What many investors overlook is that Ford Motor Company's (F 0.69%) most profitable segment outside of North America isn't even a region on a map. This secret weapon has helped Ford print billions and billions in profits over the past decade.
But what happens when that secret weapon turns into a major cause of financial pain? That's exactly what could happen with Ford Credit in the event of a recession. Here's how brutal it looked in 2008.
First things first
Let's quickly take a look at exactly what Ford Credit is, and how much it benefits the automaker. Most investors understand that when it comes to its automotive sales by region, North America drives the vast majority of Ford's total profits. But many don't realize how much the Ford Credit auto financing segment adds to the equation.
Consider that North America recorded $7.38 billion in earnings before interest and taxes during 2021, and that South America, Europe, China, and its International Markets Group (IMG) combined for an inconsequential $20 million EBIT -- mainly because Ford recorded losses in South America, Europe, and China.
Ford Credit, however, turned in a fantastic 2021 with $4.7 billion EBT. That result was very strong for Ford Credit, but it's normal for the financial segment to be the second pillar of the company's total profits. (Note: I'm comparing EBIT for Ford's automotive business, to EBT for Ford Credit, because the latter generates much of its earnings from interest, while interest is an expense for Ford's automotive business.)
In fact, since 2005 Ford Credit has only had one bad year. The problem is that when it's bad, it really hurts the automaker's bottom line, as you can see in the graphic below.
Data source: Ford Motor Company SEC Filings. Chart by author.
What happened in 2008?
To explain Ford Credit as simply as possible, imagine that it's a bank that can offer dealerships loans for renovations, but also helps some customers finance their Ford vehicle purchase. One of the problems that can turn up is when Ford Credit estimates the value of off-lease vehicles at the end of financing: If the returning vehicle comes back less valuable than originally estimated (the value on its books), it can cause massive losses when it writes down that value when the vehicle comes back at the end of a lease.
In 2008, during the financial crisis and Great Recession, the demand for vehicles plummeted and values of off-lease vehicles tanked. You can see in the graphic above how quickly billions of profit reversed into billions of losses.
On the flip side, you can also see in 2021 Ford Credit had one of its best years on record. That's because last year chip shortages caused production delays, which crippled inventory and partially caused vehicle prices and values to soar. Higher prices on vehicles coming back off-lease to Ford were more profitable than expected, leading to a much more profitable bottom-line result.
Why does this matter now?
Ford Credit has long been a secret weapon for Ford's profits, and it's generally far more profitable than all of the company's markets outside of North America, combined. But that secret weapon can turn into a dirty secret, very fast, and it's a scenario that could play out in the near future.
With economic uncertainty facing the United States, and rising interest rates, it's possible a recession and high price tags could cripple demand for vehicles at some point in the near future. And that could have a devastating impact on Ford Credit's bottom line, and Ford's overall results.
Investors should keep this overlooked entity in mind when considering investing in the automaker, because most simply aren't aware of the potential negatives that go with the financial segment. On the bright side, if you're investing long-term, a bad year for Ford Credit will only be a speed bump, because management is excellent at the balancing act of estimating vehicle values and for the vast majority of years Ford Credit is a great advantage and source of cash flow.
