Should You Be Concerned By Ford Motor Company's $117 Billion Debt?

Yeah, you read that right. Ford Motor Company (NYSE: F  ) has amassed roughly $117 billion in debt, as of its financial reporting in the latest earnings quarter (link opens a PDF). So where does all of that debt come from, and is that a company you really want to be putting your hard-earned money into? 

The short answer to that two-part question is simply, yes. But the rationale behind that answer cannot be explained until we tackle part-one of the question: Where does all of that debt come from?

To answer that question, it's imperative to know that, for all intents and purposes, Ford functions like two separate entities molded into one company. There is Ford Automotive -- the one that you are likely most familiar with -- that produces and builds vehicles. Then there is Ford Credit, which acts as sort of a middleman between car buyers and loan lenders. 

Breaking down the balance sheet
When eyeing the balance sheet, it would simply appear that Ford is carrying a burdensome load of debt. And to the untrained eye, it is. But with a little digging, you can quickly uncover why the balance sheet looks like this and what it means for the company:

Source: Ford Motor Company first-quarter earnings release

There it is, right on the balance sheet. $117 billion. But, it's not what you think. Typically, debt is viewed as a bad thing. Especially when you look at companies like Apple, Microsoft, or Google, all three of which are absolutely loaded with cash.

And in fact, the only reason some of those companies have debt is because it's cheaper to issue debt and buy back stock than it is to repatriate its foreign cash from overseas (thus paying a steep tax rate of 35%) to buy back stock. 

But in Ford's case, this is not why the company has debt. Rather, it comes from the financing that it extends to customers -- which are both individual buyers and dealerships -- when they purchase Ford vehicles. 

In other words, Ford Credit acts much like a bank does. And its increasing debt is actually a good thing, because it shows that vehicle demand is increasing as well. Of the $117 billion in debt, over $100 billion of it belongs to Ford Credit. Have a look below where the debt is spread out:

Source: Ford Motor Company first-quarter earnings release

Ford Credit falls under "Financial Services," which is outlined in red in the image above, while Ford Automotive is highlighted in yellow. 

Okay so Ford Credit has a lot of debt, is that a bad thing?
We've cleared up which division owns that massive-looking load of debt, but that doesn't change the fact that it belongs to Ford... right? 

Well, that's sort of true. But when you peel back the layers and take a closer look, investors will soon realize that Ford Credit's debt isn't debt in the traditional sense. 

Normally, a company borrows funds (debt) and pays it back over time. And not just companies do it. Normal, everyday people who want to buy a car or a house do so with a loan or a mortgage. 

Ford is a little different. Instead of borrowing debt and using it for corporate purposes, the automaker actually lends the money it borrows -- at a higher rate -- to those seeking to buy a vehicle. Sometimes, Ford Automotive is actually the borrower from Ford Credit. Other times, it's dealerships looking to fill their lots and sometimes its an individual looking to get a new car. 

And until that loan is paid back, the car being paid for is collateral. Should the borrower (AKA customer) fail to repay the loan obligations, Ford will simply repossess the car and sell it to offset the remainder of the loan. This keeps Ford's credit risk relatively low. (There is also an insurance that auto dealers can sell, offsetting any difference between the repossessed car value and the remaining loan balance). 

Ford Automotive business
Ford Automotive looks relatively healthy when you look at the balance sheet in the image above. Although I didn't highlight it, you can see the Automotive segment has $4.5 billion in cash and $20.7 billion in marketable securities. 

This leaves the Automotive segment with a net-cash position of $9.5 billion, as short-term debt (payable within one year) stands at $2.1 billion and with long-term debt equal to $13.6 billion.

Don't discount the greatness of Ford Credit

Source: Ford Motor Company

Do not simply conclude that Ford Credit is this stagnant, boring, debt-ridden machine. To me, things that make money aren't boring, and Ford Credit makes plenty of money. 

In fiscal 2013, Ford Credit made $1.75 billion in pre-tax profits on revenues of $7.5 billion. In the first quarter of 2014, Ford Credit brought in pre-tax profits of $499 million on $2 billion in revenues. In the latest quarter, that represents operating margins of 25%. Pretty darn good for a "boring" company, huh? 

Concluding thoughts
It doesn't take long for fundamental investors to pull up the balance sheet when scoping out new companies to invest their hard earned dollars in. And one of the first things I look for when I hit that balance sheet is the debt. 

However, if investors -- perhaps even you! -- are looking at Ford as a prospective investment, do not, I repeat, do not instantly dismiss the company based on the level of debt that it appears to be straddled with. Sometimes looks can be deceiving.

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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 June 24, 2014, at 4:25 PM, TMFTwoCoins wrote:

    Many investors still overlook this point and Ford Credit offers a handful of competitive advantages. I love to see articles point out the often misunderstood debt picture at Ford. Nice work.

    Best,

    D

  • Report this Comment On June 26, 2014, at 10:26 AM, Bkenwell wrote:

    Hey D -

    Thanks for comments. And I know what you mean. It is very often times overlooked, and perhaps what grinds my gears the most, is when people simply say, 'Oh Ford has $117b in debt. End of story.'

    Thanks for reading!

    -Bret

  • Report this Comment On August 05, 2014, at 1:16 PM, LolaFord wrote:

    Don't discount the risk that comes with the debt used by Ford Credit. A big chunk of that is in leases and even though most of it is high quality credit it is inherently very risky because of the inflated residual values FMCC uses to help sell vehicles with low payments. FMCC has taken huge losses on this in the past and the outlook is not good for the used car market during the next two years.

    Also the 5-6% FMCC says are higher risk loans is actually higher. They advertise to dealers that they buy the lowest FICO scores of any other captive. Their internal grading system rates low FICO scores with larger downs or shorter down payments as low risk. They don't have to report out like banks because they are not FDIC insured. They also can and do give unlimited extensions on past due customers to help keep delinquency rates artificially low.

    They make the bulk of their income from providing floorplanning for dealer inventory. They are wiling to take less rates than banks and provide insurance coverage as part of their package deals. It is very profitable - however large scale catastrophes could wipe out their profits. They took a big hit last quarter because of regional bad weather.

    They are profitable for sure but there is much risk in this heavy debt that should not be discounted when making investment decisions.

  • Report this Comment On August 05, 2014, at 1:47 PM, TMFMarlowe wrote:

    @LolaFord: Generally speaking, Ford Credit is run pretty conservatively. Is the expected drop in used-car prices a risk factor? Yeah, maybe, but if Ford Credit gets squeezed we're probably talking about a few hundred million off of Ford's bottom line over a year. That's unpleasant, but it's not going to knock Ford off course by itself.

    Bret, I missed this article when it was first published, but... this is a point that we need to be making over and over with Ford. Too many people think a glance at Yahoo Finance counts as "due diligence", and they see the total debt number and freak out.

    John Rosevear

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