Last Friday the Wall Street Journal reported that Ford is going to use new measures of creditworthiness beyond FICO scores that will allow it to approve loans to borrowers now considered too risky to provide financing to.
One of the reasons I’ve rarely owned auto company stocks is not just that they’re highly cyclical. I (hope I) can deal with that. Rather, it’s it seems to me that, invariably, as the car-buying cycle matures, operating and sales executive put pressure on the captive lending arm of the company to make riskier and riskier loans.
This happens it two ways: more liberal lending policies; and increasingly optimistic assessments of the resale value of leased cars (called residual value) when they are returned at the end of the lease.
The poster child for this type of behavior is Mitsubishi Motors, which tried years ago to jumpstart US sales through a “triple-zero” sales campaign. It offered loans with no down payment, 0% interest and no payments for the first year. The campaign produced an unwanted fourth zero when virtually no one made loan payments when required–and the firm only avoided bankruptcy through a Japanese style rescue by the less-than-pleased other members of the Mitsubishi industrial group.
Generally speaking, the PE multiple for companies whose earnings are very cyclical tends to contract as the cycle nears its peak. For auto firms, and other companies with similar in-house financing operations, this contraction is especially severe because investors fear that too-generous financing may boost sales today but be offset by big writeoffs in a year or two. Because of this, investors are not willing to pay for what they regard–historically, correctly–as artificially inflated results.
Maybe Ford will be different this time, but my guess is that investors will at least initially regard results with skepticism.