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What many investors overlook is that Ford Motor Company‘s (F 0.36%) the most profitable segment outside of 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 that secret weapon becomes a major cause of financial pain? That’s exactly what could happen to Ford Credit in the event of a recession. Here’s how brutal it was in 2008.
First of all
Let’s take a quick look at exactly what Ford Credit is, and how it benefits the automaker. Most investors understand that when it comes to its vehicle sales by region, North America drives the majority of Ford’s total revenue. But many don’t realize how much the Ford Credit auto financing 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 a paltry $20 million EBIT — mainly because Ford recorded losses in South America , Europe, and China.
However, Ford Credit had a fantastic 2021 with $4.7 billion in EBT. That result is very strong for Ford Credit, but it is normal for the financial segment to be the second pillar of the company’s total income. (Note: I’m comparing EBIT for Ford’s auto business, with EBT for Ford Credit, because the latter generates a large portion of its earnings from interest, while interest is a cost for Ford’s automobile business.)
In fact, since 2005 Ford Credit has only had one bad year. The problem is when it’s bad, it is Really hurt the automaker’s bottom line, as you can see in the graphic below.
Data source: Ford Motor Company SEC Filings. Author chart.
What happened in 2008?
To explain Ford Credit as simply as possible, think of it as a bank that can offer loans to dealerships for renovations, but also helps some customers finance their Ford vehicle purchase . One of the problems that can arise is when Ford Credit estimates the value of off-lease vehicles at the end of the financing: If the returned vehicle comes back worth less than originally estimated (the value on the books of it), it could incur a huge loss when it writes off that value when the vehicle is returned at the end of a lease.
In 2008, during the financial crisis and Great Recession, the demand for cars collapsed and the values of off-lease cars dropped. You can see in the graphic above how quickly billions in profits turned into billions in losses.
On the other hand, you can also see in 2021 Ford Credit had one of its best years on record. That’s because last year’s chip shortages caused production delays, which crippled inventory and partially drove up vehicle prices and costs. Higher prices on vehicles returning off-lease to Ford were more profitable than expected, leading to a more profitable bottom-line result.
Why is it important now?
Ford Credit has long been the secret weapon for Ford’s profits, and it’s generally more profitable than all of the company’s markets outside of North America, combined. But that secret weapon can turn into a dirty secret, very quickly, and it’s a scenario that could play out in the near future.
With the economic uncertainty facing the United States, and rising interest rates, it is possible that a recession and high prices will cripple demand for cars at some point in the near future. And that could have a devastating effect on Ford Credit’s bottom line, and on Ford’s overall results.
Investors should keep this overlooked entity in mind when considering investing in the automaker, as most of them are unaware of the potential negatives associated with the financial segment. On the bright side, if you’re investing for the long term, a bad year for Ford Credit will be a quick bump, as management is good at the balancing act of estimating vehicle values and for most years the Ford Credit is a huge advantage and source of cash flow.
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