Fitch Affirms Ford & Ford Credit IDRs at 'BBB-'; Outlook Positive
KEY RATING DRIVERS: FORD
Ford's ratings are supported by the automaker's strong liquidity position, relatively low leverage and strengthened product portfolio. The Positive Outlook reflects Fitch's expectations for increased profitability, particularly in North America and Europe, as the company continues to improve its cost structure through further production efficiencies. The outlook also reflects Fitch's expectation that leverage will trend down over the intermediate term as the company repays maturing debt obligations with cash and as earnings and free cash flow (FCF) rise. Ford has grown its market position in key emerging markets, most notably in China, and the Positive Outlook also reflects the gradual lessening the company's reliance on the mature North American and Western European markets. In addition, Ford's pensions remain relatively well funded, and de-risking actions over the past several years appear to have largely insulated them from changes in interest rates. Overall, Ford's increasingly competitive product portfolio and lower cost structure have positioned the company to withstand the significant cyclical and secular pressures faced by the global auto industry, and Fitch's ratings and outlook incorporate the expectation that the company has sufficient financial flexibility to maintain an investment-grade credit profile throughout a period of severe economic stress.
Although Ford's financial position has improved significantly over the past six years, the company continues to face numerous risks. Chief among these is the inherent cyclicality of the global auto industry, which remains tied to economic conditions in various global markets. Although the Western European market is improving, Fitch does not expect a return to pre-crisis levels in the near term, and the Greek fiscal crisis and severely weak economic conditions in Russia pose some downside risk to the broader European market. Slowing economic growth in China has heightened industry competition in that important market, and much of South America is likely to remain in a deep economic malaise for an extended period.
As part of its rating review, Fitch has analyzed the impact that another severe global automotive downturn would have on Ford's credit profile. Due to company's operating leverage, working capital profile, and capital expenditure needs, Fitch expects that Ford would likely experience a multi-billion dollar decline in cash in the early part of a downturn. However, Ford's automotive net cash position of over \\$6 billion at March 31, 2015, along with about \\$10 billion of automotive revolver capacity, would provide it with sufficient financial flexibility to withstand a severe downturn without falling into financial distress. Other changes in Ford's post-recession business profile have also positioned it to better withstand another downturn. The company's break-even sales level remains near 10.5 million U.S. industry light vehicle units, its product portfolio is more balanced and less reliant on large truck sales, and its sales mix is more globally diversified, reducing the company's reliance on the North American and Western European markets.
NEW VEHICLE INTRODUCTIONS
In 2014, Ford introduced 24 new or heavily refreshed vehicles globally, including 16 in the U.S., the largest such undertaking in the company's history. Included in the new model rollout was the completely new F-150 pickup for the 2015 model year. Per Fitch's expectations, the heavy product roll-out in 2014 resulted in lower wholesale deliveries and an increase in structural costs, particularly in the key North American market. Ford's North American pre-tax profit declined about 22% in 2014, and its North American pre-tax margin (as calculated by Ford) declined to 8.4% from 10.2% over the same period, with much of the decline traceable to lower revenue and higher costs resulting from the launches. However, Fitch expects that the refreshed vehicle lineup will provide a tailwind for the company in the latter half of 2015, with only 15 global launches expected for the year, down substantially from the 2014 level.
GEOGRAPHICAL DIVERSIFICATION IMPROVING
Historically, Fitch viewed the limited geographical diversification of Ford's sales footprint as a credit risk, and although the company remains more reliant on the North American and Western European markets than many of its global competitors, Ford continues to grow its sales in developing markets. This has been particularly true in China, where Ford's Focus has been the top selling nameplate in the country, and its lineup of small and midsize sport utility vehicles (SUVs) has given it a strong product offering in a growing segment. Ford's market share in China grew to 4.5% in 2014 from 4.1% in 2013, and market share in 2014 likely would have been higher if the company had more joint venture production capacity in the country. Ford has a new joint venture assembly plant and a joint venture engine plant that come on line in China in 2015 that will provide the company with additional capacity to increase sales. The sale of imported Lincolns in China also appears to be going according to plan, although sales volumes overall are quite low. Slowing economic conditions and the rapid improvement of the indigenous Chinese brands are leading to enhanced competition in the country's auto market, but in general, Fitch views Ford's enhanced geographical diversification is a credit positive.
