs that Ford's restructuring efforts in China and Europe are starting to gain traction as well. Even if they take a few years to pay off, the progress should be encouraging.
Moody's itself seems to acknowledge that Ford isn't really in financial danger, even if the restructuring takes longer than it expects. "The company does have a sound balance sheet and liquidity position from which to operate," senior vice president Bruce Clark said in a statement.
What it means for Ford
Generally speaking, when a company's credit rating is lowered, it has to pay more to finance its debt. That wouldn't be a disaster for Ford, but it wouldn't be helpful, either. That said, note that there are three credit-rating agencies, and so far only Moody's has downgraded Ford. Until and unless one (or both) of the others also cuts the Blue Oval's ratings, the practical effects of this downgrade will likely be minor.
For Ford shareholders (I'm one), my advice is to sit tight. This downgrade doesn't change my view that while things could get worse before they get better (and that's true of any auto stock right now), Ford is healthy and on the right track to improve its bottom line over time. I plan to stay patient, reinvest the dividend, watch Ford's new-product launches, and see where things stand a few years from now.
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