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Ford (NYSE: F ) hit another big -- enormous, in some ways -- milestone on its turnaround path on Tuesday, as Fitch Ratings upgraded the company and its financing arm to investment-grade credit status.
The upgrade to BBB-minus, the lowest credit rating that can be considered investment grade, marks Ford's first visit to the exalted land of the creditworthy since its debt was downgraded to "junk" status in 2005.
Assuming the other ratings agencies follow suit soon, it'll be a big deal for Ford, and a big victory for its leadership. But what does it mean?
What does a credit upgrade mean?
Simply put, a credit upgrade means that Ford will pay less to borrow money from now on. It will likely be able, if it chooses, to restructure its existing debt at more favorable rates -- a move that could save it hundreds of millions of dollars a year. It also means that more institutions (think: mutual funds, pension funds, etc.) will be able to invest in bonds issued by Ford.
Ford's credit default swaps -- a type of derivative security used as default insurance -- dropped significantly in price shortly after Fitch issued the upgrade on Tuesday morning, and Ford bonds trading on the secondary market should rise in price as the market digests the news.
The upshot for shareholders? While shares were up modestly on the news, mostly it's another important sign that Ford's turnaround remains on track. It is likely to show up in Ford's bottom line over the next few quarters, as the company's reduced borrowing costs are reflected in earnings.
Why did Fitch upgrade Ford now?
Fitch said in a statement that its analysis "included a focus on the impact a severe automotive market downturn would have on Ford's credit profile." For a cyclical company like Ford, which has historically gone through feast-and-famine cycles as the economy has bobbed up and down, the greatest risk is during a severe economic downturn. Indeed, the most recent severe downturn nearly killed Ford -- and drove its longtime rivals General Motors (NYSE: GM ) and Chrysler into bankruptcy court.
Why does this happen? Generally speaking, automakers' profits drop during downturns, as consumers put off new-vehicle purchases -- and often, choose smaller, less expensive (and less profitable) models when they do need to buy. Meanwhile, the automaker needs to cover its high fixed costs, and it needs to continue developing its future products -- a new car or truck can take three years or more to go from concept to production, and heavy investment is required all along the way.
The ability to sustain constant investment
General Motors cut its product-development spending to the bone during its downward spiral, and many other automakers, including Toyota (NYSE: TM ) to some extent, reduced spending when the economy went south in 2008. Ford, which had borrowed everything it could back in 2006, was able to keep development going at full speed even during the worst of the economic crisis. The result was the company's current acclaimed range of products -- products that were able to steal sales and market share over the last couple of years as competitors rushed to catch up.
Long story short, after a detailed look at Ford's current financial situation -- including its cash position, which exceeded its remaining debt by about $10 billion as of the end of 2011, and its access to lines of credit -- Fitch concluded that Ford would be able to keep all of these things going through another severe downturn.
That's good news. If I were Ford CEO Alan Mulally, or just-retired former CFO Lewis Booth, I might be tempted to open a bottle of really nice champagne tonight. I expect they, and the team of Ford managers that made this happen, would say that there's still a lot of work to be done. But this is one more sign that Ford, after decades of struggles, is on the right track.
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