Is Ford Motor (NYSE:F) A Risky Investment?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that Ford Motor Company ( NYSE:F ) does have debt on its balance sheet. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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 frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Ford Motor

What Is Ford Motor's Debt?

The image below, which you can click on for greater detail, shows that Ford Motor had debt of US$128.8b at the end of June 2022, a reduction from US$146.9b over a year. However, it also had US$28.2b in cash, and so its net debt is US$100.6b.

How Strong Is Ford Motor's Balance Sheet?

According to the last reported balance sheet, Ford Motor had liabilities of US$86.5b due within 12 months, and liabilities of US$115.1b due beyond 12 months. On the other hand, it had cash of US$28.2b and US$3.95b worth of receivables due within a year. So it has liabilities totalling US$169.3b more than its cash and near-term receivables, combined.

However, it's important to note that a large component of Ford's debt is associated with Ford Credit, the vehicle financing arm of the business. While some companies use debt to grow the business, Ford is using it as a revenue stream by issuing loans to car buyers. This doesn't mitagate the risk though, Ford still carries risk if customers fail to meet their repayments and so it's still beneficial for us to analyse Ford's balance sheet.

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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Ford Motor's net debt to EBITDA ratio is 5.8 which suggests rather high debt levels, but its interest cover of 9.3 times suggests the debt is easily serviced. Our best guess is that the company does indeed have significant debt obligations. Pleasingly, Ford Motor is growing its EBIT faster than former Australian PM Bob Hawke downs a yard glass, boasting a 279% gain in the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last two years, Ford Motor actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Our View

While Ford Motor's level of total liabilities has us nervous. To wit both its conversion of EBIT to free cash flow and EBIT growth rate were encouraging signs. 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. However, not all investment risk resides within the balance sheet - far from it. We've identified 2 warning signs with Ford Motor (at least 1 which can't be ignored) , and understanding them should be part of your investment process.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks , today.

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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.