Linking strategy

Could Ford’s secret weapon soon become a dirty secret?

What many investors forget is that Ford Motor Companyit is (F 2.00%) the most profitable segment outside North America is not even a region on a map. This secret weapon has helped Ford print billions and billions in profits over the past decade.

But what happens when this secret weapon turns into a major cause of financial suffering? That’s exactly what could happen with Ford Credit in a recession. Here’s how brutal it looked in 2008.

First of all

Let’s take a quick look at what exactly Ford Credit is and how much it benefits the automaker. Most investors understand that when it comes to its auto sales by region, North America generates the vast majority of Ford’s total profits. But many don’t realize how much the Ford Credit auto finance segment adds to the equation.

Consider that North America recorded $7.38 billion in earnings before interest and taxes in 2021, and that South America, Europe, China and its International Markets Group (IMG) combined for an inconsequential EBIT of $20 million – mainly because Ford posted losses in America South, Europe and China.

Ford Credit, however, had a fantastic 2021 with an EBT of $4.7 billion. This result was very strong for Ford Credit, but it is normal that the financial segment is the second pillar of the company’s total profits. (Note: I am comparing the EBIT of Ford’s automotive business to the EBT of Ford Credit, because the latter derives a large portion of its income from interest, whereas interest is a costs for Ford’s automotive business.)

In fact, since 2005, Ford Credit has only had one bad year. The problem is that when it’s bad, it really is hurting the automaker’s bottom line, as you can see in the chart below.

Data source: Ford Motor Company SEC Filings. Table by author.

What happened in 2008?

To explain Ford Credit as simply as possible, imagine a bank that can provide dealers with loans for renovations, but also helps some customers finance the purchase of their Ford vehicle. One of the issues that can arise is when Ford Credit estimates the value of non-lease vehicles at the end of financing: if the return vehicle comes back with a lower value than originally estimated (the value on its books), it can result in massive losses. when he notes this value when the vehicle returns at the end of a lease.

In 2008, during the financial crisis and the Great Recession, demand for vehicles plummeted and the value of non-lease vehicles plummeted. You can see in the graph above how quickly billions of profits turned into billions of losses.

On the other hand, you can also see that in 2021 Ford Credit had one of its best years ever. Indeed, last year’s chip shortages led to production delays, which crippled inventory and partially drove up vehicle prices and values. Higher prices on vehicles returning off-lease to Ford were more profitable than expected, leading to a much more profitable bottom line.

Why is this important now?

Ford Credit has long been a secret weapon for Ford profits, and it’s generally far more profitable than all of the company’s markets outside of North America combined. But this secret weapon can turn into a dirty secret, very quickly, and that’s a scenario that could play out in the near future.

With the economic uncertainty hanging over the United States and rising interest rates, it is possible that a recession and high prices will cripple demand for vehicles at some point in the near future. And it could have a devastating impact on Ford Credit’s bottom line and Ford’s overall bottom line.

Investors should keep this overlooked entity in mind when considering investing in the automaker, as most are simply unaware of the potential downsides that come with the financial segment. On the bright side, if you’re investing for the long term, a bad year for Ford Credit will only be a speed bump, as management is excellent at balancing vehicle value estimation and, for the vast majority of years, Ford Credit is a great advantage and source of cash.