$27.5 billion. I’ll say that again: Twenty-seven point five billion dollars. That’s the cash Ford Motor Company (NYSE: F) had stashed as of December 31. That’s not all: On top of that huge hoard, Ford had another $10.8 billion in available-but-unused credit lines as of the same date, for a “total liquidity” of $38.3 billion.
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To be clear, that’s not some fluke number related to Ford’s in-house bank, Ford Credit. That’s cash, cash equivalents, and marketable securities available to its core auto-making business. It’s a real cash pile, and it’s just sitting there.
Why doesn’t Ford spend it on new products, or a big share buyback, or fatter dividend payments? Why aren’t Ford’s shareholders screaming about that idle pile of cash?
It turns out there’s a very good business reason for Ford to have a giant war chest. Read on.
Lots of automakers are sitting on big cash piles now
Ford isn’t the only automaker sitting on a big pile of cash — far from it. Ford’s is pretty big, but most of the major global automakers have $15 billion or more in cash just sitting idle. General Motors (NYSE: GM) had $21.6 billion in cash as of December 31, Fiat Chrysler Automobiles (NYSE: FCAU) had $18.4 billion, Honda Motor (NYSE: HMC) had $15 billion — you get the idea. On top of that, like Ford, many automakers have set up huge credit lines that they don’t tap, often another $8 billion or more.
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What’s that about? Simply put, these are rainy-day funds. They’re huge because when it rains in the auto business, it rains really hard.
Auto sales are cyclical. They rise and fall with economic cycles, or specifically with consumer confidence. Think about it: When consumers or businesses are feeling uncertain about their income prospects, they rein in spending. They certainly don’t buy new cars or trucks unless they’re really needed.
Times have been good: Strong pickup sales have meant big profits for Ford, and a big rainy-day fund. Image source: Ford Motor Company.
Last year, Americans bought about 17.6 million “light vehicles,” the industry’s term for cars, SUVs, and pickup trucks. That was a record, but it was only up slightly from a year ago, and it’s not much higher than the sustained levels we saw in the good years before the 2008-2009 economic crisis. That’s what the U.S. new-car market looks like when times are good.
When times aren’t good, sales fall. Not to zero, or even close, but substantially. In 2009, which was the low point of the last auto-sales cycle, Americans bought just 10.4 million light vehicles.
That still sounds like a lot. But here’s the thing: For Ford, the difference between 17 million a year and 10.4 million a year is the difference between a nicely profitable quarter and a quarter that’s breakeven — at best.
Why Ford has to keep spending no matter what
Ford says it will break even or be profitable as long as the pace of U.S. auto sales stays above 10.5 million a year or so. Below that, it’s losing money. Ford has about 15% of the U.S. market, so that pace of sales means about 1.57 million Ford and Lincoln vehicles sold in the U.S. in a year — just to break even. (Ford sells vehicles all over the world, but the U.S. market still delivers the bulk of its profits.)
Mustangs roll down the line at Ford’s factory in Flat Rock, Michigan. Image source: Ford Motor Company.
Why does it need to sell so many cars and trucks just to break even? Auto companies like Ford have huge fixed costs. In Ford’s case, it has 62 factories around the world, all full of expensive tooling that has to be paid for whether the factories are idle or working around the clock.
The industry’s rule of thumb is that a car factory is only profitable if it’s working at or above about 80% of its “capacity,” meaning the number of vehicles it can produce working full speed for two shifts, five days a week. If it’s not doing that, it’s losing money.
New-product development isn’t optional anymore
Not only does Ford have to pay for those factories and pay all of its employees (about 201,000 of them worldwide) whether the economy is booming or slow, but Ford also has to continue to invest in new products, even if the economy is slow and profits are scarce.
Those investments are huge: A new-vehicle program can cost a billion dollars or more, considerably more if all-new engines are involved. Ford’s capital spending totaled $6.9 billion last year, and it expects to spend about $7 billion in 2017.
Cutting back that spending has big consequences. Think about the last time you went shopping for a new car. The latest models are usually the nicest ones, in high demand. Meanwhile, the ones that have been on the market for a while are usually available with some big discounts.
Those discounts, or “incentives,” are needed to keep sales of a less-competitive product strong, but they cut into the auto company’s profits. In order to stay competitive and keep their profit margins strong, automakers need to refresh and replace their products regularly.
Put another way, Ford has to spend at that pace just to stay competitive. If it doesn’t, if it cuts new-product spending in order to save cash, it will be left behind by rivals who will have fresh new products to sell when the economy starts to improve and buyers start to return to showrooms.
This is a lesson of the economic crisis
A lot of automakers learned that lesson the hard way during the last recession — from Ford. Then-CEO Alan Mulally had the foresight to borrow over $20 billion in 2006, before the economy took a nosedive. Ford spent that money developing a series of much-improved new global products, while rivals cut spending after auto sales took a nosedive.
Remember what a big deal it was when Ford first showed the all-new Fusion in 2012? Image source: Ford Motor Company.
Those products included all-new versions of the Focus, Fusion, Explorer, and Escape, plus major updates to the F-150 and Mustang. Remember how impressive those new Fords were when they first came out? Together, they allowed Ford to gain market share and impress a lot of new buyers (and pay off that debt) in the early part of the decade, while rivals like General Motors, Honda, and Toyota were scrambling to catch up.
So, why does Ford have a huge cash hoard?
So, why does Ford have a huge cash hoard? Because it wants to be prepared to do that again during the next economic downturn. And why do Ford’s rivals also now have huge cash hoards as well? Because they learned their lesson from Ford last time around.
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