Warren Buffett famously said, 'Volatility is far from synonymous with risk.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. As with many other companies Ford Motor Company (NYSE:F) makes use of debt. But the more important question is: how much risk is that debt creating?
When Is Debt A Problem?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. If things get really bad, the lenders can take control of the business. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.
What Is Ford Motor's Debt?
As you can see below, Ford Motor had US$128.3b of debt at September 2022, down from US$144.6b a year prior. However, because it has a cash reserve of US$32.0b, its net debt is less, at about US$96.4b.
How Strong Is Ford Motor's Balance Sheet?
We can see from the most recent balance sheet that Ford Motor had liabilities of US$90.2b falling due within a year, and liabilities of US$114.7b due beyond that. Offsetting these obligations, it had cash of US$32.0b as well as receivables valued at US$14.8b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$158.1b.
The deficiency here weighs heavily on the US$56.4b company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we definitely think shareholders need to watch this one closely. At the end of the day, Ford Motor would probably need a major re-capitalization if its creditors were to demand repayment.
We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
As it happens Ford Motor has a fairly concerning net debt to EBITDA ratio of 5.8 but very strong interest coverage of 10.6. So either it has access to very cheap long term debt or that interest expense is going to grow! Pleasingly, Ford Motor is growing its EBIT faster than former Australian PM Bob Hawke downs a yard glass, boasting a 179% gain in the last twelve months. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Ford Motor's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last two years, Ford Motor generated free cash flow amounting to a very robust 92% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.
We feel some trepidation about Ford Motor's difficulty level of total liabilities, but we've got positives to focus on, too. For example, its conversion of EBIT to free cash flow and EBIT growth rate give us some confidence in its ability to manage its debt. Looking at all the angles mentioned above, it does seem to us that Ford Motor is a somewhat risky investment as a result of its debt. Not all risk is bad, as it can boost share price returns if it pays off, but this debt risk is worth keeping in mind. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Ford Motor (of which 1 shouldn't be ignored!) you should know about.
When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
Ford Motor Company designs, manufactures, markets, and services a range of Ford trucks, cars, sport utility vehicles, electrified vehicles, and Lincoln luxury vehicles worldwide.
Undervalued with solid track record and pays a dividend.