Simply Wall St
·5 min read
Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. As with many other companies Ford Motor Company ( NYSE:F ) makes use of debt. But should shareholders be worried about its use of debt?
When Is Debt A Problem?
Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.
See our latest analysis for Ford Motor
What Is Ford Motor's Net Debt?
The chart below, which you can click on for greater detail, shows that Ford Motor had US$138.4b in debt in December 2022; about the same as the year before. However, it also had US$32.2b in cash, and so its net debt is US$106.2b.
How Healthy Is Ford Motor's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Ford Motor had liabilities of US$96.9b due within 12 months and liabilities of US$115.9b due beyond that. Offsetting these obligations, it had cash of US$32.2b as well as receivables valued at US$4.58b due within 12 months. So its liabilities total US$176.0b more than the combination of its cash and short-term receivables.
The deficiency here weighs heavily on the US$45.0b 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'd watch its balance sheet closely, without a doubt. After all, Ford Motor would likely require a major re-capitalisation if it had to pay its creditors today.
It is worth noting that a significant portion of Ford's debt is linked to Ford Credit, which provides financing services to customers. However, this does not eliminate the risk for the company. If customers default on their payments, Ford could still face financial risks. Hence, investors should consider the level of risk associated with Ford's overall debt position, including the debt associated with Ford Credit.
We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). 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 7.5 but very strong interest coverage of 11.9. So either it has access to very cheap long term debt or that interest expense is going to grow! Shareholders should be aware that Ford Motor's EBIT was down 27% last year. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Ford Motor can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last two years, Ford Motor produced sturdy free cash flow equating to 53% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.
Our View
On the face of it, Ford Motor's EBIT growth rate left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. But on the bright side, its interest cover is a good sign, and makes us more optimistic. Overall, it seems to us that Ford Motor's balance sheet is really quite a risk to the business. So we're almost as wary of this stock as a hungry kitten is about falling into its owner's fish pond: once bitten, twice shy, as they say. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should be aware of the 2 warning signs we've spotted with Ford Motor .
If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.
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