A high level of debt often scares investors away from otherwise solid companies. A high debt-to-equity ratio often causes suspicion as well. An exception is usually made for banks, because they need to borrow money to lend money. What happens, however, when a non-bank has an extremely high debt-to-equity ratio? Many investors see it as a troubling trend, but I’m here to tell you why debt levels can be deceptive.
Does IBM have a debt problem?
International Business Machines Corp. (NYSE:IBM) is a technology company, not a bank. So why is its debt-to-equity ratio so high, at almost 2? Is it financing its growth too aggressively with debt?
A big reason for the abnormally high ratio originates from International Business Machines Corp. (NYSE:IBM)’s Global Financing (IGF) division. IGF is used for things like financing credit-qualified clients who want a more cost-effective way to acquire services from “Big Blue”. Debt from financing can almost be seen as “good” debt (if there ever were such a thing), because it makes the company money. IGF was responsible for almost 9% of the company’s pre-tax earnings last year.
Looking at International Business Machines Corp. (NYSE:IBM)’s balance sheet from its most recent quarter, its huge $34.1 billion debt load might immediately scare you away at first glance– especially considering there’s only around $10 billion in cash on the books. After factoring in what this debt is attributed to, however, your concerns may be eased.
Debt from financing activities actually accounted for $24.9 billion of the overall debt load, which means International Business Machines Corp. (NYSE:IBM)’s “core” non-financing debt was only at about $9 billion. This means the company actually has more cash than core debt. That is more than sustainable, and it shines a light on International Business Machines Corp. (NYSE:IBM)’s healthy, liquid balance sheet. When factoring in the $2.7 billion in free cash flow the company generated during its recent quarter, it becomes clear that International Business Machines Corp. (NYSE:IBM) is very strong overall financially.
Will Ford Motor Company (NYSE:F) be doomed by its debt?
On Ford Motor Company (NYSE:F)‘s balance sheet, its roughly $15 billion in automotive debt looks quite manageable in comparison to its current cash level of around $14 billion. A current ratio of almost 2 also indicates high liquidity. About $91 billion of its $107 billion in total debt is due to Ford Credit, one of the company’s stronger assets. This can be chalked up as good debt, because its credit risk is generally low.
This debt is accompanied by an asset (a car that can be recovered if the debt isn’t repaid), or is lent to Ford Motor Company (NYSE:F) automotive, which means that the company is financing itself at wholesale rates. Ford Motor Company (NYSE:F)’s debt looks troubling at only a quick glance, without proper due diligence.
Like IBM, Ford Motor Company (NYSE:F)’s financing activities generate profits and provide valuable services to customers. Digging deeper into the source of its debt reveals that the majority of it originated from Ford Credit, one of the company’s stronger assets. For all reasons mentioned, investors shouldn’t avoid Ford Motor Company (NYSE:F) because of superficial first impressions.