3 Stocks Amassing the Right Kind of Debt

A quick glance at the financial statements of Ford , Caterpillar , or Deere  might leave many prospective investors concerned by their seemingly destructive levels of debt. Ford has a net debt-to-asset ratio of 494%, Caterpillar has a similar ratio of 190% and Deere has a ratio of 353%. But not all debt is created equal. In the case of these three companies, it's actually a good thing.

Making money from debt
All three companies offer customers loans to buy their own equipment, and their debt is actually related to their respective financing divisions. These businesses borrow from the market or investors at a low rate, then offer that cash to prospective customers at a higher rate. This does increase the debt on each company's balance sheet, but in theory, the debt is secured to an asset and will be repaid with interest over its life. All in all, massive debt represents a lucrative business for these companies.

High margin
In addition, leading money in this fashion often requires little or no work, unlike manufacturing, giving these financing divisions high profit margins.


Consider Ford's results at the end of the fiscal 2013 second quarter, when Ford's total debt was $108 billion. But only $17 billion of this debt was related to the company's automotive manufacturing division. The rest, $91 billion, belonged to the company's financial services sector:

 Metric

Automotive

Financial

Revenue

$36

$2

Cost of sales

$32.5

$1.6

Gross margin

10%

20%

Income before taxes

$1.4

$0.5

Margin

4%

25%

Source: Ford's Q2 2013 10-K. Figures in $US billions.

These figures show how profitable these money-lending operations can be. For example, revenue from Ford's financial services division only accounted for 5% of total revenue during the second quarter -- but income from financial services accounted for 22% of Ford's total income before tax.

Metric 

Automotive

Financial

Percentage of revenue

95%

5%

Percentage of income before tax

78%

22%

Source: Ford's Q2 2013 10-K.

That's not my debt!
Meanwhile, Caterpillar sits in a very strange position. The company had $6 billion in cash on its balance sheet at the end of fiscal Q2 2013. However, the company had amassed nearly $40 billion in debt -- although only $9.5 billion of this actually belonged to Caterpillar. The rest belonged to a subsidiary, Caterpillar Financial Services Corporation. (I know. It's complicated.) 

Basicly, Caterpillar uses this structure to distance itself from the liabilities that stem from the financial side of the business. In particular, Caterpillar wants to distance itself from customers bad debts.

Nonetheless, once again, Caterpillar has come to rely on its financial services arm to provide serious income for the company. In particular, its financial services arm only accounted for 5% of total revenue during the fiscal first half of the year, but provided 14% of Caterpillar's overall profit attributable to shareholders in the same period.. 

 MetricAmount 

Percentage of total

Sales of machinery and power systems

$26.4 billion

95%

Revenues of financial products

$1.5 billion

5%

Total

$27.8 billion

100%

Source: Caterpillar 10-Q filing. Six months to June 2013.  

 Metric

Profit attributable to shareholders

Percentage of total

Machinery and power systems

$1.58 billion

86%

Caterpillar financial services

$252 million

14%

Company

$1.84 billion

100%

Source: Caterpillar 10-Q filing. Six months to June 2013.

Double the profits
When it comes to raking in cash from lucrative customer financing, Deere beats the field.

At the end of July 2013, Deere had $6 billion of debt, balanced out with nearly $3 billion in cash. On the other hand, the company's financing division had borrowings of $24 billion, and only $400 million in cash.

According to the company's fiscal second quarter earnings report, the financing division was generating around $250 million quarterly in operating profit. That gives it a 40% operating margin, and it represents 15% of the company's total operating profit .

 Metric

Machinery

Financial

Revenue

$9.3

$0.6

Operating profit

$1.4

$0.24

Operating margin

15%

40%


Source: Deere 10-Q. Second fiscal quarter 2013 $US billions.

Metric 

Automotive

financial

Percentage of revenue

94%

6%

Percentage of operating profit

85%

15%

Source: Deere 10-Q. Second fiscal quarter 2013.

Foolish summary
So in conclusion, Ford's. Caterpillar's and Deere's corporate debt is not a bad thing, indeed it is actually the opposite. Actually, these divisions could help the companies stay profitable throughout a period of slow sales, right now this is particularly important for Deere and Caterpillar. 

What's more, the nature of a recurring income gives these companies a steady, predictable cash flow, allowing them to plan for future growth -- a privilege that not many companies have. Predictable cash flows mean secure dividends and the potential for increasing shareholder returns.

The article 3 Stocks Amassing the Right Kind of Debt originally appeared on Fool.com.

Fool contributor Rupert Hargreaves owns shares of Caterpillar. The Motley Fool recommends Ford. The Motley Fool owns shares of Ford. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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