UAW LABOR AGREEMENT
The labor agreements between the United Auto Workers (UAW) union and each of the Detroit Three expire in mid-September 2015, and negotiations on a new contract will take place through much of the summer. Although the ultimate outcome of the negotiations on Ford is difficult to predict, Fitch does not expect a significant decline in the company's profitability as a result of any new agreement. Fitch also does not expect any prolonged labor action stemming from the negotiations. Although there are difficult issues to be addressed, such as the cap on 'Tier 2' employees and their compensation level, Fitch believes the union and the company are generally aligned in their desire to keep the company financially viable. That being said, any significant deterioration in relations between the company and the union during the negotiation process that results in a prolonged labor action could be a credit negative.
CREDIT METRICS STRENGTHENING
Ford's liquidity position remains strong, with automotive cash and marketable securities at March 31, 2015 totaling nearly \\$20 billion. Including about \\$10 billion of primary revolver availability, total automotive liquidity exceeded debt by about \\$16 billion. At the same time, Ford's leverage remains relatively low for its rating category. EBITDA leverage (debt/Fitch-calculated EBITDA) was 2.0x at March 31, 2015, down slightly from 2.1x at March 31, 2014, but funds from operations (FFO) adjusted leverage rose to 2.5x from 1.7x over the same period as FFO declined. Ford ended the first quarter of 2015 with about \\$13 billion in debt, down from about \\$16 billion at March 31, 2014, while latest 12 months (LTM) EBITDA (as calculated by Fitch) declined to \\$6.7 billion from \\$7.6 billion. The Fitch-calculated EBITDA margin declined to 5% in the most recent period from 5.4% in the corresponding period of 2014, while the global automotive EBIT margin declined to 1.7% from 2.4% over the same period. In the near term, Fitch expects Ford's EBITDA leverage to decline, potentially below 1.5x by year-end 2015 and below 1.0x by year-end 2017, as the company repays maturing debt obligations and EBITDA rises on higher profitability in North America and Europe. Fitch expects FFO adjusted leverage to improve as well, as higher margins translate to increased FFO.
FREE CASH FLOW GROWING
Automotive FCF (as calculated by Fitch), was (\\$1.9) billion in the LTM ended March 31, 2015, but Fitch expects it improve significantly to a modestly positive level for the full year 2015. Automotive operating cash flow was pressured over the LTM period by lower wholesale volumes and higher structural costs tied to the new vehicle introductions, primarily the F-150, as well as very weak market conditions in South America. In 2015, Fitch expects automotive operating cash flow to benefit as F-150 production hits full run rate by the third quarter of the year. Profitability in South America is likely to remain weak, but a little stronger than in 2014, while Fitch expects Ford's profitability in Europe to improve on strengthened market conditions and as it benefits from its previous restructuring actions take hold.
Fitch expects capital spending to remain elevated over the intermediate term, and roughly in line with the 2014 level, as the company continues to invest in product development and growth initiatives. Common stock dividends will be higher in 2015 as well, following a 20% increase in the per-share payout beginning in the first quarter of 2015. Although Ford's FCF margin is likely to be low in 2015, Fitch expects the company's overall liquidity position to remain strong, as the company continues to target an automotive cash and marketable securities balance of around \\$20 billion, which Fitch views as a prudent level to protect against an unexpected downturn. Fitch expects the company will heavily consider its liquidity target when returning cash to shareholders.
