Why You Shouldn't Worry About Ford

Taking on too much debt may sound like a bad thing, but it's not always. Sometimes, debt-laden companies can provide solid returns. Let's see how.

Generally, the cost of raising debt is cheaper than the cost of raising equity. Raising debt against equity has two observable consequences -- first, the equity that shareholders value doesn't get diluted, and second, it results in a higher interest expense. As interest is charged before tax, a higher interest rate provides a tax shield, thus resulting in higher profits. Higher profits coupled with a lower share count translates into higher earnings per share.

However, when assuming debt, a company should see whether the returns from investing the money are higher than the cost of the debt itself. If not, the company is headed for some serious trouble.

It's prudent for investors to see whether a company is strongly positioned to handle the debt it has taken on -- i.e. comfortably meet its short-term liabilities and interest payments. Let's look at two simple metrics to help us understand debt positions.

  • The debt-to-equity ratio tells us what fraction of the debt as opposed to equity a company uses to help fund its assets.
  • The interest coverage ratio is a way of measuring how easily a company can pay off the interest expenses on its outstanding debt.
  • The current ratio tells us what proportion of a company's short-term assets are available to finance its short-term liabilities.

And now let's examine the debt situation at Ford (NYSE: F  ) and compare it with its peers.

Company

Debt-to-Equity Ratio

Interest Coverage

Current Ratio

Ford 1,842.1% 7.2 times 1.2 times
General Motors (NYSE: GM  ) 28.7% 7.6 times 1.2 times
Toyota (NYSE: TM  ) 111.7% 11.3 times 1.0 times
Honda (NYSE: HMC  ) 89% 45.8 times 1.2 times

Source: S&P Capital IQ.

Ford has a staggeringly high debt-to-equity ratio. High debt is common among automakers, though it's worth noting that the company has reduced its debt over the past 12 months to $98 billion from $117.3 billion.

Ford's total automotive debt -- the debt that isn't part of its credit operations and assumed from its core automotive business -- stood at $16.6 billion as of March 31. It plans to reduce this figure to around $10 billion by 2015, even as it aggressively expands its operations around the globe. It helps that Ford has a high free cash flow of $7.1 billion, so it shouldn't encounter too many difficulties in paying off its debt. And with a comfortable interest coverage ratio of 7.2, Ford is in a fairly comfortable position to pay off its debt-related interest expenses.

As for those expansion plans, electric vehicles have come more and more into the limelight, and Ford accordingly plans to increase its electric-vehicle production threefold by 2013. And as fellow Fool Neha Chamaria pointed out, Ford's geographic expansion has been focused largely on the emerging markets of China and India. These efforts should help Ford continue to bring in the green.

To stay up to speed on the top news and analysis on Ford, or any other stock, add it to your stock Watchlist.

Fool contributor Shubh Datta doesn't own any shares in the companies mentioned above. The Motley Fool owns shares of Ford. Motley Fool newsletter services have recommended buying shares of General Motors and Ford. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


Read/Post Comments (3) | Recommend This Article (12)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On October 19, 2011, at 8:59 PM, belseware wrote:

    There they go again--comparing Ford's debt-with-a-finance-company to GM's debt without one.

    The bulk of the debt is covered by the collateral of the vehicles it funded.

  • Report this Comment On October 19, 2011, at 9:17 PM, ConfidentNvestor wrote:

    I agree with belseware. GM had to sell GMAC Finance as part of the bankruptcy process. They no longer have a controling stake in GMAC. Ford, on the other hand, was in a much stronger position and didn't sell its Crowning Jewel, Ford Motor Credit Company (FMCC). The author of this article, Shubh Datta, should stick to blogging. The $98B in debth referred to in this article is secured by the automobiles that were sold to customers. These are 4 year car loans and 2 year leases to customers of FMCC. As customers pay their car loan payments (with interest), FMCC makes a profit. GM only wished they had this kind of debt on their books. Where GM went wrong with GMAC, they stepped outside of core business and began funding Credit Cards and Mortgages, which brought on huge losses and ultimately was the final nail in their financially empty couffin! Over the last 3 years, Ford has paid down their bad debt from $35B to $16B. Awsome job Ford!!!!!!!!

  • Report this Comment On October 21, 2011, at 9:52 AM, TMFMarlowe wrote:

    Shubh, the above readers are right. Ford's "automotive debt" is the only debt relevant to this conversation. Ford Credit is a bank, and its debt is secured.

    John Rosevear

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