The Long and Short
Wait for better relative value, wider spreads in Ford
This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors. This material does not constitute research.
The news cycle lately has pushed spreads wider in US and European auto names for the better part of the month. In particular, Ford (F: Ba1/BBB-/BBB-) and General Motors (GM: Baa2/BBB/BBB) paper has come under considerable pressure from doubts about future earnings potential. Most of the investment grade corporate bond market meanwhile has been grinding tighter in the week leading up to and following the Fed’s decision to cut rates by 50 bp. Much of the broader market recently has set or tested new year-to-date tights, particularly in the longer part of the credit curve. Despite the move wider in Ford cash bonds, investors should wait for better relative value as spreads likely widen further.
Recent widening in auto spreads first began on September 10, when Ally Financial CFO Russell Hutchinson warned that inflation and weak employment trends would result in higher delinquencies and net charge-offs in the current quarter by about 20 bp and 10 bp, respectively. The news triggered selling in Ford cash bonds and 5-year CDS spreads (Exhibit 1). And while both gradually recovered throughout the month, levels are once again drifting wider on fresh headlines. Auto paper came under further pressure this week when a Morgan Stanley equity analyst warned that car prices have gotten too high in the US for the rate hike to provide material relief, and that competitive pricing in China would continue to hurt margins. Auto equity and bond spreads both responded negatively to the report, establishing new local wides (Exhibit 3), but not hitting the levels tested in early August following earnings results for Ford and GM that were mostly considered less than stellar.
Exhibit 1. Ford and GM 5-yr CDS spreads year-to-date
Source: Bloomberg, 5-year CDS Spreads: White – Ford, Orange – General Motors
The recent weakness in the Automotive subgroup within the investment grade index caused current OAS to reach the 45% level of the 5-year percentile ranking (Exhibit 2). This is currently the second widest reading among Industrial subgroups only to Media Entertainment – where two potential fallen angel credits (PARA and WBD) are facing considerable uncertainty as to whether they might remain in the investment grade index. This analytic typically serves as a “rich/cheap” indicator for corporate bond investors relative to the 5-year trading range of credits within each subsector. Nevertheless, with little support for spreads in the current news cycle, holders of Ford paper appear better served to hold for now and await additional widening leading up to and perhaps following the upcoming earnings reports of GM and Ford on October 22 and October 28, respectively.
Exhibit 2. Industrial Subgroups – Current OAS and 5-yr Percentile Ranks
Source: Santander US Capital Markets LLC, Bloomberg – Sub-sector Indices OAS results
The news isn’t all negative for Ford bondholders. Notwithstanding the warning about overall auto prices in the US, the rate cut and lower potential borrowing costs should provide a better environment for top-line performance in the near to intermediate future for the OEMs. This is particularly true in key categories for Ford, such as trucks, hybrids and commercial, where the company has been generating solid momentum over the past few operating cycles. Furthermore, underlying strength in F’s credit profile in the form of low leverage and strong liquidity at the motor company provide a lot of potential cushion against near-term operating weakness, which could see a move to full investment grade ratings with an eventual upgrade by Moody’s in the not too distant future. Margins remain pressured by the challenging operating environment but appear consistent enough to support IG ratings at the parent company.
Exhibit 3. IG Auto credit curves – 10-years and in
Source: Santander US Capital Markets LLC, Bloomberg/TRACE G-spread indications only
As of the second quarter, Ford reported a cash balance of $26.6 billion, with cash net-of-debt at $6.2 billion, and total balance sheet liquidity of $44.8 billion. The company began the year with $14.2 billion in cash and $14.5 billion in marketable securities, and committed credit lines of $19.4 billion excluding Ford Credit. Overall leverage remains low at just 2.0x adjusted debt/EBITDA at the parent company excluding Ford Credit, and pension liabilities below $10 billion as of the second quarter. Management reported an adjusted EBIT margin of 6.1% for the first half of the year, which is under pressure but commensurate with ratings and considerably stable given losses in the Model e (electronic vehicle segment).
Perhaps most importantly, Ford appears to be addressing challenges head-on with a number of key strategies and initiatives across their operating platform. The more recent emphasis on quality, including key management changes, is designed to reduce long-term warranty and recall costs, which have been hampering profit margins relative to peers over recent years. Additionally, recognizing slow uptake in the Model e segment, management has been scaling back or postponing production in e-vehicles globally. While weakness in the Model e segment persists, Ford is adjusting capital spending relative to demand to bolster free cash flow. Total capital spending for the current year is projected to be $8 to 9.5 billion. The Ford Pro (commercial) segment continues to do very well both domestically and a bright spot in Europe and China, where they are taking restructuring charges to stem losses. Commercial is poised to further improve in Europe with the rollout of Ford’s new transit van next year. Also, the UAW strike led to a one-time $1.7 billion cost in 2023, and the new contract will weigh on margins going forward, but helped eliminate a key uncertainty confronting the company.
In financing, Ford Motor Credit began the year with $133 billion in receivables in the portfolio. Tangible common equity to managed receivables stood at a very solid level of 9.0%. Delinquencies and credit losses continue to appear manageable and should eventually see gradual improvement with the lower rate environment. Loss-to-receivables was 0.41% in the second quarter of 2024, down sequentially from the two prior periods. Ford credit has limited exposure to leases compared to other auto companies at only about 15% of receivables and is therefore less impacted by negative swings in used car prices. This could be a key consideration in differentiating performance from Ally, which so far was the only consumer finance company to issue a warning about higher auto delinquencies and net charge-offs in recent weeks.