WELL-FUNDED PENSIONS
The funded status of Ford's pension plans has improved significantly over the past several years. As of year-end 2014, Ford's global pension plans (including certain unfunded non-U.S. plans) were underfunded by \\$9 billion, close to the level at year-end 2013. Despite a year-over-year decline in interest rates, Ford's previous de-risking efforts contributed to the funded status remaining about the same. In the U.S., the company's plans were underfunded by only \\$1.9 billion at year-end 2014, leading to a 97% funded status and a significant improvement from the steep underfunding seen immediately after the recession. Ford contributed \\$1.8 billion to its global pension plans in 2014, and it expects to contribute \\$1.5 billion to its global plans in 2015, much of which will be mandatory. However, based on the plans' funded status, Ford does not expect to have any required contributions related to its U.S. plans in 2015. Ford continues to have a goal of fully funding and de-risking its funded plans by the end of 2016. Once fully funded and de-risked, the company expects annual contributions will likely be in the \\$500 million range to cover ongoing service costs.
KEY ASSUMPTIONS
--U.S. industry light vehicle sales total about 16.8 million units in 2015 and global sales rise in the low-single-digit range.
--Beyond 2015, U.S. industry sales growth slows as sales levels near the peak, the Chinese market grows at a mid-single digit rate, Western Europe continues to improve and South America slowly improves, but other developing markets are uneven.
--Over the intermediate term, Ford's revenue growth is tied primarily to global volume growth and modest price increases, while global market share is held about constant.
--Ford's EBITDA margins rise over the next several years as production volumes grow, the company makes continued progress on cost efficiencies, and profit increases on new model introductions.
--Capital spending runs at about 5% to 6% of revenue over the intermediate term, consistent with the company's more-aggressive investment plans.
--Dividends continue to rise over the next several years.
--The company maintains a total cash balance of around \\$20 billion, with any excess cash returned to shareholders.
--There are no labor actions as a result of the upcoming UAW negotiations.
KEY RATING DRIVERS: FORD CREDIT
The rating affirmation of Ford Credit and its affiliates reflect the direct linkage to Ford's ratings. Fitch considers Ford Credit to be a 'core' subsidiary of Ford due to its importance to Ford, as demonstrated by the high percentage of Ford vehicles sales financed by Ford Credit, and the strong operational and financial linkages between the two companies. Ford Credit further has a support agreement with Ford, which requires Ford to make capital contributions to Ford Credit, if Ford Credit's leverage ratio (defined as net debt to equity) were to be higher than 11.5x. The ratings also reflect Ford Credit's improving credit profile, consistent operating performance, captive finance company peer superior asset quality, and adequate liquidity and risk adjusted capitalization.
STRONG GROWTH IN LEASING
Ford Credit's managed portfolio increased 6% to \\$112.9 billion at quarter-end (QE) 1Q15 from \\$106.5 billion at 1QE14 primarily driven by an increase in net operating leases, which grew 17% year-over-year. The lease portfolio measured \\$21.98bn at 1QE15, but is still below the pre-crisis peak of \\$29.7 billion in 2007. Fitch notes that leasing is a relatively riskier strategy as it further exposes the company to residual value risk, particularly when used car values are expected to weaken. However, Fitch believes that Ford Credit has a good track record in managing its residual value exposure and expects the company to be prudent in setting residual values on new lease originations. Fitch also believes that Ford's improved quality and line-up of fuel efficient vehicles should generate strong resale values relative to historical levels.
PROFITABILITY NORMALIZING
Operating performance slightly declined in 1Q15 versus 1Q14 as favorable factors such as higher financing volume and lower borrowing costs were offset by higher credit loss provision expense and a lower financing margin. Fitch expects Ford Credit will generate solid profitability in 2015 but does not expect material improvement over 2014, as volume growth is expected to slow given strong SAAR gains in U.S. auto sales in recent years, which has seen SAAR return to pre-recession levels. Further, there will likely be an offset by tighter pricing/margins due to increased competition, higher provision expense from expected credit normalization, higher borrowing costs as the company continues to shift to a more unsecured funding mix, and lower residual value gains.
SOLID ASSET QUALITY
Asset quality continues to perform favorably compared to peers with Ford Credit reporting a global loss-to-receivables ratio (LTR) of 0.22%in 1Q15 and 0.19% in 2014. Fitch expects asset quality will continue to normalize given portfolio seasoning and softening in used car values. Allowance for loan losses has been prudently managed and measured 0.31% at 1QE15, offering a solid coverage over net losses.
