Why Ford’s Dividend Still Looks Safe After Moody’s Downgrade to Junk

September 10, 2019 by Jon C. Ogg

Receiving a key credit rating downgrade can be a painful experience for many companies. When a company with an investment grade credit rating is downgraded to “junk bond” status, investors have every right to worry about that company’s future borrowing costs. If borrowing costs increase too much, then the cost of capital easily could interfere with a company’s desire or ability to pay an aggressive dividend to its common stockholders.

This brings up a classical debate about the safety of Ford Motor Co.’s (NYSE: F) super-high dividend yield. Even before Ford’s shares fell 4% in the aftermath of the credit rating downgrade, its prior $9.54 closing price and the $0.60 annualized dividend per common share generated a dividend yield of about 6.3%.

Note that the Moody’s Ford downgrade was far more cautious than the equivalent agency ratings of both Standard & Poor’s (S&P) and Fitch.

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As far as whether Ford’s dividend would be at risk, its new yield with a lower price is now 6.5%. That is among the highest dividend yields among the S&P 500. A Finviz screen of the S&P stocks indicates that it would currently be the 10th highest yield of all S&P 500 stocks.

24/7 Wall St. had opined that Ford and rival General Motors Co. (NYSE: GM) were likely to be viewed as having a safe dividend even in the next recession. That is predicated on the next recession being of the “garden variety” type rather than like the Great Recession a decade ago. That said, Moody’s recently (August 29) indicated that GM has maintained a competitive presence even as the auto market demand softens. GM’s common stock dividend is more conservative than Ford’s and is currently just under 4%.

We wanted to see if there have been any major concerns about the safety of Ford’s super-high dividend yield in the wake of the fresh Moody’s credit rating downgrade. It’s impossible to say that a dividend will never be at risk, but the fresh downgrade does not appear to come with any major immediate risk to Ford’s payouts. If things continue to deteriorate, that’s another issue.

While the Moody’s downgrade was harsh on Ford’s current business and the headwinds it faces, the entire downgrade did not even address the safety or a recommendation about what Ford’s management team should do (or consider) about its high dividend. This has created a potential vacuum as some investors would have every right to worry about Ford’s dividend yield now that its credit rating has moved down into junk bond territory.

24/7 Wall St. has pulled multiple reports and opinions about how Ford should be viewed after the downgrade. Despite some concerns about higher borrowing costs ahead with a noninvestment grade, the equity analysts lived up to their tradition of not downgrading Ford’s equity ratings just because of the credit rating cut.

Credit Suisse’s Dan Levy and Robert Moon still have an Outperform rating on Ford, but they did opine about the safety of that high dividend:

Improvement at Ford must be underlied by free cash flow recovery. When taking into account Ford’s underlying EBIT and $7 billion of restructuring cash calls over the coming years, we estimate that Ford will need to use its balance sheet to partially fund its dividend. Given a robust cash balance and what we see as a trajectory of EBIT improvement, we believe the dividend is safe. Yet the Moody’s downgrade reminded us that with slightly less buffer vis a vis liquidity, to the extent more pronounced cycle issues emerge and liquidity is further challenged, Ford will need to revisit the feasibility of its dividend.

Merrill Lynch reiterated its Buy rating and still has a $13 price objective. The firm’s John Murphy sees much of the bad news already baked in here. On the dividend, his report said this:

Although we do not disagree with many of the concerns raised by Moody’s, we believe Ford’s dividend will be maintained for the foreseeable future, which should provide support for the stock. Furthermore, the near-term product cycle is robust, specifically in North America, the Global Redesign is making progress, and the credit rating downgrade alone should not materially increase costs.

We have yet to see an updated report out of CFRA after the news, but the firm has a Hold rating and $10 target on last look. The most recent report called the dividend secure:

Our 12-month target of $10 is based on 7.4x our 2020 EPS estimate, a meaningful and justified discount to the stock’s five-year average forward P/E multiple of 8.0x, in light of reduced earnings visibility, cost pressures, extremely weak vehicle sales trends in China and late-cycle global automotive market conditions. Peer valuations have contracted as the economic cycle matures, and we expect lower U.S. industry volume We believe the current $0.60 annualized dividend is secure.

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CFRA did further note:

The company pays one of the industry’s most generous dividends ($0.60/share annualized), which has remained unchanged since 2015. It also declared a $0.13/share special dividend in January 2018, but we don’t expect a special dividend to be paid again in 2019.

When Goldman Sachs reiterated its Buy rating on Ford and raised its target to $13 from $12 earlier this summer, the report made no mention of a lurking dividend risk. That said, it also didn’t point to Ford becoming less than investment grade in its corporate credit rating.

In July of 2019, S&P maintained its BBB credit rating but had a Negative credit watch on the company. S&P even noted at that time that it believed a one-notch downgrade was still likely sometime in 2019, if Europe and China are unlikely to approach breakeven over the next 12 months. S&P did also note that a two-notch downgrade to speculative-grade (junk) was unlikely over the next 24 months unless a higher risk of recession coincides with a lack of profitability improvements in Europe and China.

In May of 2019, Fitch Ratings maintained its BBB credit rating for Ford and Ford Motor Credit. At that time, Fitch also said that its rating outlook for both Ford and Ford Credit was revised to Negative from Stable.

While the dividend discussion is merited, it does not seem that the common dividend is at any great risk of being cut in the aftermath of the Moody’s cut to junk status.

It is important to consider that Ford paid out $2.905 billion in common dividend payments in 2018.

24/7 Wall St. decided to dig through Ford’s annual report (10-K for the year 2018) to see if there were any dividend stipulations that needed to be considered. Of the 22 mentions of “dividend” in the 10-K report for 2018, the following were the mentions and incidents where “dividend” and potential changes may come into play.

On pension and other post-retirement liabilities:

If our cash flows and capital resources were insufficient to meet any pension or OPEB obligations, we could be forced to reduce or delay investments and capital expenditures, suspend dividend payments, seek additional capital, or restructure or refinance our indebtedness.

On liquidity:

One of our key priorities is to maintain a strong balance sheet, while at the same time having resources available to invest in and grow our business. Based on our planning assumptions, we believe we have sufficient liquidity and capital resources to continue to invest in new products and services, pay our debts and obligations as and when they come due, pay a regular dividend, and provide protection within an uncertain global economic environment.

Ford shares were trading down 3.5% on Tuesday to $9.20, and the 30 million shares that had traded in the first 90 minutes of the session was already approaching a normal day’s trading volume. Ford’s 52-week range is $7.41 to $10.56.

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