Ford Motor Co. (NYSE: F) was just given an unfortunate verdict on how the financial markets will treat the company when it needs to raise capital. Moody’s Investors Service has downgraded the senior unsecured debt rating of Ford to Ba1 from Baa3 and it has assigned the company a Ba1 Corporate Family Rating and an SGL-1 Speculative Grade Liquidity rating. The outlook is stable.
By falling under the Baa3 credit rating, Ford is now considered a speculative grade, otherwise known as “junk bonds.”
On top of its senior unsecured regular bonds and notes being downgraded, Moody’s also downgraded Ford’s unsecured bank credit facility, unsecured convertible debt. Perhaps the only good news is that the negative outlook that had been in place just went to stable, implying that Ford is no longer under a corporate credit rating review.
According to the Moody’s credit report:
The Ba1 ratings reflect the considerable operating and market challenges facing Ford, and the weak earnings and cash generation likely as the company pursues a lengthy and costly restructuring plan. The restructuring is expected to extend for several years with $11 billion in charges, and a cash cost of approximately $7 billion. Ford is undertaking this restructuring from a weak position as measures of cash flow and profit margins are below our expectations, and below the performance of investment-grade rated auto peers. Moreover, these measures are likely to remain weak through the 2020/2021 period including a lengthy period of negative cash flow from the restructuring programs. “The company does have a sound balance sheet and liquidity position from which to operate.” said Bruce Clark, Senior Vice President with Moody’s.
One unfortunate note here on Ford is that its credit performance has eroded at a time when the global automotive conditions have been fairly healthy. And Moody’s pointed out that Ford now has to address operational problems at the same time that demand in major markets is softening and as the auto industry is dealing with “an unprecedented pace of change relating to vehicle electrification, autonomous driving, ride sharing, and increasingly burdensome emission regulations.”
Moody’s further discussed how its woes will not be remedied quickly, how earnings pressure is hurting, restructuring will take long and its margins are contracting in healthy markets at the same time that it faces environmental risks and pressure. Moody’s also anticipates only minimal impact on Ford’s earnings and cash generation before 2022 from its alliance with Volkswagen in electric, autonomous and commercial vehicles.
The downgrade from Moody’s said:
The weak performance was driven by two principal factors, which Ford is addressing, but implementation of the initiatives will take some time. First, varying degrees of operating inefficiencies developed in almost all of Ford’s key regional markets including North America, China, Europe and South America. Second, earnings in China slid from an annual profit exceeding $1 billion in 2016 to a major loss as a result of an aged product lineup, poor dealer relations, and inattention to local market conditions.
A critical element of Ford’s plan for addressing operational inefficiencies and improving returns is the Global Redesign initiative. A major component will be the restructuring of South American and European operations. Ford has considerable expertise and a successful track record of undertaking such restructurings. Nevertheless, the scope of this restructuring plan is unprecedently large and challenging. It will extend at least into 2023.
In addition to the restructuring initiatives, the Global Redesign plan will also include efforts to revitalize the China operations where Ford has already made notable progress in lowering costs. However, efforts to regain lost share, rebuild market presence, and restore meaningful profitability will be much more difficult to achieve because the Chinese auto market is becoming increasingly competitive, and near-term growth rates are likely to be much less robust than in the past.
In North America, which remains one of the healthiest auto markets globally, Ford’s EBIT margins have fallen from over 10% in 2016 to just under 8% in 2019, largely because of the product age of large portions of its domestic portfolio. However, Ford has begun an aggressive new product launch cycle. We expect that this product renewal program, which will include the highly profitable F-Series of full-size trucks, will help Ford, over the next three years, strengthen North American margins to a level that should approach 10%.
Ford has been active in addressing environmental risks, which will remain a top agenda item in its forward planning. Nevertheless, we believe that the company’s current product portfolio leaves it vulnerable to potentially large emission penalties in 2020 and 2021. Reflecting these vulnerabilities, the new product launch will include a number of battery electric and full hybrid vehicles as important contributors in Ford’s ability to comply with increasingly challenging emission regulations in the US and Europe. However, customer acceptance of these vehicles and Ford’s ability to earn an economic return on them remains uncertain.
Moody’s did warn that Ford’s ratings could be downgraded if the major initiatives do not contribute to a steady improvement in key performance metrics. The credit ratings agency noted that an upgrade of Ford in the near term is unlikely. On the stable outlook, Moody’s noted:
The stable rating outlook reflects Moody’s expectation that the initiatives being undertaken, particularly the Global Redesign effort and the new product rollout, will contribute to gradual improvement in the company’s earnings, margins and cash generation, albeit over a number of years. Ford’s $23.2 billion of cash, which exceeds its debt, and its conservative balance sheet afford the company the ability to fund its product development and restructuring intiatives. Moody’s notes that this level of financial flexibility is common across the auto industry because of the need to contend with severe downturns and sustain product investment. The stable outlook also anticipates that Ford will maintain a sound liquidity position as it funds the restructuring actions.
Ford’s common shares closed up 2.2% at $9.55 on Monday in the regular trading session, but the shares were down about 1.6% at $9.40 in the initial after-hours trading reaction. Ford has a 52-week trading range of $7.41 to $10.56, and the consensus target price from Refinitiv was $10.73 heading into this credit review news.
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