Ford investment rating cut to one notch above junk

Phoebe Wall Howard | Detroit Free Press

Moody's Investors Service issued an alert Wednesday that it had downgraded the rating of Ford Motor Co. to just above junk status and said, "The outlook is negative."

The rating, of Baa3, "is the lowest investment grade rating, one rung above speculative grade. It signifies the likelihood of a default," a Moody's spokesman told the Free Press.

The Moody's analysis said it "reflects the erosion in the company's global business position and the challenges it will face implementing its Fitness Redesign program."

Ford spokesman Bradley Carroll issued a statement within minutes that said, “Since coming through the Great Recession, Ford Motor Company has delivered year after year of solid financial results and operating cash flows. The company has a strong balance sheet, which provides financial flexibility. We know we can capitalize on our strengths, bolster underperforming products and regions and disposition where we cannot make an appropriate return. We’re confident that as we do, the market will recognize our progress.”

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Moody's said that negative developments impacting Ford include: softening margins in North America driven by higher costs; reversal of its Chinese operations in which earnings before interest and taxes have fallen from a $70 million profit in the first half of 2017 to a $633 million loss in the first half of 2018; strain in the South American operations that lost $750 million in 2017, and continued losses in Europe which are likely to worsen because of Brexit-related costs from Ford's UK operations.

A junk rating is not out of the question: "The ratings could be downgraded absent clear progress in pursuing the fitness initiatives by early to mid-2019, with evidence the company is on a strong trajectory for recovery," Moody's said.

Under the fitness program, Ford will reassess its entire business portfolio "with the goal of restructuring, contracting or exiting businesses that will not be able to generate adequate returns. Restructuring initiatives could entail $11 billion in charges with $7 billion in related cash expenditures over the next three to five years," Moody's wrote.

"The company's decision to wind down its car business in North America, which we viewed as credit positive, reflects its willingness to make aggressively disciplined capital allocation decisions," Moody's said.

On the upside, Ford has a "highly competitive and profitable position in North America; the fitness program is targeting the major areas of weakness in the company's business portfolio; the program is being implemented while global auto markets are reasonably healthy, and, the company has demonstrated the ability to successfully restructure operations in the past. In addition, Ford has a strong liquidity profile consisting of $25 billion in cash."

Restructuring is a 'necessity'

Analysts have pressed CEO Jim Hackett to provide additional details even as he has focused for the past year on his fitness plan, which Moody's calls a "necessity."

"But it will take several years for material financial and operating benefits of the program to be realized. Success could be challenged by having to address the serious performance problems in multiple business units simultaneously," Moody's wrote.

"At the same time, Ford will have to continue investing in the areas critical for the future of the auto industry. These areas include alternative propulsion, autonomous driving, ride sharing and connectivity. Investments will also have to be made in meeting the carbon emissions regulations in a number of regional markets. Of particular near-term concern is China, where Ford must rapidly renew its product lineup and rebuild relationships with dealers in order to regain lost market share. As it pursues the revitalization in China, Ford will have to contend with an environment in which domestic Chinese producers are being more competitive, pricing pressure is growing, and non-Chinese manufacturers are attempting to expand their presence."

Ford's plan:

Ford's challenges, coupled with any unexpected cyclical downturn, could make things even worse.

"The prospects for an upgrade of Ford's ratings through 2020 are very modest," Moody's wrote. "However, if the company is able to successfully execute the fitness program, an upgrade, over the long-term, could be possible."

Rebecca Lindland, executive analyst at Kelley Blue Book, upon hearing the news, said, “Ugh. That sucks.”

“It just seems really unfair when you compare how Tesla continues to be valued,” Lindland noted.

“However, Mary Barra has done an outstanding job communicating that she’s going to make super hard decisions that make General Motors profitable and is willing to break some legacies, like having to be in Europe. I like Ford's decision to cut back on sedans.

"At the same time, I think Ford needs to be even more transparent," she said. "Where’s their five-year plan? Fiat Chrysler has done an amazing job communicating their plan. General Motors has done a good job communicating their strategy. I can’t say I have that same clear vision from Ford.”

Ford's stock was flat for the day, down 4 cents at $9.97.

But the share price has been on a downward trend for four years, and "this doesn’t inspire confidence in the stock, which is already laboring to maintain its value,” she said.

Alarm bells in Dearborn

Dave Sullivan, manager of product analysis for AutoPacific Inc., also said Ford must release a clear plan.

"The alarm bells should have been going off awhile in Dearborn," Sullivan said. "Had Ford really had a bullish outlook with China, they might have kept Aston Martin, Volvo or Jaguar Land Rover" — brands it sold.

"Ford is trying to add more crossovers, but they are late to market by years," Sullivan said. "FCA and others got in while the market was hot. I think the opinion from many on Wall Street is that Ford is a one-trick pony and that pony's name is F-Series."

The F-150 and other pickups have been consistent moneymakers for Ford.

Hackett should follow the lead of former Fiat Chrysler CEO Sergio Marchionne, who said the industry needs some consolidation, Sullivan said.

"I think Ford will need to rapidly explore some other opportunities, just as they are with Volkswagen, because I don't see how they can go at this alone," he said.

Ford is, in fact, exploring unspecified strategic alliances with Volkswagen, the company said in June 2018.

And scrutiny of Hackett, who has been in his job since May 2017, is intense.

"Wall Street was underwhelmed with the presentation in New York," Sullivan said of a presentation to investors in October 2017. Nothing has been done to fix that image problem that has persisted since then. Now is the time to show their cards in their entirety. If they don't, the fear that there isn't anything there will continue to grow."

When a rating goes down, that means Moody’s sees an incrementally higher risk of a default, Bruce Clark, senior vice president at Moody’s, told the Free Press. “It’s important to remember that every rating represents some risk of default. As the ratings go down, that risk of default goes up.”

He said investors see this news as especially notable.

“It’s important because Ford’s Baa3 rating is on the cusp between the investor-grade universe and the high-yield universe. If Ford were to be downgraded one notch further, it would end up in the high-yield universe,” Clark said.

“There are many investors who currently purchase Ford’s debt that would be unable to do so. That means many investors would have to sell their bonds. It means that there are investors that Ford can currently go to to get money and might not be able to do that in the future.”

Contact Phoebe Wall Howard: phoward@ freepress.com or 313-222-6512. Follow her on Twitter @phoebesaid