This material is intended only for institutional investors and does not carry all of the independence and disclosure standards of retail debt research reports. In the preparation of this material, the author may have consulted or otherwise discussed the matters referenced herein with one or more of SCM’s trading desks, any of which may have accumulated or otherwise taken a position, long or short, in any of the financial instruments discussed in or related to this material. Further, SCM may act as a market maker or principal dealer and may have proprietary interests that differ or conflict with the recipient hereof, in connection with any financial instrument discussed in or related to this material.
This message, including any attachments or links contained herein, is subject to important disclaimers, conditions, and disclosures regarding Electronic Communications, which you can find at https://portfolio-strategy.apsec.com/sancap-disclaimers-and-disclosures.
Important Disclaimers
Copyright © 2024 Santander US Capital Markets LLC and its affiliates (“SCM”). All rights reserved. SCM is a member of FINRA and SIPC. This material is intended for limited distribution to institutions only and is not publicly available. Any unauthorized use or disclosure is prohibited.
In making this material available, SCM (i) is not providing any advice to the recipient, including, without limitation, any advice as to investment, legal, accounting, tax and financial matters, (ii) is not acting as an advisor or fiduciary in respect of the recipient, (iii) is not making any predictions or projections and (iv) intends that any recipient to which SCM has provided this material is an “institutional investor” (as defined under applicable law and regulation, including FINRA Rule 4512 and that this material will not be disseminated, in whole or part, to any third party by the recipient.
The author of this material is an economist, desk strategist or trader. In the preparation of this material, the author may have consulted or otherwise discussed the matters referenced herein with one or more of SCM’s trading desks, any of which may have accumulated or otherwise taken a position, long or short, in any of the financial instruments discussed in or related to this material. Further, SCM or any of its affiliates may act as a market maker or principal dealer and may have proprietary interests that differ or conflict with the recipient hereof, in connection with any financial instrument discussed in or related to this material.
This material (i) has been prepared for information purposes only and does not constitute a solicitation or an offer to buy or sell any securities, related investments or other financial instruments, (ii) is neither research, a “research report” as commonly understood under the securities laws and regulations promulgated thereunder nor the product of a research department, (iii) or parts thereof may have been obtained from various sources, the reliability of which has not been verified and cannot be guaranteed by SCM, (iv) should not be reproduced or disclosed to any other person, without SCM’s prior consent and (v) is not intended for distribution in any jurisdiction in which its distribution would be prohibited.
In connection with this material, SCM (i) makes no representation or warranties as to the appropriateness or reliance for use in any transaction or as to the permissibility or legality of any financial instrument in any jurisdiction, (ii) believes the information in this material to be reliable, has not independently verified such information and makes no representation, express or implied, with regard to the accuracy or completeness of such information, (iii) accepts no responsibility or liability as to any reliance placed, or investment decision made, on the basis of such information by the recipient and (iv) does not undertake, and disclaims any duty to undertake, to update or to revise the information contained in this material.
Unless otherwise stated, the views, opinions, forecasts, valuations, or estimates contained in this material are those solely of the author, as of the date of publication of this material, and are subject to change without notice. The recipient of this material should make an independent evaluation of this information and make such other investigations as the recipient considers necessary (including obtaining independent financial advice), before transacting in any financial market or instrument discussed in or related to this material.
Important disclaimers for clients in the EU and UK
This publication has been prepared by Trading Desk Strategists within the Sales and Trading functions of Santander US Capital Markets LLC (“SanCap”), the US registered broker-dealer of Santander Corporate & Investment Banking. This communication is distributed in the EEA by Banco Santander S.A., a credit institution registered in Spain and authorised and regulated by the Bank of Spain and the CNMV. Any EEA recipient of this communication that would like to affect any transaction in any security or issuer discussed herein should do so with Banco Santander S.A. or any of its affiliates (together “Santander”). This communication has been distributed in the UK by Banco Santander, S.A.’s London branch, authorised by the Bank of Spain and subject to regulatory oversight on certain matters by the Financial Conduct Authority (FCA) and the Prudential Regulation Authority (PRA).
The publication is intended for exclusive use for Professional Clients and Eligible Counterparties as defined by MiFID II and is not intended for use by retail customers or for any persons or entities in any jurisdictions or country where such distribution or use would be contrary to local law or regulation.
This material is not a product of Santander´s Research Team and does not constitute independent investment research. This is a marketing communication and may contain ¨investment recommendations¨ as defined by the Market Abuse Regulation 596/2014 ("MAR"). This publication has not been prepared in accordance with legal requirements designed to promote the independence of research and is not subject to any prohibition on dealing ahead of the dissemination of investment research. The author, date and time of the production of this publication are as indicated herein.
This publication does not constitute investment advice and may not be relied upon to form an investment decision, nor should it be construed as any offer to sell or issue or invitation to purchase, acquire or subscribe for any instruments referred herein. The publication has been prepared in good faith and based on information Santander considers reliable as of the date of publication, but Santander does not guarantee or represent, express or implied, that such information is accurate or complete. All estimates, forecasts and opinions are current as at the date of this publication and are subject to change without notice. Unless otherwise indicated, Santander does not intend to update this publication. The views and commentary in this publication may not be objective or independent of the interests of the Trading and Sales functions of Santander, who may be active participants in the markets, investments or strategies referred to herein and/or may receive compensation from investment banking and non-investment banking services from entities mentioned herein. Santander may trade as principal, make a market or hold positions in instruments (or related derivatives) and/or hold financial interest in entities discussed herein. Santander may provide market commentary or trading strategies to other clients or engage in transactions which may differ from views expressed herein. Santander may have acted upon the contents of this publication prior to you having received it.
This publication is intended for the exclusive use of the recipient and must not be reproduced, redistributed or transmitted, in whole or in part, without Santander’s consent. The recipient agrees to keep confidential at all times information contained herein.