STABLE LEVERAGE LEVELS
Managed leverage, calculated by the company, measured 8.8x at 1QE15, up slightly from 8.7x at YE 2014, but firmly in-line with management's target range of 8.0x - 9.0x, leaving more than sufficient cushion under the terms of Ford Credit's support agreement with Ford. Fitch believes Ford Credit's relatively higher leverage is mitigated by its higher quality loan/lease portfolio, which has shown superior credit performance relative to many of its captive peers. Funding and liquidity continues to improve as the company is reducing its reliance on secured funding sources, which should offer greater funding flexibility in times of stress and result in a larger pool of unencumbered assets benefiting unsecured creditors.
Short-term debt, both on an absolute basis and as a percentage of total debt, has been increasing post-crisis. Fitch recognizes the motivation to fund short term, as these sources are often less costly; however, overreliance on short-term funding can be very problematic during times of market duress, as was proven in the recent financial crisis. Currently, short-term debt is at a reasonable level of Ford Credit's total debt base (10.6% at 1QE15), especially considering the level of shorter dated assets on the balance sheet such as the commercial floorplan receivables. However, a material increase in short-term funding would be viewed negatively by Fitch.
RATING SENSITIVITIES
Positive: Future developments that may, individually or collectively, lead to a positive rating action include:
--Maintaining a North American automotive EBIT margin above 9% on a sustained basis;
--Maintaining a global automotive EBIT margin above 3% on a sustained basis;
--Maintaining a FCF margin of 1.5% or higher;
--Continued progress toward reducing automotive debt to \\$10 billion by 2018;
--Further sales growth in developing regions.
Negative: Future developments that may, individually or collectively, lead to a negative rating action include:
--A decision to reduce the company's automotive cash position to below \\$20 billion for a prolonged period;
--A sustained period of negative FCF, excluding non-recurring items;
--A shift away from the company's debt-reduction activities, particularly to fund shareholder-friendly activities;
--An unexpected merger or acquisition that materially weakens the company's credit profile.
Ford Credit's ratings will move in tandem with its parent. Any change in Fitch's view on whether Ford Credit remains core could change this rating linkage with its parent. A material increase in leverage, an inability to access funding for an extended period of time, and/or significant deterioration in the credit quality of the underlying loan and lease portfolio, could become restraining factors on the parent's ratings. Fitch cannot envision a scenario where Ford Credit would be rated higher than the parent.
Fitch has affirmed the following ratings with a Positive Rating Outlook:
Ford Motor Company
--Long-term IDR at 'BBB-';
--Unsecured credit facility rating at 'BBB-';
--Senior unsecured notes rating at 'BBB-'.
Ford Motor Co. of Australia
--Long-term IDR at 'BBB-'.
Ford Motor Credit Company LLC
--Long-term IDR at 'BBB-';
--Short-term IDR at 'F3';
--Senior unsecured at 'BBB-';
--Commercial paper (CP) at 'F3'.
Ford Credit Europe Bank Plc
--Long-term IDR at 'BBB-';
--Short-term IDR at 'F3';
--Senior unsecured at 'BBB-';
--CP at 'F3';
--Short-term deposits at 'F3'.
Ford Capital B.V.
--Long-term IDR at 'BBB-';
--Senior unsecured at 'BBB-'.
Ford Credit Canada Ltd.
--Long-term IDR at 'BBB-';
--Short-term IDR at 'F3';
--Senior unsecured at 'BBB-';
--CP at 'F3'.
Ford Credit de Mexico, S.A. de C.V.
--Long-term IDR at 'BBB-'.
Ford Credit Co. S.A. de C.V.
--Long-term IDR at 'BBB-';
--Senior unsecured at 'BBB-'.
Ford Holdings, Inc.
--Long-term IDR at 'BBB-';
--Senior unsecured at 'BBB-'.
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