Company financing: Debt and equity
A company is able to have a comparative advantage against its competitors based on lower financing costs. Ford (F) is now rated BBB- by S&P and Baa3 by Moody’s. GM (GM) is rated BB+ by S&P and Ba1 by S&P. Toyota (TM) is rated AA- by S&P and Aa3 by Moody’s. This has a direct impact on how much the companies have to spend to finance their operations. Currently, Toyota’s bond maturing in September 2021 is trading at 2.79%. Ford’s bond maturing in September 2021 is trading at a yield-to-worst of 3.49%. GM’s bond maturing in May 2023 is trading at 4.4%. In the debt market, Toyota has an advantage against Ford and GM. I once heard from a manager at a large company that he had to fire a lot of people in order to improve his operating margin 0.20%. So TM having a 1.60% lower cost financing is a real benefit to the company.
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The higher ratings of TM are interesting in light of the company’s current capitalization structure, which is 1.11 debt-to-capitalization. This means TM had more debt than book-to-equity at its March 2013 fiscal year end. GM had 84% debt-to-capitalization, meaning it had more book-to-equity than debt at its fiscal year end 2013. Ford’d fiscal year end 2013 debt-to-capitalization was 81%. The ratings of TM were supported by the company’s interest-to-coverage ratio, earnings before interest, and taxes to interest expense. This is a measure of how much earnings a company has to pay its interest due each period. In the case of TM, the coverage ratio was 57x at its fiscal year end 2013. GM’s interest coverage was 13.7x and F’s interest coverage was 6.4x.
There’s a lot of analysis that goes into a credit rating, but for investors, it’s important to know a company’s earnings versus its debt obligations. A company is financed with debt and equity. We’ll now compare what the market is saying about the three companies in the equity market.
Looking at the equity market , we’ll consider the price-to-earnings ratio (P/E), reflecting the price per share divided by the earnings per share. Each of the three companies, F, GM, and TM are pursuing their own strategies with varying success. Perceptions of their success, in the past and looking into the future, reflect in the market.
EPS for the three manufacturers reflect less volatility for Ford’s earnings in 2014, while GM and TM U.S. are facing recalls in 2014. Looking forward into 2015 and 2016, the market anticipates closer valuations among the three companies as GM continues paying for recalls, Toyota ties up its recall expenses, and Ford’s earnings improve following recent investments. Each manufacturer has opportunities and risks. Currently, GM faces a recall of 2.7 million vehicles in the U.S. and Toyota is recalling 6.4 million globally. Toyota reserved $1.2 billion for the accelerator-related recall. VOW recalled 26,000 vehicles and issued a stop sale on a couple hundred thousand vehicles earlier this month. Looking at the industry level, the recalls will negatively impact the CARZ automotive industry ETF.