Ford is down but not out

The car manufacturer remains an extremely strong global brand, explains Invesco’s Rhys Davies.

The Covid-19 crisis has had a huge impact on every area of the bond market, crushing earnings, straining balance sheets and increasing credit risk. Alongside this has come large-scale state intervention and a wave of new bond issuance. 

One name that seems to exemplify all these developments is Ford. It is facing unprecedented disruption to both its production and markets. It has had to shore up its balance sheet in the face of scepticism from the rating agencies. It has come to the bond market and, in doing so, it has offered an interesting investment opportunity that I have sought to exploit in Invesco Enhanced Income Ltd and City Merchants High Yield Trust.

Automobile manufacturing is, of course, a cyclical business. Sales have fallen with every spike in unemployment since Wards began publishing their US Light Vehicle Sales updates in 1976. Sales fell at an annual rate of more than 30% in 2009, when new jobless claims in the US were running at about 600,000 per week. In the past five weeks, US jobless claims have averaged no less than 5.3 million.

Operationally, this is the worst period in Ford’s history. It has an estimated cash burn rate of $800 million (£655 million) per week, an amazing number that shows what happens when a huge manufacturer such as this suddenly stops working. At the worst point in the last recession, Q4 2008, cash burn was $640 million per week.

Ford has dealt with lots of challenges in the past couple of decades, such as being downgraded to high yield in 2005 and coming near bankruptcy in 2006. It has learnt from experience and it came into this crisis with $30 billion of liquidity on its balance sheet. The decision to suspend its dividend will free up as much as $2 billion more in 2020. But even that provides only so much cushion with an estimated cash burn of $10 billion in the second quarter. Cash from working capital will return to the business as soon as sales begin to rise, but when that happens is uncertain.

The challenges facing Ford have already had a ratings impact. On 25 March, S&P downgraded the credit to BB+. That also moved the composite rating to BB+ and meant that Ford was officially junked. The difficulties of fallen angels and the impact they have on the wider high yield market has been a major story in the bond markets for years, one already back in the spotlight after the fall of Kraft Heinz and Macy’s in February.

The impact of adding Ford’s $36 billion of debt to the high yield market now is much smaller than when GM and Ford both fell into a then much smaller high yield market in 2005. But Ford has a big chunk of its total debt maturing in the next five years and there are very likely to be other angels falling before this crisis is over. Financing a company of this size from the high yield market could be difficult.

However, Ford will be helped as part of the huge response by the authorities to this crisis. The Fed was quick to commit to direct support of the corporate sector through loans and purchases of corporate bonds in the secondary market. The initial support packages stipulated that investment would be in investment grade bonds, but on 9 April these packages were increased and eligibility criteria were relaxed to include issuers “…rated at least BBB-/Baa3 as of March 22, 2020…”. So Ford squeaks into the remit of this $750 billion programme by three days. It is hard to believe that the company was not in the Fed’s thinking when it made this adjustment. To my mind, this move put to rest any real concerns about Ford’s access to capital in the near-term.

Ford came to the market the following week, initially looking to raise $3 billion across three, five and 10-year bonds. Initial indications on coupons were 9.5%, 10% and 11%. Meeting with a very positive market, the deal was upsized to $8 billion, with lower coupons and split as follows:

Source: Bloomberg as at 30 April 2020

The book size for the deal was reported at a staggering $40 billion, meaning that the average investor was allocated just 20% of what they committed to purchase.

In the circumstances, this was a great success for Ford. On the other hand, Ford has had to pay a painful rate of interest. As recently as November, they issued a five-year USD bond with a coupon of 3.95%.

The terms of these bonds were good enough for me to want to add them to the City Merchants High Yield Trust and Invesco Enhanced Income Ltd, as well as recommending them to the rest of the desk. In my opinion, the new capital goes a long way to shoring up Ford’s balance sheet for the medium term. The company does not need the economy or auto sales to recover all the way to 2019 levels. Even a small improvement in sales volume will see cash flowing back in and the credit story improve.

Ford may now be a high yield credit, but I believe it remains an extremely strong global brand. I think the risk is acceptable. In return I am receiving income at a rate that I think will be advantageous to my portfolios and my clients. Government bond yields are at near, or below, zero in the major economies. A judicious allocation to credit risk, in return for a substantially higher level of income, is going to be vital for investors. I think Ford’s bonds are a step towards that.

Rhys Davies is portfolio manager and senior credit analyst at Invesco.