The Debt Specter Haunting Ford

Ford Motor (F) has moved faster than General Motors (GM) to cut costs, increase quality, and streamline global product development. But GM has one big advantage over Ford. During its quick trip through bankruptcy court, GM shed $40 billion in debt. That's roughly the amount Ford could have on its books in just two years.

Yes, Ford wowed Wall Street with impressive (for the times) second-quarter results—a $2.26 billion net profit, with an operating loss of just $638 million, less than half what analysts expected. Ford also gained market share in the U.S., shoving aside Toyota Motor (TM) to reclaim the No. 2 spot behind GM. But the debt casts a long shadow. Ford is banking on a climbing share price and its brand momentum to bail it out. If that doesn't happen, Ford could have less money than its crosstown rival to spend on new vehicles and marketing in a few years. "We're really focused on the balance sheet right now and the liquidity we need to make it through [the recession]," Ford CEO Alan Mulally told reporters at a product preview on July 21. "We are watching closely but haven't seen evidence yet that we are being disadvantaged."

Mulally's first challenge is to retire $10.5 billion of revolving debt that comes due in December 2011. Himanshu Patel, who follows the auto industry for JPMorgan Chase (JPM), expects him to try to swap the debt for new shares in the next 12 months. With shares trading near 7, and Goldman Sachs (GS) predicting they will hit 9.50 by yearend, the automaker could handily surpass the $1.5 billion it raised in May when it priced shares at 4.75. But investors may not see the same upside as they did earlier this year.

Much depends on how well auto sales rebound. To break even, according to some analysts' estimates, Ford needs about 15% of the U.S. market—and that's with industrywide sales rising from the current annualized pace of 10.5 million cars to 11.5 million or 12 million. Such a scenario is not unthinkable. For the first half of this year, Ford had 16.1% of the market, and several industry analysts believe pent-up demand and rising stocks could push auto sales to 12.5 million to 13 million in 2010. The wild card is GM, whose breakeven is 18% to 19% share in a year with sales of 10 million cars. "You are going to see a resurgent Chevrolet with much more money to spend on marketing," says independent marketing consultant Dennis Keene. "And that will put a lot of pressure on Ford."

Ford's decision to shun Chapter 11 and government bailouts seems to have helped its image among consumers. In a July survey, polling firm Rasmussen found that 46% of respondents were more likely to consider a Ford because it did not need a bailout. "No question that consideration for Ford is up as a result of its rivals' problems," says Jeremy Anwyl, CEO of car-buying site "The question is: Will it stay up, and for how long?" Ford vehicles are also fetching better prices, up more than $2,000 on average, compared with a year ago, thanks to higher quality ratings and less need to discount. If the trend continues, Ford could beat its 2011 breakeven target and generate positive cash flow ahead of schedule, helping to narrow the gap with GM.

Mulally is a pragmatist. He used Ford's assets as collateral to raise billions a few years back, avoiding GM's fate. Now that Ford's top rival is a leaner competitor, he knows that competing will require not only great products but a healthier balance sheet.

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