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Here’s Why High Interest Loans Will Bankrupt Ford

Last Updated September 23, 2020 1:50 PM
William Ebbs
Last Updated September 23, 2020 1:50 PM
  • Ford has raised $8 billion in high-interest debt to help it survive the coronavirus crisis.
  • The company’s recent credit downgrade has become a self-fulfilling prophecy. The high interest rates make it harder for Ford to meet its obligations.
  • With cash flow deteriorating in every automotive segment, Ford is one step closer to bankruptcy.

Ford Motor (NYSE: F) is working hard to keep itself afloat amid the coronavirus pandemic. But some of the company’s strategies may end up doing more harm than good over the long term. Despite recently being downgraded to junk status, Ford’s management has decided to take out $8 billion in loans  with interest rates over 9%.

This comes at a time when the automaker expects to see revenue and cash flow drop dramatically due to global lockdowns and impending recession. The new junk loans will damage Ford’s balance sheet and further strain the company’s cash flow with high interest rates. Paradoxically, these loans could end up taking the company closer to bankruptcy over the long-term.

Ford stock has dramatically underperformed the S&P 500 over fears over its ability to survive a recession. | Data by ycharts. 

Ford Became a ‘Luxury’ Automaker Right Before Recession

As part of its disastrous restructuring program, Ford has decided to axe most of its low-priced sedans  in favor of higher-margin trucks, SUVs and sports-cars like the Mustang. This strategy was designed to boost the automaker’s profitability in the U.S. segment, but it may have made the company more vulnerable to the business cycle.

With people losing their jobs and getting their work hours cut amid the 2020 recession, auto buyers are less likely to purchase flashy sports cars like the Mustang or high-priced trucks and SUVs. But while the restructuring was a bad idea, Ford’s troubles started long-before the coronavirus plunged the global economy into a tailspin.

Ford’s China sales have been in free-fall for the last four years.

In 2017, Ford sold 1.2 million cars in China . That number dropped to 732,000 in 2019 and a paltry 535,000 in 2019 .

In 2019, Ford tried to stem the bleeding by pivoting to electric vehicles.  But now that Tesla plans to ramp up Model 3 production from its Shanghai factory, Ford may be forced to exit the Chinese market entirely due to extreme competition and abysmal profit margins.

Ford’s Cash Flow is Deteriorating

Ford’s cash flow is deteriorating because the automaker has extremely low profit margins on its sales. In the fourth quarter ,  U.S. EBIT margins plunged to 2.8% from 8.8% while margins in Europe and China stood at 0.3% and -21.5%, respectively.

Yes, you read that correctly. Ford’s EBIT margin in China was -21.5%  before the coronavirus pandemic.

The margins will probably get even worse in the full year of 2020. Investors can expect U.S and European margins to go negative. And they shouldn’t be surprised if Ford is forced to exit the Chinese market due to these unsustainable losses and competition from Tesla.

On Friday, Ford announced that it expects to generate $34 billion in revenue in the first quarter of 2020 –but this comes with a net loss of $2 billion and an EBIT loss of $600 million. The company just finished losing $1.7 billion in the fourth quarter of 2019 . And these endless losses will put massive pressure on the its cash flow going forward.

Ford is Sliding Towards Bankruptcy

S&P Global Ratings recently downgraded Ford to junk status over fears about the company’s ability to meet its obligations in the face of deteriorating cash flow. Unfortunately, this downgrade is turning into a self-fulfilling prophecy because it makes Ford’s debt more expensive, further eroding cash flow.

On Saturday, Ford raised $8 billion in new bonds  with maturities ranging from three to 10 years.

The 10-year bond has a staggering 9.625% interest rate while the 5-year bond has an interest rate of 9% . Four months ago, Ford could have raised this money for just 3.5% . But now, the company is caught between a rock and a hard place: deteriorating cash flow and a growing pile of unaffordable debt.

Ford now has over $20 billion in automotive debt and $140 billion in Ford credit debt. It paid over a billion in annual interest expense in 2019.  And this number will rise dramatically due to these new high-interest loans. Bankruptcy is on the table. It’s just a matter of time before the company goes belly up.

Ford’s long-term debt is skyrocketing. Its average interest rate is also rising due to the credit downgrade. Data by ycharts.  

Disclaimer: The opinions expressed in this article do not necessarily reflect the views of CCN.com. The author holds no investment position in Ford at the time of writing.