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Debtors' Prison: As Ford Pays Off Loans, Should It Borrow More?

Ford (F) was able to escape government bailout and bankruptcy in 2009 because in 2006, it borrowed $26 billion, essentially mortgaging itself in the process. That decision has paid off big time, as Ford is now the number two U.S. automaker again. It's rising share price has also enabled it to exchange more debt for securities, reducing its burden from over $33 billion in 2009 to around $16 billion now.

But the specter of more debt looms.

Why? Because Ford wants its bonds to be restored to investment grade status. They fell to junk range status after 2005, when the automotive downturn began.

Will Ford be tempted to issue new debt?
The auto industry runs on debt. Building cars is, as they say, a capital-intensive business. Consumers want access to credit to buy and lease cars, dealers need loans to finance their inventories, and the automakers want their bonds to be considered investment-grade so that they become attractive to conservative institutional investors.

However, General Motors (GM) seems to have learned from the profligate ways of its past, and is trying to make its balance sheet debt-free. Chrysler isn't, but that's only because Fiat-Chrysler CEO Sergio Marchionne hates to use his own money to do anything. Ford, on the other hand, is still operating according to the old paradigm. In its case, you could think of the Detroit Meltdown as simply a particularly violent turn of the business cycle. More debt could be in its future.

The Ford Way
You can see why GM would be debt-averse: interest payments on the billions it had issued prior to the bailout crushed the company after it stopped making money in 2005. Also, it still owes the federal government more than $40 billion and understandably wants to get rid of debt to raise its stock price so that the feds can gradually and profitably exit their equity stake.

But Ford has done a masterful job of dealing with its debt. The $23 billion it borrowed in 2006 was a Hail Mary, but the pass was caught for a touchdown. In the current auto market, which is expanding, Ford is picking up market share at a nice clip. As soon as it can return to issuing debt, it probably will, even at the risk of damaging its share price in the short term.

Maintaining the pace of invention
Ford's ascending market share is now something of a historical accident. The Japanese earthquake has put that country's carmakers into crisis. Toyota (TM) was already in trouble after the Great Recall of 2010 and is now confronted with having its own bonds downgraded. If Ford can solidify its number two position, it will potentially need to:

  • Keep pace with GM incentive spending if a price war breaks out and runs through the summer
  • Bolster its market share by continue to invest in product development
Product is everything
In the old days, it was enough for Ford to match up with GM and other carmakers by having a decent competitive sedan or an appealing SUV. But what's led Ford out of the recession is a massive improvement across its entire product line. Ford can now lay claim to having the best full-size pickup, the best full-size hybrid sedan, the best small sedan, and with the introduction of the redesigned Explorer, the best mass-market SUV.

This leadership has come from Ford's embrace of the automotive future: in every vehicle segment, it has a winner. Plus, many of its models are optimized for higher gas prices. But this lead won't last if Ford cuts the funding. That's where new debt comes in. But Ford has handled it in the past. And it can handle it again.

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Photo: Ford Media
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